Wednesday 13 December 2017

SME debt another elephant in room for banks

Richie Boucher, Group Chief Executive, and Andrew Keating, Group Chief Financial Officer, at the announcement of Bank of Ireland Group's Interim Results
Richie Boucher, Group Chief Executive, and Andrew Keating, Group Chief Financial Officer, at the announcement of Bank of Ireland Group's Interim Results
Richard Curran
Richard Curran

Richard Curran

WHEN entrepreneur Martin Naughton bought out the Dimplex group in 1977, he was able to grow his business exponentially. He then went on to buy a series of other companies with established brands, which were in trouble.

His commercial skills enabled him to build a global manufacturing empire from taking over companies in trouble, and fixing them. Without him, the businesses would have simply disappeared.

Typically, many of these companies had borrowed too heavily, were badly run or were simply hit by the downturns of the 1970s and 1980s. The current recession has left many businesses in that exact position.

Yet, few have come on the market for sale. There are some small firms, like supermarkets, pubs or filling stations, being sold off by owners or receivers, but we have not seen the massive transfer of ownership that perhaps should naturally flow from a crisis of this depth.

There are several reasons for this, including the fact that banks have been just as slow to tackle the corporate and SME debt situation, as they have been with the mortgage crisis. In fact, the similarities in prognosis and possible solutions are very similar.

The banks have had to be frog-marched into doing some debt write-off, some restructuring, split mortgages, and, where appropriate, repossessions.

The SME debt crisis has gone under the radar to some extent, but it is very serious. According to the financial regulator, half of the €50bn in lending to SME's is in arrears.

But when you analyse the financial results of Bank of Ireland and AIB published last week, that figure does not appear. The reason is both banks separate non-property SME lending from their remaining property and investment loans.

Bank of Ireland has €10bn outstanding in SME loans in the Republic of Ireland. Almost €3bn of it is in default. AIB has a total of €14.2bn in SME and commercial lending. Almost €5bn of it is in trouble.

So many SMEs risked the shop by borrowing heavily for property investment. In some cases they used the main SME firm for property speculation, through a subsidiary. Others used a totally new vehicle, but gave either personal guarantees, including pledging their family homes, or they gave some cross guarantees on the main business, as security on property loans.

This is why Bank of Ireland still has €17.4bn in property investment and construction loans on its books. AIB still has €21.3bn. This is all stuff that didn't go to Nama.

A large chunk of this debt is to SMEs, their owners or other connected family members. The individual amounts were below the NAMA threshold or it was so heavily entangled in other SME entities that it stayed with the banks.

The main SME business of these borrowers has struggled to stay afloat and in many cases it certainly cannot support the other debts.

So what are banks to do? Lots of SMEs are struggling to get basic working capital facilities for their company, partially because they may well be in default on the other loans. Over 93pc of Bank of Ireland's €3.2bn in land and development loans are in default. How many of them are SME connected? Quite a few I suspect.

Banks have been trying to separate the property loans from the core business as a precursor to restructuring the entire loan. Bank of Ireland has said that it has managed to restructure a lot of these loans.

Other banking sources say it is proving extremely difficult to untangle these loans and in some cases it simply can't be done.

The banks are clearly hanging in there to get more money back. Bank of Ireland has made impairment provisions of less than half of the €2.9bn in defaulted SME loans, and only one-third of the €6bn of investment property loans in default.

What needs to happen? Banks have to apply a suite of solutions to SME and connected debt. This has to include debt write-offs in some cases that will allow these important regional and local businesses to survive. However, there may be a strong belief that because many of these SMEs are in services, like pubs, hotels, restaurants and shops, they are replaceable.

If they close, someone else will come along in the town and set up a new one. That may happen but it isn't always the case. We have all seen businesses in towns up and down the country that had managed to stay open through several recessions, but they have closed in recent years. Legacy debt, often linked to property, has been a factor.

Sometimes it is just changed consumer behaviour with more people opting for retail parks in bigger towns or big supermarket multiples instead of local shops.

Inevitably, after disentangling their loans, banks will still have to move against some businesses. This will see a transfer of ownership take place. Many of these businesses are solid, if they could shake the legacy of bad property decisions. Some will not re-open, but buyers will emerge for others.

This will bring a new energy, approach and vibrancy to some businesses, along with a lot less debt on their balance sheet. The ideal is to find a way of giving existing owners who can make a go of it, every chance to do so, while not holding back a generation who could achieve a lot more.

Irish Independent

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