It’s widely acknowledged that the Australian economy rebounded from the GFC much stronger than the US and European markets. But despite this recovery, Australia’s four major banks remain cautious about lending and are often not willing to consider the individual circumstances of clients with seemingly complex financial arrangements.

One such group is small businesses and the self-employed. Many of those Australian SMEs made it through the crisis intact and are now ready and able to expand their businesses. However, on many occasions the major banks are now unwilling to consider further lending as the only business financials available do not reflect the current improved state of the business. With the banks turning away loan requests, one option open to them is an ‘Alternative Income Verification’ loan – the new and improved Low-Doc.

Shedding the negative stigma

Often thought of as one of the causes of the sub-prime mortgage crisis that led to the devastating Global Financial Crisis, Low-Doc loans in their traditional form now have a negative stigma that has dissuaded many from exploring them as a viable option. The good news for small businesses looking to borrow funds is that their prayers have been answered by this newly evolved form of Low-Doc - the Alternative Verification Income loan.

Alternative Income Verification loans are a type of lending where the recipient can provide income proof such as tax returns, BAS statements or a letter from their accountant, unlike Full Documentation loans from major banks, which require 24-month tax returns and other financial records. These new loans provide an alternative for those who cannot access mainstream credit from the major banks.

The positive effects of NCCP

On 1 July, 2010, the National Consumer Credit Protection Act (NCCP) was passed, creating a nationally consistent framework to legislate the way in which credit is regulated. This was a result of comprehensive discussion and negotiation between state and federal governments over several years in order to tighten all legalities regarding low documentation lending.

The new framework clearly lays out the requirements for all credit providers in relation to how they can deal with a consumer – meaning there’s now a greater level of protection for the consumer.

As a result, the NCCP has made things simpler for all Australians to know their rights and what they can expect when arranging any form of credit. It has also meant that a lender cannot make a loan unless they have complied with the responsible lending provision.

Introducing the ‘not suitable’ test

This new provision means a loan has to pass a ‘not unsuitable’ test, which has been designed to eliminate illegal lending practices often performed in the past by fringe lenders or lenders of last resort who provided unsuitable levels of credit to borrowers who were not in a clear position to manage repayments.

In addition to that, new compulsory licensing requirements for all credit providers as part of the NCCP has also begun to weed out these same lenders whose behaviour has not only unraveled the dreams of borrowers in the past, but also brought a very unnecessary element of disrepute to the industry. So therefore under the NCCP requirements, brokers and lenders now have to evidence the borrowers ability to repay their loan without undue hardship. The documentation used to evidence a borrowers ability to repay their loan is fully saleable and the Australian Securities and Investments Commission has made it clear there are options available to lenders, all of which are equally valid.

There is no longer the option of a Low Doc loan as a borrower’s income must be evidenced. The documentation that can be used to provide this evidence ranges from, in the case of a self-employed borrower, the traditional two years tax returns to alternatives such as BAS statements, business bank statements and a letter from the borrower’s accountant. In many cases the alternative options to the traditional tax returns are more reflective of the current state of a business as they provide more up-to-date evidence.

Often tax returns accepted by banks are 18 months old and do not show the current financial health of a self-employed borrower. As a result, there is much greater clarity around what is appropriate for Alternative Income Verification, creating more security and confidence in the loans, which is why the demand for these types of finance continues to grow.

For small businesses

Small business owners seeking funding are now presented with an opportunity and should discuss their options with a broker who understands the credit criteria of the lenders operating in this space. These brokers will be able to place an Alternative Income Verification loan with the right lender each time and the loan will proceed smoothly.

At present, one barrier to the growth of Alternative Income Verification loans is market confidence that has declined for the reasons outlined above. Those lenders who have survived intact from the GFC have proved that they have sustainable business models and are here long-term to support the industry.

Looking to the future

Alternative Income Verification lending is an area where non-banks are likely to emerge in strong competition to the banks. Specialist lenders like Pepper have a deep understanding of the self-employed and small business market and have designed products specifically for this type of customer. These lenders will play a leading role in providing finance to the self-employed and small businesses. Non-banks, being generally smaller and more localised, have the ability to individually assess each loan rather than push it through a credit-scoring model. Alternative Income Verification loans have performed well in Australia in the past and will continue to do so in the future, especially with more stringent guidelines now attached.

It seems inevitable that the self-employed and SME markets will continue to grow. In order to ensure these businesses can access essential funding in this way, it is essential to be aware of the opportunity and have a clear understanding of the new landscape – with confidence we are now on much safer ground than before. We also need brokers and non-bank lenders to embrace the opportunities available to them within this under-serviced market. For them, by gaining a clear understanding of how these loans work, brokers are also very likely to be rewarded for their efforts through increased loyalty from their self-employed client base.