Non-bank lenders in Australia must take holistic approach to weighing up risk

According to data from the Australian Securities & Investments Commission (ASIC) informing the federal government’s July 2023 report into corporate insolvency, the number of businesses entering administration remained at low levels until as recently as April 2022. A combination of historically low interest rates, government stimulus support throughout the Covid-19 pandemic and business support measures by the Australian Taxation Office have contributed to a lower number of businesses facing financial distress or insolvency in recent times. As a result, non-bank financiers - namely registered financial corporations and certain managed investment funds, such as credit and hedge funds - have experienced a relatively favourable market, especially as banks have retreated somewhat during this period.

The market, however, is turning. According to the most recent data from ASIC for insolvencies in April, there has been a 64% increase in the total number of companies being placed into administration when compared with April 2023. ASIC also reported consistent year on year increases in the number of companies entering external administration for the entirety of the financial year 2023-4.

In addition, the Reserve Bank of Australia recently reported that, while banks have limited exposure to businesses and are well placed to manage a further worsening in credit quality, “non-banks tend to be more exposed to riskier business loans”.

To navigate what appears to be an increasingly volatile market, non-bank lenders will need to have a clear picture of the risk they carry. Given how varied their approaches can be to key aspects of deal making and monitoring – particularly in relation to their approach to documentation, their level of experience and the types of legal advisers they appoint - some non-bank lenders will be more successful at navigating the market than others.

Differences in approach to documentation

Compared to the bank market, there is less consistency among non-bank lenders in their approach to documentation, due diligence, processes around closing transactions, record keeping and on-going monitoring - including how frequently standard form documentation is independently benchmarked against competitors and reviewed for risk.

Some leading non-bank financiers have developed sophisticated structures and bespoke provisions in their documentation, which create options and protections in times of distress and debt restructuring. Similarly, some non-bank lenders have detailed policies around what is ‘non-negotiable’ when first signing up new customers and others have a more bespoke approach.  But this level of sophistication and focus on documentation and process is not uniform.

Depending on the approach taken, some non-bank financiers could be carrying a higher level of risk than others.

Differences in skills and experience

The skills and experience of non-bank financiers in managing a deterioration in borrower performance also varies. The Australian legal system is relatively creditor friendly and there are a range of strategies available to the financier, but the outcomes of each option can differ dramatically. 

The strategies experienced financiers adopt when dealing with a distressed borrower range from proactive engagement, waivers and standstill agreements, restructurings and sales of debt, through to quasi and actual enforcement processes. Some non-bank financiers will have less experience in assessing and deploying these strategies, which could create risk if decisions are required to be made quickly.

Differences in the types of legal advisers appointed

The legal advisers appointed by non-bank financiers vary from the large national and international, to smaller specialised firms, with each option carrying its own pros and cons. 

The large firms lack independence when it comes to intercreditor issues with the ‘big 4’ Australian banks – namely, the Commonwealth Bank of Australia, Westpac, National Australia Bank, and Australia and New Zealand Banking Group. These banks also tend to have a higher cost base when appointed by financiers to manage distressed borrowers.

Smaller firms can have independence, but less breadth of market cover to reliably benchmark a financier’s documentation with the market and deliver up to date best practice, and less capacity to manage a transaction involving borrower distress, which can involve intense bursts of activity at short notice and high level strategic decisions.

Given how much these approaches – and corresponding risks – can vary, it is time for non-bank financiers to assess how much risk they are really carrying, on a holistic basis. The extent to which they can do this successfully will go a long way to determining how they fare in a market that is tougher than what they have been accustomed to.

Co-written by Jemimah George and Richard Beauchamp of Pinsent Masons.