Arthur Bloch, the American Writer, famously wrote that “Every solution breeds new problems”.
We were reminded of this quote with the recent report by Commissioner Hayne & his recommendation to amend the definition of “small business” to:
- Fewer than 100 full-time equivalent employees; and
- Loan amounts less than $5M
As with many things, the devil here is in the detail.
Currently, the definition of small business refers to Total Credit Exposure of $3M. The proposed definition changes this to less than $5M per loan.
This is important for Business borrowers because the definition of “small business” impacts on the ability of a Bank to include ongoing covenants as part of their loan contracts.
So, what’s the issue?
The upshot of this recommendation is that more ‘small businesses’ would exist under this framework and Banks would no longer be able to include ongoing loan covenants. On face value this sounds like an awesome outcome…… BUT, knowing the Industry as we do, we suspect this may have some unintended consequences.
Chief among these, we foresee, is a tightening of Banks’ risk appetite in the sub $5M debt space.
Without the ability to regularly gauge how a ‘”small business” is tracking, it’s highly likely that the major banks will seek to reduce their risk going into the transaction.
Today, most of the major Banks are willing to take a calculated punt on a business where the collateral (security assets pledged) doesn’t quite cover the loan amount because they monitor the performance of the business through reporting or financial covenants – this gives them the opportunity to get involved and act early when things are going off-track.
Without this back-end control it’s likely that the Banks’ appetite to take on these types of positions will reduce. So, what does that mean for borrowers?
Well, in a word – SECURITY – and more of it!
Without the ability to oversee & confirm the capacity of a business to continue to meet repayments (in Bank speak, their “primary exit”) through regular covenant controls, the Banks are more likely to bolster their security coverage (… their “secondary exit”) for these loans under $5M.
Another possibility is an increase in the interest rates that “small business” will pay. Why? Because the Banks may seek to “price for risk” and nudge up their “customer margins” to compensate for the unknown financial performance of the borrower over the term of the loan.
Overall, it’s just more uncertainty in what is already an uncertain financial market.
If you’ve got debt & less than 100 Employees it’s probably a good time to pick up the phone and have a chat to the team at STAC Capital.