Terry Haydon says it is time to make business loan costs transparent, and extend the CCCFA true cost of credit requirements to SME lending. That will bring both fair competition and better options for borrowers

By Terry Haydon*

The Government says it is assessing the problems SMEs currently have accessing working capital and development funding.

Finance Minister Grant Robertson is reported as saying he wants “to ensure that small and medium enterprises can get the access to the credit that they need” and; “That’s where the Small Business Cashflow Loan Scheme would come in. What I am talking about is a much more long-term scheme about how we support small business to get access to finance”.

The Finance Minister’s comments contradict the findings of the MBIE Small Business Council Report (SBCR) which called for an open and transparent market place. He then seems to confuses specific failed functions of the New Zealand capital marketplace, that have failed business rather than the failure of the capital market ‘per se’ to provide a level playing field for all lenders to compete in an efficiently structured open, transparent and honest environment.

The issue is set out clearly in the SBCR, pages 17 to 20. The report was produced at the request of Minister Stuart Nash and summarised the issues that needed to be addressed regarding access to various types of finance required to support business and in particular the small to medium business sector.

1. "Small business requires access to the right kind of finance quickly when they need it, at affordable rates and for the right reasons.”
2. "Measures need to be taken to make small business more attractive borrowers for lenders and remove the need for property as collateral."
3. "A lending and capital marketplace would provide greater transparency of available sources of finance and lending criteria, making for a level playing field for small business. It should also create greater competition amongst finance providers which would improve outcomes for small businesses seeking funding."

It is the New Zealand capital market that has failed business. Successive governments have continued to neglect their primary role to create and maintain a transparent, efficient and open playing field for both borrowers and lenders alike.

The current Minister of Finance is going down the same path as his predecessors, and the Minister seems on a path to have the taxpayer subsidise selected funders when the capital market, if given the chance, would provide the required funding. Such schemes as contemplated by the Minister of Finance have failed in the past and by selecting a chosen few to benefit from the subsidy rather than the market as a whole has the effect of destroying those providers who are not part of the subsidy scheme.

Examples.

• The 2008 Crown Retail Deposit Guarantee Scheme put in place to support failed finance companies destroyed many second-tier lenders who were excluded from the scheme because they did not fail and eventually the scheme cost the taxpayer around NZ $2.00 billion. Many solid and well managed providers could not compete with the Government guaranteed scheme backing the failed companies to obtain retail funding and eventually left the sector leaving a dearth of second tier providers until some of the failed recovered, at the taxpayers’ expense.
• The recent Government Guarantee Scheme that made around NZ $27 billion available to banks at a subsidised interest rate with a security guarantee of 80% of any exposure just exacerbated the failure of the capital market and was used by some banks to take out second tier lenders who could not compete with the terms and rates of interest offered the banks and the few selected finance companies.

The ongoing need to fund business described by the Minister is different to the support offered business due to the Covid-19 catastrophe. The Government's Covid-19 packages is about survival of the business sector and should not to be confused with the ongoing funding of the productive sector of New Zealand economy.

The failure of the current market to provide access to Items 1 and 2 in the SBCR is no doubt the catalyst for the Minister of Finance to propose a revamped Small Business Loan Scheme, however the failure to fulfil these particular market functions is a symptom of the failure of the current capital marketplace, not its lenders. That is why the SBC in its report identified the shortcoming of the current market place and its suggestion for a revitalised capital market to include:

• A lending and capital marketplace that would provide greater transparency of available sources of finance and lending criteria, making for a level playing field for both small business and lenders.
  • It should also create greater competition amongst finance providers which would improve outcomes for small businesses seeking funding.
  • The SBC also recommend a Government Guarantee scheme which totally contradicts its support for a truly open and competitive market place and as such ignores the benefits of a truly competitive marketplace. It is illogical to suggest, pending the establishment of a truly transparent and open market, that the Government, on behalf of taxpayers, could do a better job than experienced professional lenders and again put taxpayers’ funds at risk on loans that seasoned professionals would not offer.

Why is a revitalised capital market necessary?

Through a loophole in the legislation most current business lenders are misleading business borrowers as to the true cost of credit.

The major commercial trading banks who offer business overdrafts with the mandatory line/management fee are equally guilty as they do not provide annualised costs of credit for these fixed charges, unlike the requirements of the Credit Contract & Consumer Finance Act where annualised cost of credit calculations are mandatory.

Relying on this loophole other business lenders are either quoting in monthly instalments, flat interest rates and/or fixed charges that are not disclosed in the annualised cost of credit calculation, meaning:

• The borrower is unaware of the true cost of credit.
• The market lacks transparency and openness as to a lender’s facilities.
• The borrower has no reliable universal yardstick to compare the true cost of competitive options.
• Both borrower and lender are deprived of a level playing field to operate in.

Without these fundamental requirements the market cannot operate as an efficient, transparent and open market place as desired by the SBCR and the Small Business Minister.

All borrowers, not just consumers, should be able to rely on lenders to disclose the true cost of borrowing to them.

Consumers must be told of borrowing costs but SME’s need not be

In most cases consumers are protected by the Credit Contracts and Consumer Finance Act (CCCFA) and the Financial Markets Conduct Act (FMCA). However, business owners have little such protection.

As noted by the Commerce Commission it means that without clear guidelines SME owners are being misled as to the true cost of credit.

It is disappointing that there is no compulsion to show the true annual interest rate and thus providers can confuse borrowers by publishing flat rates and not the true interest rate.

“The Commission’s view is that disclosing the flat rate without a clear explanation of how the interest is calculated has the potential to mislead customers. Without a clear explanation, customers may not understand the basis on which the cost of credit has been calculated and/or assume that the flat rate is the same as an annual rate. This may give rise to a possible breach of the Fair-Trading Act.”

If the Commerce Commission is unhappy with the use of a flat rate calculation for consumers, it is likely horrified by the antics of some online lenders who do not offer an interest rate at all. Only a repayment sum that conveniently disguises their annual interest rate. Rates which can reach up to and some times over 100% pa when annualised.

There is just no rationale for this omission by the Commerce Commission other than perhaps ongoing lobbying from the Banking sector on the premise floated when the CCCFA was introduced, ‘that business should know how to work out the true cost of credit’.

This assumption is unrealistic when, in my experience, even many chartered accountants seem unable to explain the difference between flat and true rates of interest. So how can it be expected of the average business owner?

Classification aside, both consumer and business borrowers should be able to rely on the disclosure of the true annualised cost of borrowing by lenders.

The Commerce Commission took Harmony Money to task for obfuscating the true cost of credit by excluding a 'platform fee' from its disclosure document yet it allows the use of similarly misleading flat interest rates or additional flat fees (account management or line fees) by the banks and other lender that have taken advantage of this apparent ‘loophole’.

To put this into context and as an example one of the major commercial trading banks offers business overdrafts at a disclosed cost of credit at around 16.50%pa with an undisclosed annualised line/management fee of 1.80%. When annualised the undisclosed cost of credit ranges from between 18.3% pa (16.5% + 1.8%) to 38.1% pa (16.5% + 21.6%) depending of the collective use of the overdraft throughout the previous twelve-month period.

• 18.3% pa relates to maximum usage thought out the twelve-month period, effectively a term loan, not what overdrafts are designed for, whereas
• 38.10% pa is the true cost of credit if the usage is restricted to a collective one month out of the twelve-month period.
• Even at a 6-month collective usage scenario the undisclosed cost of credit becomes 20.1%pa and far from the 16.5%pa disclosed on the borrower’s bank statement.
• Another quirk of the current structure is that the quicker the overdraft is repaid, from monthly cashflows, results in a higher cost of credit which must be seen as less than equitable from a borrower’s perspective.

The only difference between businesses being charged flat interest rates and fees comparable to Harmony Money's ‘platform fee’ is the lack of legislation akin to the CCCFA to protect business borrowers, leaving business borrowers vulnerable to misleading undisclosed costs when borrowing.

Solutions

It is clear business is being disadvantaged by the lack of transparency and fair trading by some lenders. However solutions are readily available. The prime advantage would be the ability to restructure the available security (Mortgage and/or GSA) so that it is evident that the borrower is paying too much for too little, however to get to that point the borrower needs to know just what the true cost are of their current facilities.

Risk-based loan pricing requires fundamental core disclosures.

Simply extending the CCCFA requirement of disclosing the true annualised cost of borrowing to business borrowers will go a long way to assisting in establishing the transparency required for business lending, one not skewed in favour of the lender and will immediately help solve the three problem areas identified by Minister Nash and the MBIE Small Business Council's Report.

Terry Haydon is managing director of Cashflow Funding Limited, and Commercial Factors Limited, an SME lender in Auckland. You can contact him here.