Tag: SME

Prospa removes unfair loan terms for small business borrowers and guarantors

Following an ASIC review, Prospa Advance Pty Limited (Prospa) has changed   loan terms in its standard form small business loan contract to address terms being unfair under the unfair contract terms provisions of the ASIC Act.

The review of Prospa’s contract is part of a broader surveillance by ASIC to examine lenders’ small business loan contracts to reduce the risk of unfair contract terms.

As a result of ASIC’s review, Prospa has made a number of changes resulting in improved terms for borrowers and guarantors. The changes include addressing problematic terms outlined in ASIC Report 565: Unfair contract terms and small business loans, and changes to other terms which could have operated unfairly for borrowers and guarantors.

Prospa has agreed that all customers who entered into or renewed contracts from 12 November 2016 will have the benefit of the changes agreed with ASIC. Prospa will be communicating these changes to its small business customers with the amended contract coming into effect in early October.

ASIC’s surveillance of small business loan contracts is ongoing, and will consider regulatory action where appropriate.

Changes to Prospa’s loan contract

Prospa has agreed to make the following changes to its standard form small business loan contract:

  • amended the early repayment clause so that borrowers can now      prepay their loan early without requiring Prospa’s consent, and removed      Prospa’s absolute discretion whether to provide a discount for prepayment – Prospa will now apply a published Early Prepayment Policy so borrowers  can determine the discounts they they can expect to receive if they do pay back their loan early;
  • amended the ‘unilateral variation’ clause to significantly limit Prospa’s ability to unilaterally vary contracts to specific instances. Prospa has also extended the notice period to 60 days where Prospa intends to vary fees;
  • amended clauses defining events of default to add remediation periods and materiality thresholds and to permit changes to control of the Borrower with the lender’s consent (not to be unreasonably withheld);
  • removed a broad ‘cross-default’ clause which allowed Prospa to call a default under the loan contract due to any default under another finance document related to the loan (for example, guarantee or security document);
  • restricted the borrower’s indemnity to ensure that:

–    the borrower is required to indemnify only Prospa, its employees and agents (and not third parties that are not parties to the contract such as receivers or contractors); and

–    the borrower is not required to indemnify Prospa for losses or costs incurred due to the fraud, negligence or wilful misconduct of Prospa, its employees, officers, agents, contractors or receivers appointed by Prospa;

  • removed an ‘entire agreement’ clause which absolved Prospa from contractual responsibility for conduct, statements or representations made to borrowers about the loan contract;
  • limited the class of people who can provide guarantees under the loan contract to:

–    people who are actively involved in the management of a borrower’s business;

–    if the borrower is a company, people who are directors or shareholders of the borrower; and

–    if a shareholder of the borrower company is a company, directors or shareholders of that company.

  • inserted a 5-business-days’ notice provision to guarantors about:

–    borrowers who are 30 calendar days behind their agreed repayment schedule; and

–    the commencement of legal proceedings against a borrower or the appointment of a receiver.

  • limited the guarantor’s liability so that the guarantor is not liable for any increase in the amount of the loan principal and interest agreed at the start of the loan(but the guarantor is liable for fees and reasonable enforcement costs).
  • inserted a provision to obtain consent of the guarantor:

–    where there is a discharge or release of any security held by Prospa given by the borrower or a guarantor; and

–    where there are multiple guarantors, before releasing a guarantor.

  • limited the actions of lender-appointed attorneys where there is an event of default under the loan contract so that an appointed attorney cannot act in a way that prefers the interests of the attorney over the interests of the borrower or guarantor.

Prospa’s Interest Charges and Late Fees

Prospa charges a factor rate for interest on its fixed term loans. The amount of interest, which can be considerably higher than bank loans, is fixed and disclosed at the outset and does not vary even if the loan term is extended.  The amount of interest is therefore part of the “upfront price” of the loan and is excluded from review under the unfair contract term provisions.

Late payment fees for missed payments are, however, subject to review under the unfair contract term provisions. ASIC will be undertaking further monitoring of Prospa’s charging of late payment fees to assess whether the manner in which the fees are being charged is unfair in practice.

Background

In March 2018, ASIC published REP 565, which outlines changes to small business loan contracts made by the big four banks to comply with the UCT law. This report also provides guidance to the broader small business lending industry.

At the same time ASIC announced that it will also examine other lenders’ small business loan contracts to ensure that their contracts do not contain terms that raise concerns under the UCT law. ASIC is reviewing the contracts of bank and non-bank small business lenders, including Prospa, to check their compliance with UCT law.

Since publishing REP 565, ASIC is also monitoring the big four banks’ compliance with the UCT law. In March 2017, ASIC and the ASBFEO completed a review of small business standard form contracts and called on lenders across Australia to take immediate steps to ensure their standard form loan agreements comply with the law (refer: 17-056MR).

In August 2017, ASIC and the ASBFEO welcomed the changes ASIC required to small business loan contracts by the big four banks (refer: 17-278MR) that have:

  • ensured that the contract does not contain ‘entire agreement clauses’ which prevent a small business borrower from relying on statements by bank officers (for example, about how bank discretions will be exercised)
  • limited the operation of broad indemnification clauses
  • addressed concerns about event of default clauses, including ‘material adverse change’ events of default and specific events of non-monetary default (for example, misrepresentations by the borrower)
  • limited the circumstances in which financial indicator covenants will be used in small business loans and when breach of a covenant will be considered an event of default
  • limited their ability to unilaterally vary contracts to specific circumstances with appropriate advance notice.

Fintech Spotlight: GetCapital

Fintech, GetCapital, one of the most interesting SME business lenders here in Australia, recently announced a distribution agreement with aggregator PLAN. So I took the opportunity to discuss the growth of the business with GetCapitals’ COO  Frank Sterle in our occasional Fintech Spotlight series.

Frank Sterle COO GetCapital

GetCapital is a specialist lender to the SME sector. It was founded in 2013, and really hit the market in earnest in 2015, offering finance to businesses with an annual turnover of typically between $200k and $2m, though they have written deals for much bigger firms too. Their focus is the Australian and New Zealand Markets. They have lent more than $250 million in loans so far, and this is still growing, with a team now topping 100.

Frank, who by the way previously worked at Deutsche Bank within the Fixed Income, Currencies and Commodities (FICC) division of its Investment Bank, highlighted that they will consider deals across all sectors, and they offer loans for a range of business purposes from vehicle purchase, working capital, equipment finance and import lines of credit, with the proviso that borrowers will need to provide a personal guarantee as a minimum.  They operate in the “Prime” to “Near-Prime” credit space.

Around one third of leads come via their direct channel – using an on-line application, one third from strategic partnerships, and one third from a portfolio of aggregators, including AFG, CFG, Fast, Plan, and others. In fact, this is the channel which is expanding fastest and they expect to announce additional aggregator partnerships soon.

Their underwriting processes are interesting, as they have invested big in technology at the back end, for example to be able to capture bank statement data using tools from Proviso and this supports quick assessments of deals by their dedicated Relationship Managers, who will also consider credit history, and serviceability.  Although a portion of loans with a low “expected loss” are fully automated, GetCapital still used a final human overlay by an experienced credit officer for larger and more complex underwrites. This also enables a broker to transparently workshop a deal with their Relationship Manger rather than being advised of a black box “computer says ‘no’ response”. They can approve finance in under 24 hours, often much less. They have three price tiers, with the lower value one typical of the sector, averaging around $40,000, but the average is much higher in the stronger credit tiers, with different pricing structures above.  Frank was at pains to underscore the prime quality of the loans they write thanks to their specialist capabilities, and that their loss rates are very low, across the country.  They claim to be “sharp on price” as well, though the price will depend on how long the business has been trading, their credit score and the assets backing the deal.

They are funded by a couple of institutional investors, including NAB, who provides their wholesale funding, so no crowd funding in sight here!

The experienced team also includes CEO, Jamie Osborn, ex. Managing Director at Macquarie Capital; Chief Commercial Officer Renata Cihelka, ex. ANZ, AMP, Morgan Stanley and CBA; Head of Sales, Cristian Fedrigo, ex. AFG, CBA; Head of Customer Operations, Brad Kinna, ex. ING Direct and Rabobank and Chief Risk Officer, David Hurford, ex. Westpac Institutional Bank.

Looking ahead, Frank believes the SME funding market is set to grow, but in so doing, there will be a bifurcation in the target market, with some focussing on the higher more sophisticated end of the sector, while others will battle it out at the lower end. He thinks they are well positioned for the former, and sees the prospect of further expansion in Australia ahead.

My sense is that GetCapital is indeed well positioned to disrupt core prime lending to SME’s in Australia, and as such are becoming a force to be reckoned with. Highly relevant given the feedback from our latest SME surveys which shows again that the incumbent lenders are forcing SME’s to jump though ever higher hoops to get a loan.

Further evidence of the digital disruption of finance ahead!

GetCapital appointed to PLAN Australia aggregator panel

GetCapital, specialist lender to small and medium sized businesses (SMEs), has announced its appointment to the lending panel of aggregator PLAN Australia from 20 August.

PLAN is one of Australia’s largest mortgage aggregation groups, with over 1,650 members and a total loan book value close to $70 billion. The aggregator’s commercial and asset finance volumes reached $990 million in the six months to March 2018.

The partnership will see GetCapital’s multi-product offering of business loans, equipment finance and trade finance become available on PLAN’s extensive broker network across Australia.

“We welcome the opportunity to work with PLAN as part of our commitment to support the growth of Australian SMEs,” said GetCapital CEO Jamie Osborn. “We look forward to delivering real value to PLAN’s experienced brokers, their customers and their businesses”.

PLAN has one of the largest partnership manager (PMs) workforces in Australia, with PMs across all states providing personalised support and business advice. They work with established financial planners, accountants and property business owners to find a sustainable way of delivering both end-to-end advice and lending services.

“We are delighted to partner with GetCapital and have them join our panel”, said Anja Pannek, CEO of PLAN Australia. “This will further strengthen our commercial and asset finance options for our brokers and their customers.”

Technology-enabled whilst still taking a traditional relationship management approach to servicing brokers, GetCapital’s range of finance solutions feature flexibility and convenience over traditional lenders, including approvals in under 24 hours.

These benefits complement PLAN’s broker support offering through technology, professional and business development, based on its four C’s: customer first, compliance focused, commercially oriented, and committed to the industry.

About GetCapital

Founded in 2013, GetCapital is a specialist provider of finance to SMEs. GetCapital offers fair and transparent financing facilities to mainstream businesses including business loans, trade finance facilities, equipment finance as well as property secured loans.

In 2017, GetCapital was named one of Australia’s fastest growing companies in Deloitte’s Technology Fast50.

SME Insolvencies On The Rise

New data from one of Australia’s biggest insolvency firms has revealed there are nearly 10,000 small to medium businesses on the brink of collapse, and experts says business strength is unlikely to improve, via SmartCompany.

The SV Partners Commercial Risk Outlook Report for August 2018 shows there are 9,948 businesses with annual turnover of less than $50 million that are at “high risk” of insolvency in the next 12 months, with political uncertainty and a downturn in property markets pinned as the main contributing factors.

Those SMEs make up 80% of the total 12,464 businesses the insolvency firm detected as being high risk, with SV Partners managing director Terry van der Velde recommending SMEs have a “rigorous” approach to risk management to try and prevent insolvency where possible.

“SMEs often struggle more with solvency than larger businesses, as their smaller income streams, tighter margins and difficulties sourcing finance can make dealing with short-term shocks more challenging,” van de Velde said in a statement.

“That’s why small and medium-sized business owners need a rigorous approach to risk management, to ensure that their business has a plan to deal with unexpected situations.”

A number of high-profile businesses, particularly in the retail space, have entered administration throughout the end of 2017 and into 2018. These include Toys ‘R’ Us, a selection of Adriano Zumbo’s patisseries, SumoSalad, and Oliver Brown.

Speaking to SmartCompany, Patrick Coghlan, managing director of credit reporting agency CreditorWatch, says there’s definitely been a significant increase in the number of insolvencies for both incorporated and unincorporated businesses.

CreditorWatch’s own research shows the number of unincorporated businesses that have gone from active to inactive between March 2017 to March 2018 is up 60%, suggesting the businesses being hit the hardest are also the smallest.

“We’re seeing people really struggle from a cash flow point of view, and we know from our research that it’s pretty much a 50/50 split between SMEs that are running cash flow positive and those that aren’t,” he says.

Coghlan puts this down to the ever-present issue of payment times, saying a lot of SMEs are still finding it hard to get payments from suppliers on time.

However, he also attributes some insolvencies to a “general softening” of the economy overall.

Fintech OnDeck Lent More Than US$9 billion

Global, online SME lender OnDeck has reached a new milestone for the value of loans written since it entered the market, just over 10 years ago, via Australian Broker.

With operations across the US, Canada and Australia, the OnDeck Group has lent more than US$9 billion to more than 80,000 small business customers.

Demonstrating the strength of the local market, the group’s Australian business contributed significantly to the total and Australia is now the second largest alternative finance market in the APAC region, behind China.

Cameron Poolman, COE of OnDeck Australia said, “The Australian market is growing at 37% annually. However, while the total size of the alternative finance market in Australia is now 25 times the size it was in 2013, our market is still an emerging on-line lending market,”

OnDeck’s own data shows a number of pain points in the SME finance landscape and the lender has regularly called for better financing options for small and medium sized enterprises.

One in five Australian small businesses are unable to take on new work because of cash flow restrictions and nine out of 10 small businesses report better cash flow could improve revenue by an average of 11.7%.

Despite the challenges, Poolman expects the market will continue its strong growth trajectory and will likely reach maturity in less than six years; a process that took 12 years in the US.

OnDeck was one of six online lenders that signed the new fintech code of lending last month. The code was developed by the Australian Finance Industry Association (AFIA), the Australian Small Business and Family Enterprise Ombudsman (ASBFEO), SME advocate theBankDoctor.org and industry association FinTech Australia.

Kabbage Reaches a New Milestone of $5 Billion of Funding to Small Businesses In US

Very interesting release from Kabbage, highlights the growth of lending to small business online, and outside banking hours. Another example of the digital revolution well underway. 24/7 access rules…!

ATLANTA – June 28, 2018 – Kabbage, Inc., a global financial services, technology and data platform serving small businesses, reports its 145,000-plus small business customers accessed over 300,000 loans during non-banking hours, reaching a record total of more than $1 billion in funding. In total, Kabbage has now provided access to more than $5 billion in funding to its customers across America. The non-banking hour analysis illustrates how Kabbage’s fully automated lending solutions remove the age-old hurdle of normal business hours by offering companies 24/7 access to working capital online.

“The findings illuminate the true around-the-clock nature of business owners,” said Kabbage CEO, Rob Frohwein. “While we wish small business owners could reclaim their nights and weekends, we built Kabbage to allow business owners to access funds on schedules convenient to them, not us.”

Economic Impact of $5 Billion

A new report from the Electronics Transactions Association (ETA), in partnership with NDP Analytics, a Washington, D.C.-based economic research firm, finds that for every $1 provided to small businesses via online lending platforms, including Kabbage, results in $3.79 in gross output in local communities. The study provides context to how the new milestone of $5 billion provided through Kabbage has helped to stimulate the U.S. economy.

After-Hours Lending on the Rise

The total number of dollars accessed through Kabbage outside of typical banking hours increased more than 6,000 percent between 2011 and 2018. The growth illustrates small business owners are increasingly comfortable accessing capital online, and they rely on the convenience of managing cash flow needs any time of day, particularly outside of open business hours for most banks. Non-banking hours in this analysis represents the local time between 6 p.m. and 6 a.m. on the weekdays, and the full 48 hours over the weekends.

Weekday vs. Weekend Lending

The majority of after-hour lending (64 percent) was accessed during the work week, totaling $754 million. The remaining 36 percent occurred on Saturdays and Sundays, totaling $429 million. The data is a nod to the dedication of business owners as more than one-third extend their work weeks to handle cash flow needs even on the weekends.

About Kabbage

Kabbage, Inc., headquartered in Atlanta, has pioneered a financial services data and technology platform to provide access to automated funding to small businesses in minutes. Kabbage leverages data generated through business activity such as accounting data, online sales, shipping and dozens of other sources to understand performance and deliver fast, flexible funding in real time. With the largest international network of global-bank partnerships for an online lending platform, Kabbage powers small business lending for large banks, including ING and Santander, across Spain, the U.K., Italy and France and more. Kabbage is funded and backed by leading investors, including SoftBank Group Corp., BlueRun Ventures, Mohr Davidow Ventures, Thomvest Ventures, SoftBank Capital, Reverence Capital Partners, the UPS Strategic Enterprise Fund, ING, Santander InnoVentures, Scotiabank and TCW/Craton. All Kabbage U.S.-based loans are issued by Celtic Bank, a Utah-Chartered Industrial Bank, Member FDIC. For more information, please visit www.kabbage.com.

ASIC Scrutiny Good for Fintechs – Moody’s

The close attention of ASIC that prompted Prospa to scuttle its IPO will ultimately work out well for the fintech small business lending sector, says ratings agency Moody’s via Fintech Business.

In a note published on Friday, Moody’s Investors Service senior analyst John Truijens said ASIC’s focus on Australian fintech lenders will be a “credit positive” for the sector over the long term.

Ultimately, Mr Truijens said, closer regulation of fintech small business lenders will result in improved transparency and governance in the sector.

The comments come after Prospa indefinitely delayed its planned IPO on June 6 with minutes to spare following queries from ASIC about the terms of its loans.

Regulators (and the royal commission) are reviewing unfair loan contract terms, said Moody’s – and the fintech sector is working on a new code of conduct to “lift transparency” on the sector.

Because most small business loans are unsecured, lenders will have less incentive to safeguard their position by acting on non-monetary default clauses, said Moody’s.

“We therefore expect that any adjustment required to contract terms to address any of these unfair terms will have a muted impact on the credit quality or commercial value of such loans,” said the note.

“Unfair contract term law gives courts a power to find that a term is ‘unfair’. If a contract term is found to be unfair, it will be void, which means it is not binding. The rest of the contract will continue to bind the parties if it is capable of operating without the unfair term,” said Moody’s.

The fintech small business lending sector, which has already pushed for self-regulation, is in the process of creating a code of conduct with a target date of 30 June 2018.

“In light of the development of the code of conduct, we expect that the disclosure of interest rates implicit in loan contracts will be adopted by the industry as the standard practice in the future,” said Moody’s.

“Greater transparency around the cost of loans and the improved governance resulting from an industry code of conduct will enhance the sustainability of the sector.

“There is therefore reduced risk that a borrower’s obligation to pay their loan will be waived due to any of the non-monetary default clauses under review,” said the note.

Prospa, ASIC and the Conundrum of Unfair Contract Terms Law

The aborted Prospa IPO raises questions not just about the online SME lender’s compliance with UCT but also ASIC’s role in applying and enforcing this law which came into effect in November 2016 says TheBankDoctor.

In its prospectus Prospa said “we have reviewed our loan contract in relation to UCT in July 2015 and again in September 2017. We will continue to review our loan contract as and when required in light of relevant case law and regulatory guides that may be issued”. Then the day before the IPO, Prospa received a letter from ASIC which is thought to have raised queries about whether its standard form contract contains clauses that may breach UCT.

Following a hastily arranged meeting with ASIC the following day, Prospa announced the IPO would be deferred for 48 hours. It said after this meeting “ASIC has been wonderful and very positive in their engagement” and the company felt “it does not need to make additional disclosures about its compliance with UCT regulations”. Prospa noted ASIC had not raised questions about the company’s disclosure or prospectus. And ASIC made no comment about what was in its 5th June letter or what was discussed or resolved at the meeting.

The IPO is now on hold yet we are none the wiser as to whether Prospa believes it is compliant or whether ASIC thinks Prospa may not be compliant. Until this uncertainty is cleared it’s hard to imagine how the IPO can proceed and in the meantime, ASIC’s collaborative approach to the application and enforcement of this law will come under closer scrutiny.

Prospa’s equivocal prospectus statement on UCT hasn’t helped its cause. It would be surprising if the Prospa directors did not seek and obtain written advice from their lawyers prior to signing off on the prospectus. Other fintechs that are not looking to list, have obtained written opinions from their lawyers stating their standard form contracts are UCT compliant.

Given the statement that it would “wait for case law or regulatory guides to inform it of any non-compliance with UCT” perhaps Prospa is of the view ASIC will tell them if it has contrary views and until or unless they receive input from ASIC nothing further is required?

There has been speculation ASIC’s last minute intervention may have been influenced by the Royal Commission’s questioning of ASIC’s Michael Sadaat on June 1st when counsel assisting Kenneth Hayne queried the collaborative approach adopted by ASIC and the Australian Small Business & Family Enterprise Ombudsman to get the big four banks to amend terms and conditions in their standard form contracts. At one stage, Mr Hayne asked Mr Sadaat “why say, in a media release, we will work with those who are not complying rather than saying, those who are not complying with the law should do so?”

In response, ASIC defended its approach saying that it “has been appropriate and moulded to addressing the risk of contravention of those provisions”. ASIC pointed out that since November 2016 it is has not initiated any legal action to enforce the law. This is more likely a reflection of ASIC’s priorities than the number of potential breaches. In addition, ASIC says it has received only one complaint about potential UCT concerns in a small business loan contract. The reason ASIC has received only one complaint is not that this is not a problem, it is because SMEs are not complaining. They are either too busy, don’t want to be exposed publicaly, don’t see any benefit for themselves or, as often as not, just don’t know ASIC is interested in their concerns.

In due course there is every likelihood the Royal Commission will make findings about the need for ASIC to tighten up enforcement of UCT laws particularly in the burgeoning non-bank SME lending market. But ASIC and lenders cannot and should not await the Royal Commission. SMEs who need access to funding offered by these lenders are entitled to know whether lenders comply with the law.

If Prospa believes its standard form contracts comply with UCT why doesn’t it just say so?. Similarly, if ASIC believes Prospa might not compliant why doesn’t it say so and then take whatever action it deems appropriate. Proving in court that a standard form contract term is unfair would not be easy although there are several clauses in Prospa’s standard form contract that, at the very least, raise questions about UCT compliance. These include:

1. Material Adverse Effects. Any event which in the lender’s reasonable opinion has had or may have a material adverse effect constitutes an event of default. Five types of events are defined as a Material Adverse Effect. They are not linked to non-payment. In such circumstances, no notice is required to demand repayment in full, use the direct debit authority as many times as the lender so desires or appoint a receiver.

2. Entire agreement. The loan agreement supersedes and overrides any other agreement, verbal or in writing.

3. Broad indemnification clauses. The loan agreement makes the borrower and any guarantors liable to the lender for losses, costs, liabilities and expenses suffered or incurred by the lender including, it seems, those that may arise outside the control of the borrower or guarantor.

4. Voluntary repayment. A borrower may at the discretion of the lender repay a loan early but this does not reduce the amount of interest payment unless the lender agrees. That is, if a borrower wants to repay early, they can be required to pay all the interest for the unexpired period of the loan.

This is not a “penalty” because the borrower accepts this clause when signing the loan agreement. Meanwhile in the Frequently Asked Questions section of the Prospa website, potential borrowers are advised, “there are no additional fees for early repayment”.

The voluntary repayment clause has caught out a number of unsuspecting borrowers. Last weekend’s AFR reported the case of a Perth based businessman with an existing Prospa loan who accepted an offer to borrow more but rather than simply increase the existing facility, Prospa sold him a second loan which was in part used to pay off the original loan. But despite paying that loan out early, the borrower says he was still required to pay the full interest and other fees as if the loan had run to its full term.

It may be that in recent times Prospa has made changes to its standard form contract although this seems unlikely given the prospectus states the last review was conducted in September 2017.

Compliance with UCT is an issue for the entire non-bank SME lending sector, not just fintechs or Prospa. But as the dominant player in the rapidly emerging fintech space, Prospa has an opportunity, arguably a responsibility, to demonstrate that fintechs can become a trusted alternative source of finance for the thousands of SMEs that cant get funding from banks. SMEs, who are generally time poor and financially unsophisticated, are entitled to expect that laws designed to protect them are enforced.

It remains unclear what the Prospa board and ASIC think about Prospa’s compliance with UCT law and until this is clarified, the cloud overhanging the company will persist and the IPO will remain in limbo. And hopefully ASIC will take the steps necessary to ensure UCT law is applied and enforced without unnecessary delay.

Re-posted with permission.

RC hearings too short to cover ‘breadth’ of cases: Ombudsman

From The Adviser

The Small Business Ombudsman has called for another set of royal commission hearings to investigate more cases of inappropriate practices pertaining to small business loans.

Speaking with The Adviser, the Australian Small Business and Family Enterprise Ombudsman (ASBFEO), Kate Carnell, said that the “dilemma” with the third round of royal commission hearings (which focused on the provision of credit to small businesses) was too short, resulting in only a limited number of cases being investigated.

“The royal commission was called on because of a huge amount of agitation from many small businesses, a joint parliamentary inquiry, a range of cross-benches that indicated they might cross the floor because they had small business constituents, who believed that they hadn’t had an opportunity to have their cases heard,” Ms Carnell told The Adviser.

“I believe that they need to do another two weeks [of hearings] or another set of cases.”

She added that the few cases heard in the third round of hearings is “[not] representative of the breath of cases that exist”, though noted that the next round, which will focus on the provision of finance to customers in regional and remote areas, could bring to light further issues experienced by small businesses.

Ms Carnell cited cases where the banks had dragged out a loan’s sign-off process, then decided against the loan as little as 24 hours before it was expected to roll over, thereby not giving enough time for the business to find an alternative solution.

“Small businesses [are] getting very mixed messages… In a number of the cases that we saw, the bankers were telling [the small businesses] ‘no problem, we’ll refinance you’ and then two weeks (or in one case, 24 hours) before the rollover was due to happen, the bank said they changed their mind,” the ASBFEO said.

“There’s no capacity to refinance, to find another bank… and so the business ends up going into default, at which stage their interest rates double or even triple in some circumstances.

“The [cases] where banks actually told people one thing and then did something totally different and where timelines for businesses were just far too short to allow [them] to reorganise their operations… I don’t think were brought out nearly enough.”

Another issue that Ms Carnell argued didn’t get enough airtime at the last royal commission hearings is the nature of the relationships between banks and third-party valuers, administrators, and liquidators, which she said are frequently problematic.

“The small business pays for the liquidator or the valuer or the investigative accountant… but they have no input into the appointment in many cases,” the ASBFEO said.

“In our inquiry, we found it interesting and concerning that regularly the investigative accountants that gets sent in to have a look at the business to determine what should happen is then appointed as a liquidator, [which we thought] certainly didn’t look right.

“You could argue [that] an investigative accountant ends up financially benefitting from recommending a liquidation if they’re going to end up with the job… [This] isn’t an occasional scenario; it’s very regular.”

She also questioned whether banks are getting “friendly valuations” that work in both the bank’s and valuer’s favour.

“I’m not suggesting valuers and administrators aren’t professional people, but if their livelihood depends on bank work, there are some questions to be asked,” Ms Carnell said.

“Is [the] motivation for what you do in the interest of the consumer, who is paying you, or is it in the interest of the bank, who you rely on for work?

“In situations like that, transparency is really important… You’ve got to really know whether there are any kickbacks, any real incentives for people to act in particular ways [such as] provide a low valuation or a high one, or recommend a liquidation or not, recommend a particular loan product or not.”

Ms Carnell concluded that transparency around the banks’ relationships with third parties needs further exploration by the royal commission.

Lack Of Transparency In Unregulated Non-Bank SME Lending Market

From theBankDoctor.

Prospa’s impressive growth trajectory is set to receive a boost when it becomes Australia’s first online small business lender to list on the ASX. But the prospectus exposes issues of transparency for the acknowledged market leader in what is a largely unregulated market.

Propsa will raise $146m of new capital of which $100m will fund the growth of its loan book and investment in new products and markets while $46m will enable existing shareholders and management to take some money off the table.

Since its establishment in 2012, Propsa has lent over $500m to Australian SMEs and has a current net loan book of $200m. It has won or placed highly in many awards including Deloitte TechFast 50, Telstra Business Awards, KPMG Fintech 100 and AFR Fast Starters.

Prospa doesn’t really compete head-on with the banks but rather its niche is those SMEs that need relatively small amounts of money in a hurry. It’s average loan size is $26,000 and 98 per cent of loans are for less than $100,000. The average term is 11.7 months and 94 per cent of loans are for 12 months or less.

Perhaps the main reason SMEs seek funding from Prospa is that they know they can get an immediate answer and if their application is approved they can have the money in their bank account within 24 hours. Another is its “pain free customer experience” as evidenced by a Net Promoter Score of 77 which compares to the average of the big four banks of -9. And thirdly, they dont have to offer security other than a personal guarantee.

Borrowers don’t go to Prospa because its cheap. In fact borrowing from Prospa can be very expensive with annualised rates ranging from 40 per cent to 60 per cent. But the question needs to be asked “expensive compared to what?” If the bank wont lend there is no point in making a comparison to bank interest rates. And if all other options have been exhausted and the need for the money is urgent, accepting “expensive” money from Prospa is entirely a decision for the borrower.

It is important that SMEs have this option and if they prioritise speed and convenience over cost that is their prerogative. But at the same time, borrowers are entitled to be able to readily tell how much a loan will cost and whether they can get a better deal elsewhere. On this front, Prospa has some way to go.

When quoting its rates, Prospa prefers to use a “factor rate” as it believes the simplest way to describe the cost of a loan is via a payback multiple. Prospa’s prospectus offers an example based on an projected factor rate of 1.24. For an average loan of $26,000 over a term of 12 months this means that the repayments would total $32,240 of which the interest payments would be $6,240.

Whilst this does sound like a simple explanation, some people might mistakenly conclude that the annual interest rate is therefore 24 per cent ($6,240/$26,000). This would be correct if the borrower had the use of the full $26,000 for the entire term but in reality the principal is repaid progressively over the term. The only time the borrower gets access to the full amount of the principal is on day one and every day thereafter it reduces but the repayments remain the same. An alternative, more broadly accepted comparative measure of cost is the annual percentage rate or APR.

A note in the prospectus discloses Prospa’s historic APRs. At 31 December 2017, its weighted average APR was 41.3 per cent, in the year to June 2017 it was 45.2 per cent and to June 2016 it was 59 per cent. Prospa projects a slight further fall in the 2018 year. It would appear these rates exclude origination fees as well direct debit fees which all add up. An origination (establishment) fee on a $26,000 loan could be $500 which adds 1.9% to the total cost of the loan. 43 per cent of Prospa’s loans are on a daily repayment plan and with a direct debit fee of $5, this will cost $1300 over 12 months adding 5 per cent to the cost of the average loan of $26,000. APRs are a good measure but you need to know what is included or not.

Time poor and relatively unsophisticated SMEs usually don’t pay much attention to fees and charges outside of the headline periodic repayment amount but this is where they can get caught out. For example, Prospa applies significant charges and penalties if a borrower cant make a payment including a dishonour fee and a late payment fee which is calculated as a percentage of the outstanding balance for every day that the loan is late.

If a borrower wants to repay early, they can be required to pay all the interest for the unexpired period of the loan. This is not a “penalty” because a clause deep in the loan agreement stipulates “any prepayment under this clause does not reduce the amount of fees and does not reduce the interest payment unless the lender agrees”. Meanwhile the website and advertising material states “there are no additional fees for early repayment” and “once you make the final payment your balance will be $0”. All technically correct but fair and transparent?

In the prospectus, Prospa notes “changes in loan contracts or other documentation may have a materially adverse effect on the perception of distributors or borrowers of the cost of Prospa’s products relative to other financial products which may have a material adverse effect on Prospa’s business”.

One possibility that was identified was the Royal Commission recommending disclosure of broker commissions which could lead to a change to Prospa’s pricing disclosure. Prospa sources about two thirds of its loans through intermediaries such as finance brokers and aggregator networks. Fees paid by Prospa to brokers and introducers, and not disclosed to borrowers, are often around 4 per cent but can be as high as 8 per cent. Payment of undisclosed fees at this level for doing nothing more than making a referral can drive behaviour that is not in the best interest of borrowers.

In November 2016, Unfair Contracts Terms law was extended to protect small businesses from unfair terms in standard form contracts. Prospa says it has reviewed and has committed to continuing to review its loan contract as and when required but it stopped short of stating that it is currently compliant with UCT law.

The prospectus is a window into the opportunities and challenges faced not just by Prospa but other fintech lenders as well. As the first to float and as the acknowledged market leader, Propsa needs to lead by example. It is part of a group of other balance sheet fintech lenders that at the end of June are expected to agree on a code of lending practice which will outline best practice principles and provide measures for standardising transparency and disclosure, including use of standard terms, comparative pricing measures and a summary loan agreement page. This is expected to include the use of APRs and other comparative measures.

It is to be hoped that this industry led initiative will help SMEs to more easily and accurately work out how much a loan will cost and to compare this with alternative offerings. The adoption of a code of practice will be an important first step but then the work begins in earnest. As we have seen at the Royal Commission, codes are worthless unless properly applied and diligently enforced. ASIC which has come under scrutiny at the Royal Commission for going too easy on the banks, cannot afford to stand by as revelations surface about poor conduct in the largely unregulated non-bank SME lending sector.

Fintech lenders have moved beyond their start up phase and are now a genuine alternative source of debt funding for many SMEs. There is no doubt the upside for the leading player in this transformational market is very significant. Only time will tell whether Prospa which in the 2017 statutory accounts recorded revenue of $56m, EBITDA of $3.8m and NPAT of $1.2m is worth its $576m IPO price tag. There are many factors which will drive Prospa’s share price but none are more important than its genuine commitment and adherence to transparent and responsible lending practices.

Reproduced with permission.