Mortgage Lending is slowing and banks are tightening their underwriting standards still further, so what does this tell us about the trajectory of home prices, and the risks currently in the system?
Welcome to the Property Imperative weekly to 30th September 2017. Watch the video, or read the transcript.
We start our review of the week’s finance and property news with the latest lending data from the regulators.
According to the RBA, overall housing credit rose 0.5% in August, and 6.6% for the year. Personal credit fell again, down 0.2%, and 1.1% on a 12-month basis. Business credit also rose 0.5%, or 4.5% on annual basis. Owner occupied lending was up $17.5 billion (0.68%) and investment lending was up $0.8 billion (0.14%). Credit for housing (owner occupied and investor) still grew as a proportion of all lending. The RBA said the switching between owner-occupier and investment lending is now $58 billion from July 2015, of which $1.7 billion occurred last month. These changes are incorporated in their growth rates.
On the other hand, data on the banks from APRA tells a different story. Overall the value of their mortgage portfolio fell 0.11% to $1.57 trillion. Within that owner occupied lending rose 0.1% to $1.02 trillion while investment lending fell 0.54% to $550 billion. As a result, the proportion of loans for investment purposes fell to 34.9%.
This explains all the discounts and special offers we have been tracking in the past few weeks, as banks become more desperate to grow their books in a falling market. Portfolio movements across the banks were quite marked, with Westpac and NAB growing their investment lending, while CBA and ANZ cutting theirs, but this may include loans switched between category. Remember that if banks are able to switch loans to owner occupied categories, they create more capacity to lend for investment purposes. Putting the two data-sets together, we also conclude that the non-bank sector is also taking up some of the slack.
Our mortgage stress data got a good run this week, with the AFR featuring our analysis of Affluent Stress. More than 30,000 households in the nation’s wealthiest suburbs are facing financial stress, with hundreds risking default over the next 12 months because of soaring debts and static incomes. This includes blue ribbon post codes like Brighton and Glen Iris in Victoria, Mosman and Vaucluse in NSW and Nedlands and Claremont in WA.
The RBA is worrying about household debt, from a financial stability perspective, according to Assistant Governor Michele Bullock. She said households have really high debt – mainly mortgages, as a result of low interest rates and rising house prices, and especially interest only loans. “High levels of debt does leave households vulnerable to shocks.” She said. The debt to income ratio is rising (150%), but for some it is much higher. We will release our September Stress update this coming week.
Debt continues to remain an issue. For example, new data from the Australian Financial Security Authority shows that in 2016–17, the most common non-business related causes of debtors entering personal insolvencies was the excessive use of credit (8,870 debtors), followed by unemployment or loss of income (8,035 debtors) and then domestic discord or relationship breakdown (3,222 debtors). However, employment related issues figured first in WA and SA.
It is also worth saying the Bank of England has now signalled that the UK cash rate will rise, and this follows recent statements from the FED in the same vein. It is increasingly clear these moves to lift rates will raise international funding costs to banks and put more pressure on the RBA to follow suit.
Meantime, lenders continue to tighten their underwriting standards.
ANZ announced that it will be implementing new restrictions on some loans for residential apartments, units and flats in Brisbane and Perth. Now there will be a maximum 80 per cent loan-to-value ratio for owner-occupier and investment loans for all apartments in certain inner-city post codes. We think these changes reflect concerns about elevated risks, due to oversupply and price falls. ANZ’s policy changes apply to all apartments in affected postcodes, including off-the-plan and non-standard small residential properties valued at less than $3 million. Granny flats though are excluded.
More generally, ANZ also issued a Customer Interview Guide with specific which topics brokers should discuss with home and investment loan borrowers. “We expect brokers to use a customer interview guide (CIG) to record customer conversations as a minimum moving forward,” noted ANZ “while it is not required to submit the CIG with the application, it should be made available when requested as a part of the qualitative file reviews.”
CBA launched an interest-only simulator to help brokers show customers the differences between IO and P&I repayments and a new compulsory Customer Acknowledgement form to be submitted with all home loan applications that have interest-only payments to ensure that IO payments meet customer needs. CBA said that brokers must complete the simulator for all customers who are considering IO payments irrespective of whether the customer chooses to proceed with them. These requirements will be mandatory for all brokers and will become effective on Monday, 9 October.
Suncorp announced it is introducing new pricing methodology for interest only home lending. Variable interest rates on existing owner-occupier interest only rates will increase by 0.10% p.a and variable interest rates on all investor interest only rates will increase 0.38% p.a., effective 1 November, 2017.
But what about property demand and supply?
The ABS said Australia’s population grew by 1.6% during the year ended 31 March 2017. Natural increase and Net Overseas contributed 36.6% and 59.6% respectively. In fact, all states and territories recorded positive population growth in the year ended 31 March 2017, but Victoria recorded the highest growth rate at 2.4%. and The Northern Territory recorded the lowest growth rate at 0.1%. Significantly, Victoria, the state with the highest growth rate is currently seeing the strongest auction clearance rates, strong demand, and home price growth. This is not a surprise, given the high migration and this may put a floor on potential property price falls.
On the other hand, we also see an imbalance between those seeking to Trade up and those looking to Trade down, according to our research. Those trading up are driven by expectations of greater capital growth (42%), for more space (27%), life-style change (14%) and job change (11%). Those seeking to trade down are driven by the desire to release capital for retirement (37%), to move to a place which is more convenient (either location, or for easier maintenance) (31%), or a desire to switch to, or invest in an investment property (18%). In the past we saw a relative balance between those seeking to trade up and those seeking to trade down, but this is now changing.
Intention to transact, highlights that relatively more down traders are expecting to transact in the next year, compared with up traders. Given that there around 1.2 million Down Traders and around 800,000 Up Traders, we think there will be more seeking to sell, than buyers able to buy. As a result, this will provide a further drag on future price growth, especially in the middle and upper segments of the markets, where first time buyers are less likely to transact. This simple demand/supply curve provides another reason why prices may soon pass their peaks. Up Traders have more reason to delay, while Down Traders are seeking to extract capital, and as a result they have more of a burning platform.
Finally, auction clearance rates were still quite firm, despite the fact that property price growth continues to ease and time on market indicators suggest a shift in the supply and demand drivers, especially in Sydney.
So, overall, banks are on one hand still wanting to grow their home loan portfolios (as it remains the main profit driver), but lending momentum is slowing, and underwriting standards are being tightened further, at a time when home price growth is slowing.
This leaves many households with loans now outside current lending criteria, households who are already feeling the pain of low income growth as costs rise. More households are falling into mortgage stress, and this will put further downward pressure on prices and demand.
So we think the risks in the mortgage market are extending further, and the problem is that recent moves to ease momentum have come too late to assist those with large loans relative to income. As a result, when rates rise, as they will, the pain will only increase further.
And that’s the Property Imperative weekly to 30th September 2017.
A recent policy pledge by Shadow Treasurer Chris Bowen has given fresh heart to campaigners for the restoration of the former National Housing Supply Council (NHSC).
The Abbott government axed the council in 2013. With housing stress intensifying across much of Australia, a reinstated and revitalised council could strengthen policymaking in this contested area.
NHSC Mark 1
The Rudd government created the NSHC in 2008. The council’s role was to put housing policy on a sound base of evidence. It was guided by expert members drawn from the construction industry as well as senior planning, social housing, economics and academic ranks.
The council provided ministers with housing supply and demand estimates, projections and analysis. It also investigated the influence of infrastructure investment, housing-related taxation and urban planning. Its remit included a focus on:
… the factors affecting the supply and affordability of housing for families and other households in the lower half of the income distribution.
Importantly, NHSC reports explicitly recognised that untargeted supply-enhancing measures were not the sole answer to easing this group’s housing stress. The council also examined influences on housing demand. These included the price-stimulating effect of tax incentives for residential property investors.
The case for restoring the NHSC
Unaffordable housing and homelessness of course remain burning issues in national media and policy debate. Across most of the country, these problems have mounted since the NHSC’s demise.
In Sydney, for example, median house prices have climbed 40% since 2013. Rents are up by more than 12%. Average New South Wales earnings, however, have risen by only 8% in this time.
From 2011 to 2016, census data show that, nationwide, the proportion of tenants having to spend more than an “affordable” amount on rent rose in every state capital other than Perth. And latest published statistics reveal homelessness service users rising at 5% per year (2016 census data on this are still awaited).
Housing affordability is subject to complex influences – regulatory, economic, demographic and other factors. Most of these transcend state and territory boundaries, and many call for improved data. As a landmark official report acknowledged only last year, the lack of information essential to underpin housing policymaking is highly problematic.
Overcoming these data deficiencies would be central to the mission of a restored NHSC. This includes metrics on the supply pipelines of serviced land, dwelling demolitions and underused housing.
In its day, the NHSC drew support from many quarters, notably spanning the property industry and the affordable housing lobby. Leading property sector groups lamented its abolition. And, alongside Bowen, the Property Council of Australia is among recent advocates for NHSC reinstatement.
A government wanting to beef up its understanding of this area could assign a wider and more analytical role to other official data-gathering or research bodies. But neither the Australian Bureau of Statistics nor the Australian Institute of Health and Welfare possesses the in-house policy expertise or industry-connectedness to provide a credible alternative to a restored NHSC. And the Australian Housing and Urban Research Institute (AHURI) is not set up for this role.
A reinstated NHSC can be improved
A new NHSC should be established by statute, not just by executive decision. This would strengthen its hand in obtaining required data from possibly reluctant state and territory ministries. In addition, this would provide more protection against arbitrary abolition by a future federal government in “wrecking mode”.
It will be vital that a reinstated NHSC’s remit includes a more granular, localised focus on supply and demand imbalances. Housing supply is only productive when suitably located in relation to jobs, infrastructure and services.
Housing provided needs to be of a type and configuration that matches demand, and at a price that people in that locality can comfortably afford. Property market conditions may be quite diverse even within a single capital city. Oversupply in one part of a metropolis can co-exist with shortages elsewhere.
Beyond calibrating overall housing demand and supply, the reborn NHSC must monitor the supply-demand balance by market segment, including low-cost rental. Similarly, the council’s former brief should be extended so it specifically assesses Australia’s unmet need for social and affordable housing. That’s both the current shortfall and the newly arising need predictable within a given period.
As recently instanced in Wales and Scotland, methodologies of this kind have a long lineage in UK housing policymaking. While Australia has residential stress metrics galore, none provide an ideal basis for government-supported rental housing construction. Such a program should be a central plank of national housing policy.
As Bowen has argued, a restored NHSC can also help hold states and territories to account for their supply commitments under the new National Housing and Homelessness Agreement. This is currently under negotiation between the two levels of government.
Reinstating the NHSC in a revitalised form would help government make more rational and informed policy choices on which supply and demand levers to pull to improve housing affordability. This is especially important for the lower-income renters who are doing it tough in cities like Sydney and Melbourne as well as in many other areas, such as the resort settlements along much of the east coast.
Stronger, better-founded evidence about the nature and extent of the affordable housing problem may help build consensus about how to tackle it effectively. And that is an outcome we badly need.
Authors: Hal Pawson, Associate Director – City Futures – Urban Policy and Strategy, City Futures Research Centre, Housing Policy and Practice, UNSW; Oliver Frankel, Adjunct Professor, UTS Business School, University of Technology Sydney
Suncorp has announced that customers with a Suncorp Clear Options Credit Card can now access Samsung Pay.
Suncorp Executive General Manager Deposits & Investments, Bruce Rush, said the introduction of Samsung Pay was the first step in Suncorp’s plan to enhance its digital payment offering.
“As we move to an increasingly cashless society, we know that our customers need more efficient and sophisticated technology, including digital wallets,” Mr Rush said.
“From 27 September, 2017 all customers with a Suncorp Clear Options Credit Card, and compatible Samsung device, will have the option to use Samsung Pay.
“We will continue to invest in our payment technologies and are committed to delivering new services that our customers want and need.”
Samsung Pay is a secure and easy-to-use mobile payments service available on compatible Samsung devices, including the recently released Galaxy Note8. Head of Mobile Payments at Samsung Electronics Australia, Mark Hodgson, said Suncorp and Samsung are committed to improving customer experience through innovation.
“With Samsung Pay, Australians are provided with the convenience, security and choice to undertake everyday tasks when transacting,” Mr Hodgson said. “In addition, Suncorp Clear Options Credit Card cardholders can now benefit from Samsung Pay’s unique features, such as our three-layered security system, and can enjoy using the service anywhere you can pay with a contactless credit card.”
Access to Samsung Pay only applies to Suncorp Clear Options Credit Card cardholders and does not include Suncorp debit cards.
The latest RBA data on credit, to August 2017 tells a somewhat different story to the APRA data we discussed already. There were clearly adjustments in the system [CBA in particular?] and the non-bank sector is picking up some of the slack.
Overall housing credit rose 0.5% in August, and 6.6% year-ended August 2017. Personal credit fell again, down 0.2%, and 1.1% on a 12 month basis. Business credit also rose 0.5%, or 4.5% on annual basis. But overall lending for housing is still growing.
Here are the month on month (seasonally adjusted) movements. Owner occupied lending up $17.5 billion (0.68%), investment lending up $0.8 billion (0.14%), personal credit down $0.4 billion (-0.24%) and business lending up $4.2 billion or 0.47%.
As a result, the proportion of credit for housing (owner occupied and investor) still grew as a proportion of all lending.
Another $1.7 billion of loans were reclassified in the month. This will give an impression of greater slowing investment loan growth as a result.
Following the introduction of an interest rate differential between housing loans to investors and owner-occupiers in mid-2015, a number of borrowers have changed the purpose of their existing loan; the net value of switching of loan purpose from investor to owner-occupier is estimated to have been $58 billion over the period of July 2015 to August 2017, of which $1.7 billion occurred in August 2017. These changes are reflected in the level of owner-occupier and investor credit outstanding. However, growth rates for these series have been adjusted to remove the effect of loan purpose changes.
The latest data from APRA, the monthly banking stats to August 2017 shows the first overall fall in the value of mortgage loans held by the banks, for some time, so the macroprudential intervention can be said to be working – finally – perhaps! Or it could be more about the continued loan reclassification?
Overall the value of mortgage portfolio fell 0.11% to $1.57 trillion. Within that owner occupied lending rose 0.1% to $1.02 trillion while investment lending fell 0.54% to $550 billion. As a result, the proportion of loans for investment purposes fell to 34.93%.
This explains all the discounts and special offers we have been tracking in the past few weeks, as banks become more desperate to grow their books in a falling market.
Here are the monthly growth trends.
Portfolio movements across the banks were quite marked. There may be further switches, but we wont know until the RBA data comes out, and then only at an aggregate level. We suspect CBA did some switching…
The loan shares still show Westpac the largest lender on investor mortgages and CBA leading the pack on owner occupied loans.
All the majors are below the 10% investor loan speed limit.
So the question will be, have the non-bank sector picked up the slack? In fact the RBA says $1.7 billion of loans were switched in the month. This probably explains only some of the net fall.
More than 30,000 households in the nation’s wealthiest suburbs are facing financial stress, with hundreds risking default over the next 12 months because of soaring debts and static incomes, according to analysis of the nation’s household financial hotspots.
Hundreds of households in Sydney’s harbourside Vaucluse, where the median property price is $4.5 million, or Melbourne’s bayside Brighton, where a median priced house is $2.6 million, are being severely squeezed as costs continue to stretch incomes, the Digital Finance Analytics research finds.
“A lot of people making seriously good money have borrowed serious amounts of money. The one thing that sorts them out is when interest rates begin to rise,” said Christopher Koren, a buyers’ agent for Morrell and Koren, which specialises in top-end real estate.
“When it comes to top-end household cash flow – ‘Houston, we have a problem’,” said Martin North, principal of Digital Finance Analytics, who claims lenders are making incorrect assumptions about household incomes rising to meet increasing costs.
The analysis reveals that nearly 1000 households in Brighton, where a beachbox without electricity sells for more than $320,000, are under distress, or could face default in the next 12 months. Joe Armao, Fairfax Media.
The Reserve Bank of Australia this week warned property buyers stretching to enter the property market when interest rates are at record lows could be “vulnerable” to economic shocks, such as rate rises or a change in personal circumstances.
The bank’s research shows that debt for the nation’s top 20 per cent of households is at least 190 per cent of income, an increase of more than 50 per cent in the 12 years to 2014, the latest Reserve Bank of Australia numbers.
Brendan Coates, Australian Perspective Fellow for the Grattan Institute, said top-end debt is likely to have risen even higher during the past three years.
By contrast, debt for the bottom 20 per cent has remained at 60 per cent of total income.
Mr North said: “The banks have been very free in their lending to affluent households.”
Higher end is more exposed
It is based on traditional lending models that indicate lower income earners and the mortgage belt property buyers are the most vulnerable if rates rise, or the economy slows.
“But they have missed the point that massive leverage at the top end, static incomes and the high proportion of affluent households with interest-only loans means the higher end are significantly more exposed,” he said.
“A lot also have multiple households. Because rents are based on incomes, are lot of these investments are under water, which means they are losing money,” he said.
According to SQM Research, which monitors rents and house prices, the national average rental income for apartments is about 1.4 per cent and 2 per cent for houses, compared to 2 per cent inflation and interest rates typically about 4.5 per cent for investor loans.
Some investors, particularly from Sydney, are selling up, releasing capital and buying cheaper investment properties, in places like Adelaide, according to market analysts.
A median property in Sydney’s metropolitan area, which sells for about $1 million, will buy two inner suburban properties in Adelaide.
Households are ‘stressed’ when income does not cover ongoing costs, rather than identifying a percentage of income committed to mortgage repayments, such as 30 per cent of after-tax income.
Those in “severe distress” are unable to meet repayments from current income, which means they have to cut back on spending, or rely on credit, refinancing, loan restructuring, or selling their house.
Mortgage holders under “severe distress” are more likely to seek hardship assistance and are often forced to sell.
The analysis reveals that nearly 1000 households in Brighton, where a beachbox without electricity sells for more than $320,000, are under distress, or could face default in the next 12 months.
More than 600 households in Vaucluse and Watsons Bay are under similar pressure.
RBA assistant governor Michele Bullock said regulators remain concerned about the high level of household debt, which is a result of low interest rates and rising house prices.
“High levels of debt do leave households vulnerable to shocks,” she said.
Mr Coates said rich households having the most debt provided some comfort for regulators comparing Australia’s potential vulnerability to an economic shock with the US, where those most exposed were poorer, sub-prime borrowers.
“The RBA is less worried because people who hold the debt are relatively well off,” Mr Coates said.
Anecdotal evidence suggests top-end earners are increasing their spending at the same pace as rising property prices.
“Many in Melbourne and Sydney think they are bullet proof,” said Mr Koren. “They’ve bought property in premium suburbs in the best performing markets in the world and they suddenly think they are always making money, despite earning the same amount of pay”.
Across the nation, more than 860,000 households are estimated to be in mortgage stress, with more than 20,000 in severe stress, or a rise of about 1 per cent to about 26 per cent to the end of August, the analysis finds.
About 46,000 are estimated to risk default, it finds.
A mortgage market analyst has said that he is “astonished” that banks don’t tell borrowers how much their repayments will be if rates were to rise.
More than half of borrowers have no clue what impact a 2 per cent rate rise will have on their home loan, according to Digital Finance Analytics principal Martin North.
“One of the things I’m amazed about is lenders don’t actually tell people what their repayments will be if rates were to rise by 2 or 3 per cent — in other words, back to normal levels,” Mr North told The Adviser.
“They do the calculations because of serviceability buffers, but that is not disclosed to consumers,” the principal said, adding that borrowers have very little “feel” of how their mortgages will behave in a rising interest rate environment.
“My research suggests that only half of them have a budget and know what they are spending. If you ask them what the effect of a 2 per cent rate rise will be on their mortgage, more than half have no idea.”
Mr North’s comments come amid growing speculation that the Reserve Bank will begin lifting the cash rate from next year. High levels of household debt are a chief concern for the RBA as it looks to tighten monetary policy.
Last week, Reserve Bank governor Philip Lowe warned that in the current environment, “household spending could be quite sensitive to increases in interest rates”.
DFA’s Martin North explained that on a $100,000 mortgage, a 25 basis point rate rise equates to about $30 more a month on mortgage repayments.
“On a million-dollar mortgage, you can see that even a small interest rate rise is a huge cash cost each month.”
His comments come as new figures show that a concerning number of property investors are unaware of how they will be effected by lending changes.
The 2017 PIPA Annual Investor Sentiment Survey, released this week, found evidence of mortgage stress among investors moving from interest-only (IO) to principal and interest (P&I) mortgages.
PIPA chair Ben Kingsley said that there are a few worrying figures that reflect a level of uncertainty among investors when it comes to finance.
“We did see some evidence of lending fatigue in terms of investors that have been forced to stop borrowing,” Mr Kingsley told The Adviser.
While the majority of investors with interest-only (IO) loans said that they won’t struggle to meet the new principal and interest (P&I) repayments once their current IO period expired, 12 per cent said that they would.
“I was a little bit worried that 12 per cent said if their loans switched to P&I they would struggle,” Mr Kingsley said.
“What was even more interesting to me was that 20 per cent were unsure. I would like to think that many investors should know what is important to them.”
The latest data shows that customers of the smaller mortgage lenders are significantly more likely to be satisfied than those using the big four. And overall the smaller players are hitting the high note in terms of service compared with their larger competitors, with mortgages leading the way.
According to Roy Morgan Research, customer satisfaction with Bendigo Bank in August 2017 was 89.3%, making it the top performer among the ten largest consumer banks. Not only was Bendigo the satisfaction leader but it improved it’s rating over the month by 0.9% points, against an overall decline of 0.2% points for banks in total.
Smaller banks lead in customer satisfaction
Not only does Bendigo Bank lead in customer satisfaction among the major ten banks with 89.3% but it was followed by other small banks such as ING Direct with 86.7%, Bank of Queensland (84.2%), Suncorp (83.0%) and St George (82.0%). The best performer among the four majors was the CBA with 80.2%, followed by Westpac on 78.5%, NAB (78.4%) and ANZ (77.3%). The overall average satisfaction for all banks was 80.8% in August.
Consumer Banking Satisfaction August 2017 - 10 Largest Consumer Banks1
1. Based on customer numbers 2. Include banks not shown Source: Roy Morgan Single Source (Australia). 6 months ended July 2017, n= 26,184; 6 months ended August 2017, n= 26,119. Base: Australians 14+
Over the last month the major banks to show improved satisfaction were Bendigo Bank (up 0.9% points), Bank of Queensland (up 0.7% points), Suncorp (up 0.5% points), Westpac (up 0.4% points) and NAB (up 0.1% point). The biggest drop in satisfaction was by ING Direct (down 1.2% points) but they remained in clear second place overall.
Low satisfaction among mortgage customers of the big four banks reduce their overall satisfaction
The mortgage customers of each of the big four banks continue to be a drag on their overall satisfaction, despite historically low home-loan rates. Over the last month, satisfaction among the big four’s home-loan customers has fallen marginally further behind their other customers with a decline of 0.4% points to 75.7%, compared to a drop of only 0.1% points for non home-loan customers (to 79.8%).
Satisfaction of Mortgage and Non-Mortgage Customers August 2017 - 10 Largest Consumer Banks1
1. Based on customer numbers Source: Roy Morgan Single Source (Australia). 6 months ended July 2017, n= 26,184; 6 months ended August 2017, n= 26,119. Base: Australians 14+
Bendigo Bank has the highest home-loan customer satisfaction (of the top 10) with 96.3%, followed by Bank of Queensland with 93.6%. These two remain well ahead of their major competitors, with the next best being ING Direct (86.8%). The CBA has the highest home-loan customer satisfaction of the big four with 77.4% (down 0.7% points over the last month), followed by NAB on 75.4% (up 1.6% points).
The Ten Network’s recent experience of voluntary administration and subsequent rescue by CBS demonstrates how insolvency law works for large Australian companies. But 97% of Australian businesses are small or medium size enterprises (SMEs), and they face a system that isn’t designed for them.
60% of small businesses cease trading within the first three years of operating. While not all close due to business failure, those that do tend to face an awkward insolvency regime that fails to meet their needs in the same way it does Network Ten.
The lack of an adequate insolvency regime for SMEs inhibits innovation and growth within our economy. It adds yet more complexity to the already difficult process of structuring a small business. Further, it inceases the cost of funding. Lenders know that recovering their money can be onerous if not impossible, so they impose higher costs of borrowing.
Australia’s insolvency regime
Australian insolvency law is divided into two streams, each governed by a separate piece of legislation.
The Corporations Act deals with the insolvency of incorporated organisations, and the Bankruptcy Act addresses the insolvency of people and unincorporated bodies (such as sole traders and partnerships).
Both schemes are aimed at providing an equal, fair and orderly process for the resolution of financial affairs. But a large part of the Corporations Act procedure has been developed with the complexity of a large corporation in mind. For example, there are extensive provisions that allow the resolution of disputes between creditors that are only likely to arise in well-resourced commercial entities.
The Bankruptcy Act, by contrast, takes account of the social and community dimensions of personal bankruptcy. This legislation seeks to supervise the activities of the bankrupted person for an extended period of time to encourage their rehabilitation.
SME’s awkwardly straddle the gap between these parallel pieces of legislation. Some SMEs are incorporated, and so fall under the Corporations Act. SMEs that are not incorporated are treated under the Bankruptcy Act as one aspect of the personal bankruptcy of the business owner. But of course, SMEs are neither people nor large corporations.
How insolvency works
Legislation governing corporate insolvency is founded on the assumption that there will be significant assets to be divided among many creditors. Broadly speaking, creditors are ranked and there are sophisticated and detailed provisions for their treatment. If Ten would have proceeded to liquidation, creditors would have been broadly grouped into three tiers and paid amounts well into the tens of millions.
One type of creditor is a “secured creditor”. Banks, for example, will often require that loans for the purchase of business equipment are secured against that equipment. In the event of default, the bank takes ownership of the equipment in place of the debt, if they can’t be paid out.
Unsecured creditors, on the other hand, do not have an “interest” over anything. If a company goes into liquidation, an unsecured creditor will only be paid if there are sufficient funds left after the secured creditors have been paid, and the cost of the process has been covered. There is no guarantee that unsecured creditors will be paid. Most often, they are only paid a portion of what they are owed.
The unique challenges of SME insolvency
When it comes to SMEs, there is little or no value available to lower-ranking, unsecured creditors in an SME insolvency estate. At the same time, higher-ranking, secured creditors tend to have effective methods of enforcing their interest outside the insolvency process. For instance they could individually sue the debtor to recover money owed. As a consequence, creditors are rarely interested in overseeing or pursing an SME insolvency process. This means the system is not often used and creditors with smaller claims go unpaid.
Even if creditors do want to use the insolvency process, it is likely the SME’s assets are insufficient to cover the cost of employing an insolvency practitioner and the required judicial oversight.
This problem is made worse because SMEs often wait too long to file for insolvency, owing to their lack of commercial experience or the social stigma of a failing business. Instead, debts continue to grow well beyond the point of insolvency, and responsibility falls on creditors to deal with the issue.
There are further difficulties depending on whether the SME is incorporated. Incorporated SMEs are frequently financed by a combination of corporate debt, taken on by the SME, and the personal debt of the business owner. This may result in complex and tedious dual insolvency proceedings: one for the bankruptcy of the owner and the other for the business.
Unincorporated SMEs, in turn, suffer from two stumbling blocks. First, the personal bankruptcy scheme has not been created to preserve the SME or encourage its turnaround. Second, personal bankruptcy proceedings require specific evidence that the person has committed an “act of bankruptcy”, such as not complying with the terms of a bankruptcy notice in the previous six months.
This hurdle makes the process far more time-consuming than the corporate scheme. It is also more difficult for creditors to succeed in recovering their investment and, by extension, prevents them from efficiently reallocating it. There is a real danger that this will deter creditors and raise the cost of capital at first instance.
What can we do about it?
The best way to meet the needs of SMEs would be to create a tailored scheme that sits between the corporate and personal regimes, as has been done in Japan and Korea. These regimes focus on speeding up the proceedings, moving the process out of court where possible and reducing the costs involved.
However, as the legislation in these two countries notes, there can be marked differences between small and medium-sized businesses that all fall under the SME banner. Therefore, what is needed is a flexible system made up of a core process, together with a large array of additional tools that may be invoked.
Designing such a scheme remains no easy feat. However, at its core, such a scheme would ideally allow business owners to commence the insolvency process and remain in control throughout. The process would sift through businesses to identify those that remain viable, and produce cost-effective means for their preservation.
Non-viable businesses would be swiftly disposed of, using pre-designed liquidation plans where possible and relying on court processes and professionals only where absolutely necessary. Creditors would therefore receive the highest return possible, and importantly, honest and cooperative business owners would be quickly freed from their failed business and able to return to economic life.
Authors: Kevin B Sobel-Read, Lecturer in Law and Anthropologist, University of Newcastle; Madeleine MacKenzie, Research assistant, Newcastle Law School, University of Newcastle
Welcome to the Property Imperative weekly to 30th September 2017. Watch the video, or read the transcript.
Here are the month on month (seasonally adjusted) movements. Owner occupied lending up $17.5 billion (0.68%), investment lending up $0.8 billion (0.14%), personal credit down $0.4 billion (-0.24%) and business lending up $4.2 billion or 0.47%.
As a result, the proportion of credit for housing (owner occupied and investor) still grew as a proportion of all lending.
Another $1.7 billion of loans were reclassified in the month. This will give an impression of greater slowing investment loan growth as a result.
Here are the monthly growth trends.
Portfolio movements across the banks were quite marked. There may be further switches, but we wont know until the RBA data comes out, and then only at an aggregate level. We suspect CBA did some switching…
The loan shares still show Westpac the largest lender on investor mortgages and CBA leading the pack on owner occupied loans.
All the majors are below the 10% investor loan speed limit.
So the question will be, have the non-bank sector picked up the slack? In fact the RBA says $1.7 billion of loans were switched in the month. This probably explains only some of the net fall.
The analysis reveals that nearly 1000 households in Brighton, where a beachbox without electricity sells for more than $320,000, are under distress, or could face default in the next 12 months. Joe Armao, Fairfax Media.
1. Based on customer numbers 2. Include banks not shown Source: Roy Morgan Single Source (Australia). 6 months ended July 2017, n= 26,184; 6 months ended August 2017, n= 26,119. Base: Australians 14+
1. Based on customer numbers Source: Roy Morgan Single Source (Australia). 6 months ended July 2017, n= 26,184; 6 months ended August 2017, n= 26,119. Base: Australians 14+
