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Brokers diversifying into writing private debt for business customers could end up exposed to unexpected risk if they do not fully investigate whether the loan is really for business purposes.
Australia’s private credit market for business lending has been growing, with estimates from the Reserve Bank that private credit providers now account for a quarter of all small businesses lending.
While this is good news for SMEs, Non Conforming Loans managing director Ray Ethell (pictured above left) said unwary brokers could be at risk if they mischaracterised regulated loans as unregulated loans.
Regulated or “code” loans are covered by the National Consumer Credit Protection Act (NCCP) which enforces higher degrees of consumer protection for borrowers in the residential market.
Unregulated loans from the private credit market fall outside the remit of the National Credit Code, and are used by SMEs for a variety of non-residential business funding purposes.
Ethell, who recently launched a new business providing private lending options, said demand has been strong due to the current demand for finance from private debt sources.
However, he said he received a lot of enquiries from coded loan applicants, which could be a risk to less experienced brokers should they mistake them for non-code loans.
Ethell said some private lenders would even suggest ways brokers could get from coded to non-coded loans, though this could land them in trouble if the loan “goes pear shaped”.
“The issue is surrounding getting borrowers to sign a business purpose declaration to massage the deal as private lending can be used for business use, not for personal use,” Ethell said.
“ASIC has confirmed through precedents that business purpose declarations are ineffective, including where a broker or credit provider would have known, if they had made reasonable inquiries about the credit purpose, that the credit was in fact to be applied for personal use.”
RedZed national commercial BDM Craig Stuart (pictured above right) said the regulated and unregulated loan issue was “one of the most contentious talking points in the private lending sector right now”.
He said it was important for brokers to understand the difference between the two types of loans, and that on occasion, it could be difficult for brokers when writing these loans.
“Private debt is typically appropriate as an unregulated loan. That is, the purpose must be a genuine commercial or business purpose,” Stuart told Australian Broker.
“Unfortunately, that can sometimes be difficult to work through. Brokers should carefully consider instances where borrowers establish a company to purchase a residential property, for example. Private loans are not the appropriate loan for these borrowers.”
Stuart said private lending had grown during recent challenging times for the mortgage market.
“It’s estimated that the private debt pool under management is tracking towards $200 billion in Australia, representing a massive opportunity for savvy brokers,” he said.
While private debt was not for everyone, due to costs and the short-term nature of private loans, there were many circumstances in which it made sense to consider private debt.
“For example, we recently assisted a self-employed borrower in purchasing an existing business utilising equity in their commercial factory,” Stuart said. “This typifies the types of loans banks find challenging given the nature of the loan purpose but they sit squarely in RedZed’s wheelhouse.”
However, Stuart recommended that, given the complexity and particular purpose of private debt products, brokers should ensure they were educated and understood the market.
“Brokers must equally ensure they only provide private debt as an option to the right borrower,” he said.
This involves doing due diligence on each client, by asking them what the purpose of the loan actually is, and investigating if the facility will be beneficial and meet the client’s needs.
They should also assess if the client can exit suitably within the loan term, Stuart said.
“The private debt sector has seen a plethora of new entrants over recent times with varying degrees of credit experience, capital, infrastructure and terms.
“I highly recommend brokers spend time formulating a checklist of questions before making any commitments, talking to respected colleagues and reading the loan offer closely.”
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