Wednesday, 19 September 2012

Study suggests that different warning signals can be identified, particularly for smaller firms and borrowers with small versus large loans.

Small firms 'more likely' to default on their loans

By Peter Flanagan
Wednesday September 19 2012

VERY small companies are far more likely to default on their loans, a Central Bank report released yesterday reveals.
The level of indebtedness on an SME only has a real effect on very small companies and not on SMEs with larger balance sheets, it found.
The report on loan defaults by Central Bank economists Fergal McCann and Tara McIndoe-Calder also shows there is a clear link between how long a manager has been with the particular company and the chances that company will default on its debts.
The research is based on the status of nearly 7,000 small to medium enterprise (SME) loans at the end of 2010. Details of the loans were made available by the banks to the Central Bank as a sample of their entire loan book last year.
Nearly one-fifth of loans in construction were in default by the end of 2010, while between 10pc and 15pc of lending involving the real estate, hospitality and manufacturing sectors had defaulted by that time.
Those rates are believed to have risen substantially since then, however.
The research paper demonstrates what it calls the "irrelevance" of financial ratios in trying to predict a default on small loans, but these ratios become much more useful when assessing larger loans.
"Among the largest firms, where the default rate is below 4pc, no borrower level information significantly predicts default.
"The majority of borrower-level determinants are found to have more predictive power among smaller firms and among larger loans, suggesting that particular attention must be paid to the financial health of small firms and borrowers with large exposures," the authors state.
When dealing with smaller loans, the report finds that ratios, "such as the loan to total assets, leverage ratio, liquidity and profitability, are found to be significant predictors of default".
The experience of an SME's managers also plays a large role, with companies far more likely to default when management are less experienced.
"Further, the length of time the borrowing firm's owner or manager has been with the firm mitigates the likelihood of default.
"The study suggests that different warning signals can be identified, particularly for smaller firms and borrowers with small versus large loans."
This is the first Central Bank paper on SME lending since a paper by the same authors compared Irish lending rates to the rest of Europe.
That report caused a huge storm after it showed lending conditions in Ireland were among the toughest in Europe.
Small business groups have repeatedly claimed the banks aren't lending.
Both AIB and Bank of Ireland have maintained they are providing credit to sustainable businesses.
- Peter Flanagan
Irish Independent

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