Collateral damage

A recent article in Smartcompany commented on signs that the banks are starting to lend for business as the residential, negative gearing property rort shows signs of slowing. Not likely. What this does not factor in is the relationship between business credit and the heavy dependence on lending against property.

According to the Australian Prudential Regulation Authority loans under $2 million, the six months to September 2010 was the second-strongest half-year period on record for new lending activity. Reserve Bank figures released on March 31 showed a 0.6% lift in business lending for February. Moreover, according to the article, there is some anecdotal evidence that banks are hiring bankers who might know something about lending to business:

Australia and New Zealand Banking Group is hiring hundreds of business banking staff as it talks up plans to become the second-biggest business banker. National Australia Bank’s ‘Breaking up’ marketing campaign to grab a greater share of the retail market has been widely praised, but figures show its business banking share is also rising. Up in Sydney, Westpac Banking Group has hired hundreds of local bankers, while Commonwealth Bank of Australia is seen as a lender that maintained support for many customers, relative to the actions of other banks.

While many SMEs will be sceptical about this new-found enthusiasm for SMEs, it is not all marketing spin. Figures from the Australian Prudential Regulation Authority show that for loans under $2 million, the six months to September 2010 was the second-strongest half-year period on record for new lending activity.

It is all too little, too late. Australian banks pretty much only know how to lend against property. From time to time they rabbit on about lending against cash flow, but the truth is they do not have the skills. They vanished in the 1990s when merchant banks started disappearing.  Investment banks are just financial tricksters fiddling with assets. As we see with Macquarie’s fate, they do not know how to invest in real businesses that achieve steady growth from serving customers.

There has been a sharp rise in business credit for SMEs since the mid 1990s, which pretty much tracks the property asset bubble. In 1996 it was about $13 billion, two thirds of which was secured against property. By 2008 it was $63 billion, 75% of which was secured against property. In 2010, it fell to $56 billion. Again, about 75% is secured against property. About two thirds is secured against residential property.

This level is high by developed world standards. According to the World Bank,the average for developed economies is to have 56% of SME loans secured against property.

The idea that banks will start to shift their lending to business as a way to diversify away from their exposure to an inflated residential property market is fanciful. The capital structure is entrenched. It is probable that a lot of the demand for investment properties has actually been driven by small businesses trying to move their exposure to the banks away from their family home and over to an investment property. That way, if the business fails, they only lose the investment property.

This is what the CPA says about it:

Banks are still lending, but mostly only where the loan is fully secured by tangible assets and personal guarantees (and, in some cases, key man insurance). Where there is an existing loan, banks are requiring additional security. Members stated that lenders were no longer prepared t provide finance on “soft” security — such as cash flow or good will (unsecured finance) — as had been available pre-GFC.

Conclusion? If property prices do fall sharply, so will business lending. Australia is in hock to house prices. The wrong side of the two speed economy will spin into recession. An article in Business Spectator shows how the push for more responsible lending is likely to draw SMEs into a trap. It is a glimpse of what will happen if there is a property collapse:

But here is the rub.  In nearly every case where a bank has loaned monies against residential property for business purposes, the property also owes them something for consumer finance purposes.  For example, the owner of a business has given the bank a mortgage over the home to secure an overdraft of $150,000, a business term loan of $350,000, and still owes say $200,000 on the home loan.

For a new bank to refinance this lot, they can’t ignore the fact they have to take on the home loan too. Then whammo – you’re in ‘responsible lending’ territory.

If the SME involved has had a rough year (all will now and then, for whatever reason), then serviceability of the home loan may not be sufficiently evident for the bank to be able to ‘lend responsibly’.

An article in Time described how this dynamic played out in America, with it especially hitting start ups, which are the engine of employment growth (not so much small business as new business):

From 2006 to 2009, the number of jobs created in the economy fell by 25%, while the number of of the jobs created by start ups fell by 34%. The likely reason? This recession was about not just slack demand but also a massive credit crunch. That particularly hurt young companies, the sort often financed by credit cards and home equity loans.

Australian SMEs have been drawn into the property bubble, because it is the only way to get credit. If that bubble pops, they will come under extreme pressure. It is a good thing we have a lot of iron ore and coal to sell.

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  1. Bankers in Australia only need to be able to calculate 80% of a big number.

    I have a small business if I need capital I go to other sources. The banks are only interested in secured loans to property. All that guff about business banking, they will look at your financials but the first question is “do you have anything to secure your loan against”.

    Dont need brains to be a banker that is one thing for sure. Stooges.

  2. The_Mainlander

    Thank you, great bog post and what is interesting is that your article clearly shows how tied in the SME sector is to rising home values and the consumer economy. I think from Memory that 90% of Australian Businesses are SME.

    If we crunch, it will be our biggest crunch ever – I think.

    Be interesting to watch how business defaults travel… if such a report is readily accessible as with Consumer Credit (and sentiment) which seems to be actively monitored and reported but not SME strange isn’t? Particularly if 90% of Australian Businesses are SMEs!

    Wow, that just scared me.

    • Good thoughts…

      …but i really had to point out the hilarity of your comment re: “good bog post” 😉

      Late Sat night chuckle for me! 😉

    • Oh dear…! You’ve made all the pieces in the article fall into place in my head. Oh boy! No (bloody) wonder our gracious Government and cohorts are doing all they can to keep property prices in orbit. With the I.M.F. stating Australian property prices are over-inflated anywhere from 5-56% depending on the location, just one humble question that comes to mind, is it all sustainable?

      Would the number of empty commercial properties, and For Lease signs around Sydney be any indication of where its’ all heading?

  3. Dear Mr Sell on the News,

    Our loans were secured by property mortgages, debentures over assets, directors guarantees and cross compamy guarantees. It was a bit like margin lending on steroids. The collateral was way over the top for the funds lent or available. And we used to let all this stuff just sit when parts of our debt were repaid. Less work if we wanted to borrow more later. Yes it was a pain in the neck but you accepted it as what had to be done if you wanted to get the finance. Changing banks – forget it. So if our experience was not exceptional the consequences of a fall in residential property prices are moot – depends on how much margin the banks have. On the other hand if your cash flow dries up and you are having trouble making payroll then you really need to worry.

    Banks making a beeline for property as collateral is understandable. The figure used to be about 90% of small businesses don’t make it to their 10th anniversary.

    As for the “negative gearing rort”, I don’t get it. Form a group, set up another coy, buy a property (or two), and you can transfer losses between members of the group. Is this still a rort?

    Your suggestion that ” It is probable that a lot of the demand for investment properties has actually been driven by small businesses trying to move their exposure to the banks away from their family home and over to an investment property” is likely an overstatement but there is probably some truth in it.

    Several years ago one organisation I was associated with decided to start building a portfolio of residential properties. It didn’t get too far. Chasing tenants for rent, running around getting maintenance problems fixed sucks, especially when you are busy trying to run a small business. (Generally much easier if you can get the right commercial property).


  4. Our four-and-a-half pillar banking system is so screwed up, we need a Mother-of-all Wallis inquiries.

  5. I do have the perfect commercial property in Darlinghurst with an excellent return but can not sell it because the thug banks now want 40% deposit.

  6. I like your point regarding Mac bank. They like the political party that supported the Banks meteoric rise, only knew how to spin and fleece!