Scott Morrison to revolutionise small business lending

Christopher Joye
Nov 14 2018
AFR

Scott Morrison’s globally unique proposal to invest $2 billion into small and medium enterprise loans sourced by smaller banks and non-banks has the potential to revolutionise the sector by radically expanding the capital available to SMEs, which will reduce its cost and bolster competition outside of the oligopoly.
Under a plan to be announced by Treasurer Josh Frydenberg, the government will ask the Australian Office of Financial Management to invest an initial $2 billion into two bottlenecks in the financing chain connecting small businesses with investors that fund the money they borrow from the likes of Bank of Queensland, Liberty and Prosper.
The first will be into the “warehouse facilities”, which are normally controlled by the big banks, that smaller banks and non-banks rely on as bridging finance to aggregate portfolios of SME loans before selling them to investors.
During the global financial crisis, these warehouses were often pulled, frozen, or became punitively expensive, allowing larger banks to crush their rivals.
Taxpayers should capture almost risk-free revenue of $30 million to $40 million a year on the $2 billion investment, making the entire initiative highly profitable.
Once a warehouse facility is full of newly originated SME loans, they are transferred into an “asset-backed security” (ABS), which is a bond backed by SME loans.
The lender then repays the warehouse with the money raised from investors, which enables a second round of SME lending to be initiated. And this process continues ad infinitum.
Continuously recycled
The government will invest its $2 billion alongside private investors in both the warehouse facilities, which is a global first, and the ABS bonds that replenish the warehouse.
This will allow the $2 billion to be continuously recycled, underwriting tens of billions of dollars of SME lending outside the majors. That’s a big deal in a market where the total annual value of SME loans is about $80 billion.
Since the government will only be investing in highly rated warehouse facilities and ABS issues, it will bear little to no risk (no AAA-rated Australian securitisation has ever defaulted).
But it will be paid handsomely, earning an interest rate above the government bond yield, which is its cost of borrowing, of between 1.5 and 2.0 per cent annually.
This means taxpayers should capture almost risk-free revenue of $30 million to $40 million a year on the $2 billion investment, making the entire initiative highly profitable.
There is a powerful precedent via the government’s successful, $15 billion co-investment with the private sector into the residential mortgage-backed securities (RMBS) market during the GFC.
As with ABS, the interest rate the government was paid on its RMBS was miles above its cost of borrowing, generating huge “carry” profits for taxpayers.
Greater appetite
This particular policy, which I developed with Joshua Gans in March 2008, saved smaller banks and non-banks that were reliant on institutional funding, and has since powered the Aussie RMBS market into a massive $100 billion sector that is being underwritten by Asian and European investors. In fact, it has emerged as the second largest securitisation market in the world.
In a recent RMBS issue, a single Japanese bank bought $1.6 billion of the entire $1.75 billion deal. And if these overseas investors are willing to pour billions into our home loans while house prices are falling, there is no reason why they shouldn’t have an even greater appetite for SME loans offering superior returns.
The government’s willingness to co-invest directly into SME loan securitisations will provide an enormous vote of confidence that will amplify the demand from both local super funds and offshore investors that embrace any sovereign imprimatur.
Ultimately, that will mean much more money being made available to SMEs at lower cost outside of the oligopoly. And since the government will be investing in highly rated debt, there will be no increase in its net debt ratio that credit rating agencies like to focus on.
A final important feature of the policy is that it will fund both secured SME loans backed by residential properties and unsecured loans favoured by fintechs. That means it will support all forms of SME borrowing.