Why bankers are so worried about their small business loan books

That means that 57 per cent of people whose home loan deferrals were due to expire in September – some 22,900 borrowers owing a total of $8.7 billion – felt they were now in a position to meet their loan repayments.

As a result, the Commonwealth Bank has seen a gratifying improvement in its home loan book in the past month alone.

At the end of August, 9.8 per cent of its giant home loan portfolio (measured in terms of value) consisted of loans in deferral. By the end of September, this had dropped to 8.0 per cent. (This translates into some 93,000 home loans, with a combined value of some $37 billion.)

What’s more, October is likely to see a further steep fall in deferred home loans, with deferrals due to expire on some 52,000 home loans (worth a combined $20 billion).

If more than half of home loan borrowers are confident enough to resume repayments this month, the Commonwealth Bank should see its basket of deferred home loans shrink by another $11 billion or so.

But investors will also be keenly aware of some worrying trends lurking in the Commonwealth Bank’s latest figures.

According to the country’s largest lender, the borrowers most like to resume loan repayments have been the lower risk borrowers: the owner-occupiers, who are paying principal and interest on their home loans and whose mortgages are below 90 per cent of the value of their home.

The trouble is that pushes up the risk profile of the home loans that are still subject to deferral. According to the bank’s figures, of the home loans deferred as at the end of September, 34.1 per cent are loans for investment properties, 16.3 per cent are interest only, and 14.2 per cent have a loan to valuation ratio (LVR) of more than 90 per cent.

Of these, it’s likely that Commonwealth Bank investors will be most concerned by the rise in the proportion of home loans with high LVRs, because this means that the bank is at a higher risk of suffering a loss in the event of an eventual forced sale.

Still, investors will be greatly cheered by signs the largest lender has also been making impressive strides in reducing the number of small business loans on life support.

In September, the bank saw a precipitous 23,000 drop in the net number of deferred loans to small and medium-sized business borrowers (worth some $8 billion) on its books, as the bank’s automatic deferrals on small business loans of up to $5 million reached their expiry date.

September’s sharp decline left the bank with some 31,000 small and medium-sized business loans in deferral at the end of the month, worth around $4 billion.

And October is likely to see another steep decline, with some 28,000 loan deferrals (worth some $2.8 billion) to small and medium sized enterprises (SMEs) due to expire in the month.

Despite the Commonwealth Bank’s success in persuading small business owners to resume their repayments, deferred loans still accounted for 7.7 per cent of the bank’s SME loan portfolio as at the end of the September.

This remains a concern, particularly given the consensus in the banking community is that the banks’ greatest vulnerability is from their exposure to small businesses, particularly in troubled sectors such as tourism, hospitality and accommodation.

The Reserve Bank of Australia voiced a similar concern last week, when it warned that “business failures will rise substantially as loan repayment deferrals and income support come to an end.”

It added that “business failures have flow-on effects to their creditors, both financial institutions and other businesses, and their employees.”

In its Financial Stability Review, the Reserve Bank noted that the combination of COVID-linked government subsidies, loan deferrals from the banks, and rent waivers had boosted the “cash buffers” held by businesses since the pandemic struck in March.

As a result, it said the “majority of businesses are well placed to service their debts given the extent of income support, as well as low levels of gearing and falls in interest rates over recent years.”

And it pointed out that the government’s decision to allow companies to claim back previously paid taxes “will further support cash flows for many businesses.”

But, the Reserve Bank warned that segments of the business community are in more dire straits.

“At least 10 to 15 per cent of small businesses in the hardest-hit industries still do not have enough cash on hand to meet their monthly expenses”, it said.

“These businesses are in a tenuous position and are particularly vulnerable to a further deterioration in trading conditions or the removal of support measures.”

It added that “survey evidence indicates that about one-quarter of small businesses currently receiving income support would close if the support measures were removed now, before an improvement in trading conditions.”

The federal government’s budget released last week shifted away from providing income support measures, such as the $102 billion JobKeeper wage subsidy, in an attempt to keep struggling companies afloat.

Instead, it contained measures aimed at supporting companies that are better equipped to survive in the post-pandemic environment.

The author owns shares in the major banks.

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