Briefing note for the appearance of John Trethowan and Catherine Collins from the Credit ReviewOffice, before the Oireachtas Committee on Jobs, Enterprise and Innovation
on 13th November 2012.
The Credit Review Office welcomes the opportunity to update the Committee on the activities of the office, and to outline observations on the SME lending market from our work.
This briefing document will describe:
1) The background to the Credit Review Office operations
2) A summary of our observations of the SME / Farm Lending market.
3) A description of the AIB/ BoI; €3.5bn lending targets set by the Minister of Finance.
1. Background
The Credit Review Office was established in April 2010 under section 210 of the NAMA act. It is empowered to accept appeals from SME and Farm borrowers for new or additional lending up to €500k from the covered banks, principally Allied Irish Banks and Bank of Ireland.
The Statutory Instrument specifies that the Credit Review Office allocates it costs on a pro-rata basis on the appeals received between the two banks. These are billed to the two banks quarterly. The banks’ funding of the Credit Review Office is at arms length and does not influence our impartiality or decision making – nor do the banks seek to influence our decisions in any way. We are very clear on the Credit Review Office mandate to ensure that viable or potentially viable SMEs and farms have access to credit.
The appeals process is borrower driven, and we have invested heavily in advertising on radio and in the press to ensure that the Credit Review Office service is recognised. In addition both AIB and BoI are obliged to advise eligible borrowers which have been declined credit of the Credit Review Office service, and also the banks’ own internal credit appeals processes.
The Credit Review Office also has a mandate to monitor bank behaviours in terms of length of time to process loan applications, the nature of requirements for security for loans, and the rate charged for credit. We examine these as part of each appeal processed.
To date, the Credit Review Office has received 281 applications for formal appeals, of which 175 opinions have been issued and the process completed.
Of these,97 appeals or 55% have been upheld, which has resulted in €10.7M facilities being made available to SMEs and Farms, and in doing so 870 jobs have been created or protected to date.The banks are obliged to ‘comply with our opinions, or explain why they do not’. To date the banks have complied with almost all of the opinions issued.
We have upheld the bank decision not to lend in 78 cases, however in many of these cases we have suggested alternative solutions to assist the business or farms, such as micro finance or asset sales to deleverage.
A further 22 cases have required additional work to be completed by either the borrower or the bank to make the lending deal viable. I have included tables showing a breakdown of all cases in an appendix at the end of this briefing paper.
In addition to this formal recording many more SME /farm enquiries have been resolved by the interaction between the Credit Review Office helpdesk and the banks without the need to proceed to the formal appeals process. The helpdesk has taken 1800 calls to date.
The Credit Review Office also provides ongoing assistance to the Ministers in the Department of Jobs, Enterprise and Innovation in liaising with all banks in seeking resolution of requests for assistance from businesses directly to DJEI, or from Deputies.
We do not log these informal interventions by the Credit Review Office, but would estimate that it would double the statistics for lending and job preservation on the formal appeals mechanism.
I have published 9 progress reports on the activities in the Credit Review Office which included commentaries and recommendations on the performance of both the supply side (banks), and the demand side (SMEs/farms).
Many of the recommendations arising from these reports have already been implemented which have included :
- Formal surveys on the demand for credit by SMES;
- The increase in the appeals limit from €250k to €500k;and
- The introduction of a standardised application form, business case and cashflow which has been adopted by all the major banks and the new microfinance fund.
These reports can be found under the publications tab at
2. Our key observations of the market
The Credit Review Office is uniquely placed to commentate on the SME lending market in seeing actual declined loan applications, and interacting between borrowers and banks.
The problems caused by profligate asset backed lending prior to 2008 continue to challenge our banks and influence their current behaviours.
In the past 4 years we have seen a contraction in the number of active banks lending into the SME market to only 3 main players - AIB, BoI and Ulster Bank. In addition,someof these banks are now also reducing their physical presence by closing branches and reducing staff. This lack of competition could lead to a dysfunctional credit supply.
We have a number of banks which have either been prohibited from new lending (Anglo/IBRC), have announced they are winding up / leaving Ireland (Certus/ BOSI), or have strategically ‘shut up shop’ to concentrate on deposit taking or other specialist activities (smaller foreign owned banks). These banks all maintain legacy SME / Farm borrowing, and this will become a challenge when more of these borrowers require new credit to participate in an economic recovery
Perhaps a symptom of this lack of competition is in all the major banks pursuing the same business model of largely centralising credit decision making, which is unpopular with both SMEs and farms. This centralisation, coupled with the reduction of many rural branches, and the continuingchurning of front-end staff has led to many SMEs feeling isolated and remote from their banks.
Most business in Ireland is transacted on a basis of a relationship and trust, and these current very unpopular bank delivery business models mark the passing of traditional relationship banking on which Irish Banking was founded and thrived, and which was also a vital part of the wider national business culture. Whilst it is acknowledged that banks have their own internal prudential and cost challenges to resolve, local relationship banking was not the main driver of the problems which the banks have encountered.
As our banks deal with the asset quality legacy of the tiger period, they have continuing challenges in their current residential mortgage and SME/Farm loans. Banks advise that a significant % of their SME loans are challenged or criticised. To date the banks have not been given recognition they deserve for the debt forbearance on business lending which has kept many businesses and jobs in existence, whilst awaiting an economic upturn driven by a recovery in domestic demand.
The Troika have asked that banks now move beyond short term forbearance to a more structured workout plan for those impaired /criticised SMEs which can show a viable business plan for present or future viability. This may mean that the weakest businesses, or those that choose not to work with the banks will have to fail.
My last two reports have encouraged banks to do more to support ‘enterprise type’ lending. My view is that a low risk appetite and overly tight lending policies have gone too far to ensure that new lending and future loans do not cause a repeat of the recent past. This over-prudence may risk banks not fully supporting an economic upturn, when SMEs will require access to more working capital and seek to invest for a more profitable future.
One of the suggestions implemented from previous Credit Review Office reports has been the ½ yearly Department of Finance survey on SME lending demand. Work is underway to complete the latest survey up to September 2012, and this will be published shortly.
The most recent available survey results up to March2012 show a consistent level of recent demand for credit from @ 37% of SMEs. This low level of demand is understandable, as most businesses have adjusted to current trading levels, and the demand for new investment loans is subdued pending economic activity levels which can better assure a return of investment for businesses..
The survey also highlights the challenges facing SMEs with only 45% reporting a profit in the survey, 28% broke even, and 27% reported making losses. When coupled with the levels of challenged and criticised lending in the banks’ legacy SME loan books, the size of the national challenge can be more readily understood.
My previous reports have highlighted some of the challenges faced by SMEs and Farms. These can be characterised into four main areas:
1) Low consumer confidence, and the level of domestic demand for goods and services from non exporters, suppressing current business turnover and profits (see above).
2) Some businesses had invested in realistic and feasible capital projects during the boom years (at boom prices). The borrowing costs of some of these projects cannot now be sustained at current activity levels. (e.g. Car showrooms; Retail capacity which now exceeds the domestic demand turnover levels).
3) Some businesses invested their reserves from the tiger years into fixed assets (principally buy to lets, or foreign property). These assets have now fallen into breakeven or negative equity and provide no cashflow benefit to struggling businesses. Indeed in some cases servicing the borrowings on these assets are a drain on current business cashflow.
4) As well as bank forbearance keeping many SMEs in existence, many business owners have also ploughed their personal cash into their businesses to keep them going, by way of Directors loans. It is debatable, after 4 years of challenging trading conditions, whether there is much more cash available from this source.
The importance of the SME/farm sectors is increasingly being recognised as sitting alongside Foreign Direct Investment as cornerstones of the nation’s economic strategy. SMEs provide @70% of all private sector employment, and as such are also a significant source of repayment capacity (via employees) for the banks’ mortgage books. The two loan books are heavily interdependent.
Banks whilst undoubtedly being a major driver of the problems Ireland has faced, are also a vital part of the solution going forward. The Credit Review Office is one of a series of government tools to ensure that this fundamental economic system works as well as it can given the challenges both the credit supply and demand sides face.
3. Banks’€3.5bn targets
There remains considerable confusion within commentators on the lending targets set by the Minister of Finance, and the figures reported to the Central Bank. Simply put, the two sets of reports have different objectives and measure different aspects of lending:
(i) The Department of Finance targets only apply to the two pillar banks. They are designed to motivate the two banks to make loans, and primarily focus on the level of loans sanctioned by these banks. This is ALL money being made available to SME Businesses – whether they actually use it or not.
Some sanctioned term loans take some time to be drawn down, and some never do, as investment projects are deferred or cancelled. Of the overdrafts sanctioned, these will not ever be 100% drawn down as this would mean that all businesses are using their full overdrafts at the same time. Overdrafts utilisation rate varies from 0% to 100% in individual firms, and at present aggregate usage is in the region of @ 40%.
(ii) The Central Bank of Ireland reporting primarily measures actual loan amounts outstanding on all banks’ balance sheets.
This is summarised in the following tables:
Department of Finance Reporting / Central Bank ReportingNumber of banks reporting / Only AIB and BoI / All Banks
including those which have ceased trading and are winding down their loan books
Information reported / Loan Sanctions i.e. total amount made available.
This includes:
(i) Loans sanctioned but not yet drawn or utilised e.g. overdrafts are typically only @40% utilised.
(ii) ‘contingent liabilities’ to support trade, such as letters of credit for exporters and performance bonds for certain contracts.
These only become drawn balances if the transaction defaults.
(iii) restructuring activities
without which many more businesses would have failed, however unless this also includes ‘new money’ the amount is already on the banks’ balance sheets. / Loans Drawn Down i.e. only the amount of credit used and appearing on bank balance sheets.
Categories Reported / All trade sectors. / All trade sectors but excluding lending to:
(i) Property and Construction
(ii) Financial Intermediation
(iii) SME personal promoters for business uses.
(iv) Any commercial lending to Government bodies.
The Department of Finance targets cover new lending and restructured loans. The logic behind this is:
1) Restructured lending are loans which have come to the end for their contractual period and are due for repayment. Where the borrower is unable to repay the loan the capital must either be re-borrowed from another lender, or restructured onto another loan contract in the same bank.
If the SME is unable to repay the debt due, at present it is unlikely that they will find another institution willing to re-bank the facility, given the small number of playersin the market as described previously in section 2;coupled with banks current reluctance to countenance others’ debts at this time. This leaves restructuring the debt onto a new contractual term in the current lender as a vital element of continuing support for SMEs, and the employment they sustain.
2) New Lending is a vital component of economic growth and it is this area which the Credit Review Office is encouraging banks to be more accommodating. The level of new lending is however tempered by the level of current economic activity and this is reflected in SME loan demand levels of @ 37%, as previously outlined in section 2. The challenged financial condition of manySMEs is also a prudential constraint on their ability to sustainthe repayment costs of new loans being made.
If the Department of Finance lending targets were to be restricted to new lending only, the current levels of €3.5bn for each bank would need to be dramatically reviewed downwards to reflect the current capacity of the SME economy, the actual demand for new credit, and the challenged condition of many SMEs.
To put this in context, the two banks cumulative sanction targets for 2012 currently amount to €7bn, and if Ulster Bank were expected to perform to the same level this would take the target lending figure up by Ulster’s market share @20%, to @€8.75bn.
The current total value of SME lendingin Ireland is @€27bn., (using the Central Bank measurement criteria which excludes real estate, investment and financial intermediaries).
Thus an €8.75bn increase in lending new money would require @30% increase in outstanding balances; notwithstanding that demand levels for new credit from SMEs is relatively low @ 37%, and the prudentially challenged financial nature of many of the SMEs ability to sustain the repayment costs of borrowing new money.
Making this level of new credit available would increase this sector’s debt to GDP to twice the level in Germany, the EU’s strongest economy.
My view is that the current sanctioning targets are appropriate in encouraging the pillar banks to sustain existing SMEs’ lending - particularly in light of the Troika’s advice to move to longer term resolution of SME legacy debt; and also to monitor the level of new money to ensure that an economic recovery is fully supported by these banks.
The Department of Finance and myself continue to work with the Central Bank and the two banks to ensure that both measurement systems are fully understood by policy makers.
Appendix
Summary of Credit Review Office activity on formal appeal applications:
Applications:
Application Rec’dbut held at Office
until eligibility
confirmed with
Bank / Overturned by Internal
Appeals/ got credit* / Abandoned /Withdrawn by customer** / Application Received
and proceeding
through Review
process / CRO Decision / Total
Banks’ Credit
Decision Upheld / Bank’s Credit Decision
Disputed / Bank
Subsequently Provided
Credit / More work required by Borrower and Bank or withdrawn by customer
AIB / 13 / 10 / 10 / 14 / 44 / 49 / 9 / 149
BoI / 5 / 10 / 13 / 9 / 34 / 48 / 13 / 132
Total / 18 / 20 / 23 / 19 / 78 / 97 / 22 / 281
Outcomes:
Appeals / Banks’ Credit Decision Upheld / Jobs at risk / Bank’s Credit Decision
Disputed / Bank Provided Credit / Jobs protected
Total Numbers / €7,152,653 / 515+35p/t / €10,713,724 / 823+46p/t
AIB / €4,213,700 / 341+ 21p/t / €5,587,874 / 359+ 14p/t
BoI / €2,938,953 / 174+14p/t / €5,125,850 / 464+32p/t
Summary of Banks’ Formal Internal Appeals