Published in the Sunday Business Post on 14 September 2014. Reprinted with permission.
According to a report from the Central Bank published last month, one fifth of Ireland’s SMEs have an exposure of some kind to property. In addition, those SMEs who borrowed money to invest in property are almost twice as likely to default as similar size businesses without property debt.
Most of these borrowings originated from loans taken out during the boom period and account for one third of the outstanding bank borrowings of the SME sector. In total, there are loans of € 67.7 billion outstanding to the SME sector which in itself is an extraordinary number, with potentially serious implications for the Irish economy.
The loan performance of Irish SMEs is an issue of major economic concern, particularly from an economic recovery perspective but also because the health of these loans may have a material impact on the performance of domestic Irish banks.
The SME sector is a crucial part of the fabric of the Irish economy accounting for 70% of all private sector employment, according to the Central Bank. This sector has been hit hard by the economic and banking collapse.
In the initial years after the downturn, banks were under pressure to deal with the bigger loan portfolios and the transfer of loans to NAMA. At the time, they did not seem to possess the necessary resources to tackle the debt problem in the SME sector. However, at this stage, Irish banks have put in place structures to deal with the SME loan book. Earlier in the year, Bank of Ireland and AIB both indicated that they had reached resolution in 90% and 65% respectively of their distressed SME cases. The position of the non-Irish banks is less clear as a number of them are exiting the economy and some of them may not have the same sense of obligation to protect the SME sector.
The Central Bank is involved in a process of assessing financial institutions in their efforts to move distressed SME borrowers into longer term solutions, but they have not reported on progress in this regard.
In our experience, many SMEs have a viable and sustainable business model but they are burdened by the overhang of property debt.
Policy makers now need to adopt a balanced approach between creditor and debtor in creating an environment whereby debt restructuring and the sustainability of employment in the SME sector is fostered and developed. Measures should be introduced to enable the separating and warehousing of the property related debt from the core business debt, to ensure that viable SMEs can survive.
The examinership process is a useful tool to enable insolvent companies to explore all opportunities for their survival and it gives them breathing space to do so. Traditionally it has not been suitable for SMEs because of the significant cost involved. However, the new “examinership lite” provisions enable a small company to elect to apply directly to the Circuit Court (rather than the High Court) for the appointment of an examinership. Examinership lite has been promoted as a more cost efficient process for the restructuring of SMEs. However, the only real difference is the lower legal costs relating to Circuit Court jurisdiction rather than the High Court. Otherwise, the professional and working capital costs relating to examinership remain the same. The costs of the process may overwhelm the vast majority of companies likely to seek the solution. A streamlined approach more voluntary in design and with less court input would be more efficient and suitable for companies of this size.
There is a significant link between the SME sector and personal insolvency issues. Significant numbers of directors of SMEs gave personal guarantees to banks for loans made to companies of which they were directors during the boom. As a result, large numbers of company directors remain on the hook. Furthermore, in the boom years many of those in the SME sector were advised to invest in property as a pension or retirement fund and these loans are now impaired and being called in.
Key to the success or failure of the new personal insolvency legislation is whether bank and mortgage lenders will be prepared to accept a write down of secure debt. Some banks are vocal about their reluctance to accept write downs. We believe that all banks would have a preference for informal arrangements to be carried out with the borrowers without reference to the legislation.
The personal insolvency legislation as it stands may not achieve the objective of relieving debt for individuals and directors within the SME sector. In order to secure value in the economy and to deal with the problem of distressed debt in the SME sector, significant changes need to be made to the system to ensure the sustainability and indeed the viability of over indebted entities.
The government needs to constantly review the legislation for its usefulness and effectiveness in dealing with debt in both the personal and corporate sphere.