How interest rates hikes are affecting SME financing

This article was current at the time of publication.

Australian official interest rates have risen at an unprecedented pace, from record lows less than a year ago to their highest level in more than a decade.

The effects are being felt right across the economy. Hundreds of thousands of Australian homeowners are now on the edge of a steepening mortgage cliff, with their ultra-low fixed-rate home loans soon to expire.

When that happens – and they’re automatically shifted by their lender to a much higher variable interest rate – many households will face a cash flow crisis as their monthly loan repayments soar.

The same scenario is playing out for hundreds of thousands of Australian small-to-medium enterprises (SMEs).

Reserve Bank of Australia (RBA) data shows SMEs collectively had more than $475 billion of outstanding loans at the end of December 2022, with almost one-quarter ($110 billion) on fixed-rate loans.

Small businesses, defined by the Australian Bureau of Statistics as enterprises employing fewer than 20 people, accounted for $142 billion of the total. About half ($68.2 billion) were secured by residential properties, according to the RBA.

That’s an impending problem for smaller businesses. As well as the certainty of higher loan repayments as interest rates rise, many small business owners face the prospect of their loan security value being diluted if home prices across Australia continue to fall.

Challenges and opportunities

Finance industry professionals note that many SMEs are already finding the current economic environment difficult because of higher loan repayments, staffing and supply chain costs.

As the cycle of rate rises aimed at combating inflation continues, they expect financing conditions for many SMEs to worsen.

“One in four mortgages are coming off a fixed rate in 2023,” says Daniel Behman, Managing Director of Melbourne-based business finance broking firm Core Financial Group. 

“The implication of that, particularly in the small business space, is it can create challenges where lenders look to lend against the equity of a house.”

However, Behman says there are several things SMEs can do to mitigate the problem.

“The first is to make sure you have a really good business plan,” he says. “Speak to your accountant to make sure you understand the numbers, and that the numbers tell the story of not just what your business has done but what your business is going to do.”

Behman says it’s also important for business owners and their advisers to see if there are ways to reduce costs or create better efficiencies that can create additional cash flow, so they don’t necessarily need to borrow extra money.

Brent Szalay FCPA, Managing Director of Melbourne-based financial and business advisory group SEIVA, says many SME owners use the equity in their house for part of their business working capital.

“Refinancing may not be as easy as it once was,” Szalay acknowledges. 

“With house prices mellowing at the moment they may not be able to access the funds they could have in the past to get themselves out of tight situations.

“Some of our clients are forecasting lower profits because they are in industries that are project-based and people are deferring projects.”

He agrees that SMEs should first take stock of their situation to understand their costs and where they can be reduced.

“We advise SMEs to look at anything they can delay, and to see if there’s any other way they can get more income to counteract some of their costs,” he says.

“But access to funds is going to be difficult for businesses that are trying to grow and expand.

“Some business owners are trying to raise extra money by selling off assets they don’t need, like holiday homes, caravans or boats, to try to stay ahead of the game.”

Lenders more cautious

Behman says that in the current environment, lenders have become reticent and are paying close attention to the ability of businesses to withstand financial shocks that may occur in the next 12 to 24 months.

“The most obvious one is rising costs,” he says. 

“It’s no surprise that lenders are aware of this, that staff costs have increased, materials have increased, and there are costs from supply chains that are flowing through to all parts of the business. Rents have increased, particularly for those who have CPI fixed-price increases.

“Lenders are looking at all this and really assessing not just the business’s ability to withstand that, but also what the business owner’s plan is to overcome some of these things.

“It is important business owners are aware of what levers they can pull. Can costs be passed onto customers – are costs going to be reduced within the business, are they going to employ other strategies that might help them, are they going to engage a consultant, and are they going to work closely with their accountant?”

Behman warns businesses that aren’t properly prepared with their application – and able to properly articulate their circumstances – face a higher risk of being declined.

Jason Bertalli FCPA, Director of Melbourne-based BNR Business Accountants, says more lenders are trying to shift their risk by asking accountants to write letters stating their clients can repay their business loans.

“We push back pretty hard on that in our firm,” Bertalli emphasises. 

“Especially the second-tier lenders [who] are now starting to push [borrowers] on this. You know – ‘give me a letter from your accountant that says you can afford it’.”

Bertalli says there are risks in doing this and accountants should be willing to say no to [some] clients.

“No. I understand your circumstances, but I’m not going to be a shadow guarantor for your loan to your business, especially in trying times.”