Review of Lending to SMEs. Final Report March - September 2009

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1 Review of Lending to SMEs Final Report March - September 2009

2 Table of Contents Page Introduction 1 Summary 5 Section 1 Approach Adopted 11 Section 2 Demand for Credit from SME s 17 Section 3 Supply of Credit 35 Appendices 61 Appendix I Demand Survey Questionnaire Used Appendix II Data Definitions Appendix III Assumptions & Limitations

3 Introduction

4 Introduction Background In June 2009, Mazars prepared a report on SME Lending (the Mazars Report) which was published by the Department of Finance following a Review involving lending to SMEs across five banks. This Review was required under the Bank Recapitalisation Programme (February 2009), in order to determine the actual position in relation to the availability of credit to SMEs in Ireland and to recommend appropriate actions to improve credit availability, taking account of the terms of the Credit Institutions (Financial Support) Scheme The current report is being produced as a follow up to the June 2009 report and seeks to determine the actual position in relation to lending to SMEs in Ireland in the period March to September 2009 based on an analysis of both the demand for and supply of credit to SMEs. The examination of demand for credit was conducted in October 2009 focusing on the period March 2009 to September 2009 and the examination of the supply of credit was conducted in November2009 focusing on the same 7 month period. Customer Size This Review was conducted on the basis of companies falling into one of three categories of SME, as determined by the EU definition of each category, which can be broadly summarised as follows: Employees Turnover Balance Sheet Value Micro <=10 <= 2million <= 2million Small <=50 <= 10million <= 10million Medium <=250 <= 50million <= 43million Analysis of the Demand for Credit This involved an independent and comprehensive study of a statistically representative sample of Irish SMEs in October Individual SMEs were asked a series of questions, based on a questionnaire prepared by Mazars and set out in Appendix I to this Report. This study was conducted by a third party specialist firm Ipsos MRBI (formerly TNS MRBI) in conjunction with Mazars, and the results of the analysis of the responses provided by SMEs are set out in Section 2 of this Report. Scope The scope of the September 2009 report included the following: Analysis of the Supply of Credit A study of the supply of credit amongst the five banks participating in the Review was conducted by means of a detailed analysis and review of information and data held by each of the five participating banks over the period March to September 2009 as detailed in Section 3 of this Report. 2

5 Introduction Credit Products The Review was limited to the following credit products as set out in the Code of Conduct for Business Lending to Small and Medium Enterprises, issued by the Financial Regulator in February 2009: Loans Terms loans (often loans and term loans are grouped together and are not separately distinguishable) Overdrafts Invoice discounting Leasing Hire purchase (often part of leasing). Any products that make use of credit insurance e.g. supply line credit product, not specified in the Code of Conduct, have also been included in the Review. The initial Review, published in June 2009, also included an analysis of the following, none of which have been examined in this Review: Credit policy and its application Credit pricing and its application Changes in bank lending including terms and conditions of credit, security, repayment terms, credit insurance and rates charged The reasonableness or otherwise of refusals by banks of requests for credit. Participating Banks The following five banks who participated in the initial Mazars Report (June 2009) are included in the current report: Allied Irish Banks (AIB) Bank of Ireland (BOI) Ulster Bank (UB) Anglo Irish Bank (Anglo) National Irish Bank (NIB) A number of additional banks have indicated their willingness to participate in future quarterly reports Data Elements As in the June 2009 report, this Report includes an analysis of the following: Exposure Credit applications Approvals/ declines Overdrafts limits v utilisation Credit quality The following additional data elements have also been introduced in the current Report: Drawdowns Flow back of credit Reclassification This Report, which covers the period March to September 2009, involved a more in-depth analysis of SME lending by participating banks than that represented in the June 2009 SME Lending Report. Additional information obtained has resulted in the technical reclassification of lending in a small number of instances. This lending 3

6 Introduction had been previously included as SME lending under the terms of this Review and has been reclassified in this Report. This has led to revisions in both the product category and sectoral exposure figures. The overall impact has been to restate the value of lending to SMEs by some million but overall trends in lending in this and the earlier report are unaffected. Our work was specific in scope and nature and was based solely on the review of information and analysis of data provided to us in the form of a data return by the five banks who participated in the Review, together with an independent study we conducted of the demand for credit. Future Quarterly Returns The 5 participating banks in conjunction with Mazars and the Irish Banking Federation have agreed to report on lending to SMEs on a quarterly basis. The basis of this reporting will be similar to the information presented in this Report, and over time, and if it is possible to do so, may also include additional information on credit supply, interest rates and conditions. We have relied on assurances provided by individual banks as to the completeness and accuracy of the data and information provided to us. Furthermore, we have relied on explanations given to us by individual banks without having sought to validate these with independent sources in all cases. Mazars assumes no responsibility in respect of, or, arising out of, or in connection with this document. In addition it is proposed that an additional number of banks will participate in future Reviews Mazars December

7 B56 KFNC AI S Review of of Lending to SMEs Demand Survey Summary Results Input for Ulster - Allied Bank Irish Ireland Banks Limited Plc ackground Supply to the Independent of Demand Detailed Credit inancing Context ompany for ey Terms Volume Approach Recommendations Demand Credit Bank of the Information August ntroduction onclusions the of from Reference Financing ppendices ppendix Insurance Business ummary Adopted Activity Survey Review 2009 SMEs III IV II I September 2009

8 Summary The following is a summary of the main points arising from the Review of lending to SME s, covering the period March 2009 September 2009: Similar to the June Review, this Review was conducted in two parts; an examination of the demand for credit amongst SMEs, conducted by means of a comprehensive survey of Irish SMEs across all sizes of company and sectors in the economy and an examination of the supply of credit by the banks, conducted by means of the analysis of a data return provided by the five banks who participated in the Review, and some limited testing of internal bank credit systems and data returned. The examination of demand for credit was conducted in October 2009 focusing on the period March 2009 to September 2009 and the examination of the supply of credit was conducted in November 2009 focusing on the same 7 month period. Demand Side Highlights 46% of survey respondents made one or more requests for credit in the 7 months to September 2009, representing a reduction in the demand for credit in the period of approximately 6 percentage points when compared to the previous demand survey included in the June 2009 SME Lending Report. Of those requests for credit 79% of applicants made a formal request (defined as filling out formal application form which is assessed internally by the bank). Only 11% of respondents indicated that they had requested or applied for a form of non bank finance The most common reasons for requests for new credit, amongst demand survey respondents, were for working capital/cash flow reasons, to address declines in business revenues and to support a slowdown in debtor collection. The most requested products were loans, followed by increased overdrafts, leasing/hire purchase products and new overdrafts 6

9 Summary Survey responses indicated that SMEs continue to operate in difficult trading conditions in the 7 months to September % of respondents reported a continued decrease in turnover with 45% experiencing a decrease in turnover of 20% or more. A levelling off in the rate of decline in employee numbers is apparent in the 7 months covered by this Report. The most common reasons for decline cited by respondents to the demand survey were change in bank lending policy as was the case in the June 2009 demand survey, however it is important to note that on this occasion decline in business performance was now recognised by applicants as one of the main reasons behind the decline of an application for credit (16%), this represents a substantial movement in the 7 months to September Of those who were successful in their request for credit 13% did not (either wholly on in part) avail of those facilities, primarily to the fact they did not need it at that time. Supply Side Highlights Total lending to the SME sector, as ascertained by the supply side review, has decreased from 33.6 billion in February 2009 to 32.7 billion in September 2009 or by 2.6%. Total SME lending excludes lending to development and speculative construction, speculative real estate and certain other non relevant subsector as outlined in Section 3 below. The number of formal applications for credit received by the participating banks continued to decrease in the current review period. In the prior period the volume of formal applications decreased by 11%. In the current period the volume decreased by a further 23%. In value terms formal applications received by the participating banks decreased by 42% in the prior review period, followed by a decrease of 27% in the current review period. This indicates that participating banks are experiencing a continued decrease in demand for new credit 7

10 Summary The quality of the SME loan book as measured by bank credit grading systems deteriorated significantly in the period under review. In June % of lending (in value terms) was contained in the Watchlist or Impaired categories i.e. customers who are operating in excess of their repayment obligations. In February 2009 the percentage had increased to 22% and by September 2009 it had increased further to 32%. This indicates that at September 2009 approximately one third of total SME customers represented by participating banks are operating in excess of their repayment obligations. A review of the average utilisation of approved overdraft limits across the participating banks shows that 48% (or 2.6 billion) of approved overdraft limits were on average unutilised throughout the period to September In the prior review period on average 51% (or 3 billion) of approved overdraft limits were unutilised. In the period March 2009 to September 2009, an amount of 2.6 billion was drawn down by customers of the participating banks against approved Loan and Finance & Leasing facilities. This is the first period for which we are reporting on drawdowns and as such no comparison is available. The average flowback rate for the seven month period covered by this Review was 10.7%. This equates to an annual flowback rate of 18.3%. At this rate, the repayment term for total lending to SMEs would be almost 5.5 years. This varies substantially amongst individual participating banks. Flowback is being reported from the perspective of Loans and Finance & Leasing only (as Overdrafts and Invoice Discounting products whereby customers operate on a limit basis do not lend themselves to this type of analysis) 8

11 Summary Decline Rate Analysis The decline rate associated with SME lending can be examined from two distinct perspectives: The demand side i.e. the decline rate derived from an analysis of responses to a customer survey conducts as part of this Review The supply side i.e. the decline rate derived from an analysis of data supplied by participating banks A significant difference is apparent between both decline rates. Demand Side The rate of decline of applications for credit reported by SMEs (based on the demand survey) was 28% across all requests, an increase of approximately 4 percentage points on the June 2009 survey. The decline rate across banks representing the significant majority of applications varied with a range of 17% to 30% with the remainder outside that range. Micro companies reported the highest level of decline at 31%. It should also be noted that the decline rate on requests for non bank finance was 31% It is likely that some level of overstatement is inherent in the demand decline rate, however given the fact that only two such surveys have been conducted to date, and as such significantly less data exists than on the supply side, it is not possible to quantify the extent of that overstatement as of yet. Supply Side If the decline rate is calculated using a consistent approach, to that used in the June 2009 report, and on the basis of the data currently held in the participating banks systems, a rate of 13.6% is apparent (14% June 2009 Report). This represents a difference of some 14 percentage points between the decline rate reported by customers based on the demand survey and the decline rate recorded by banks based on the data currently held in their systems (supply side) 9

12 Summary Comparative Analysis The difference in the demand and supply decline rates would primarily appear to arise as a result of A difference in perception as to what constitutes an application for credit amongst customers and banks Differences in when and how credit applications are recorded on participating banks systems Certain limitations associated with the use of telephone surveys such as those used on the demand side The fact that informal requests for credit or enquiries are not in all cases recorded by participating banks The fact that processes used in participating banks for the recording of credit applications and declines are not the same across all banks. However the processes used by each bank are consistent with those they used in the period covered by the June 2009 SME Lending report. The fact that the demand survey is based on all banks participating in the Irish market, whereas on the supply side, the data is based on the five banks participating in this Review only, although this is not likely to have a material effect on the decline rate On the basis of these differences and following our analysis of bank records, it is our opinion that the impact of these limitations in bank systems and processes is to understate the overall supply side decline rate. As such and in order to address this difference, we have performed an additional level of work in order to determine the quantum of this understatement. This work involved: The analysis of the variances in the range of credit decline rates across application classes and sectors An assessment of the impact of the adjustment of decline rates for anomalies apparent in data received The reworking of credit application and decline rates based on this analysis for a portion of credit applications On the basis of the additional work which we have performed, and given the limitations inherent in bank systems and processes as outlined above, it is our opinion that a decline rate of approximately 18 % in this and the prior period may be more representative. The participating banks are attempting to address the limitations in their credit application systems and processes and we understand will do so over time. However it is unlikely that it will be possible to ever completely address the limitations associated with credit application processes and systems and in particular to fully record informal requests for credit. This is outlined further in Section 3 below. 10

13 B56 KFNC AI S Review of of Lending to SMEs Demand Survey Summary Results Input for Ulster - Allied Bank Irish Ireland Banks Limited Plc ackground Supply to the Independent of Demand Detailed Credit inancing Context ompany for ey Terms Volume Approach Recommendations Demand Supply Credit Bank of the Information August ntroduction onclusions the of from Reference Financing ppendices ppendix Insurance of Business ummary Adopted Activity Survey Review Credit 2009 SMEs III IV II I September 2009

14 Approach Adopted This review of SME lending was conducted as a follow on exercise to the review conducted in June 2009 which sought to determine the actual position in relation to the availability of credit to SMEs in Ireland and to recommend appropriate actions to improve credit availability, taking account of the terms of the Credit Institutions (Financial Support) Scheme demand survey was conducted by a third party specialist firm Ipsos MRBI (formerly TNS MRBI) in the period October The requirement to conduct a separate demand study was based on our assessment of the data captured or held by individual banks and on the following specific limitations: This review, as its predecessor was conducted in two distinct parts as follows: Review of demand for credit from SMEs: this was conducted by means of an independent and comprehensive study of a large sample of Irish SMEs in October 2009 as detailed in Section 2 of this Report Review of supply of credit: this was conducted by means of the detailed analysis and review of information provided by participating banks in the form of a data return and the subsequent analysis and testing of this data where possible. The data return was prepared on the basis of the period March to September 2009 as detailed in Section 3 of this Report. Whilst there are some limited exceptions, records of enquiries or requests for credit are generally not maintained by the banks. We have been able to analyse formal credit details or applications that are entered on to the credit systems of the participating banks only It would appear in most cases that enquiries for credit from SMEs are initially assessed informally by the relationship, lending or branch manager in each bank. These managers form an initial view as to the merits or otherwise of the credit proposal. Using their experience of the lending process and the client s background, the manager responsible advises as to whether the enquiry is suitable to proceed to formal application stage As such formal applications for credit cannot be considered as a comprehensive estimate of full demand for credit. 1.1 Review of Demand for Credit In order to address the limitations associated with credit demand information available through individual bank systems, a separate In order to address these deficiencies, the survey assessed the demand for credit from Irish SMEs across all products and sectors included in scope of the Review. The survey was conducted on the basis of 6,220 discrete telephone calls made to individual companies categorised as SMEs. 1,052 completed questionnaires resulted from these phone calls. 12

15 Approach Adopted A number of calls were made to individual SMEs to ensure that the correct person completed each part of the questionnaire. There were only 403 refusals to participate in the study and only 114 quota fails (i.e. where companies took part but could not qualify for the survey because the quota for the sector in which they were trading had already been reached). The data arising from this survey was reviewed and in turn analysed by Mazars, the results of this analysis and the detailed technical approach to the survey, are set out in Section 2 of this Report. 1.2 Review of Supply of Credit Our review of the supply of credit to SMEs is based on the analysis of the data submitted by each individual bank in the form of a data return, covering the period March to September In the case of most of the participating banks, this return was then reviewed by Mazars on site, to determine the consistency of the methodology used in the collation and presentation of the data returned where possible. Our review incorporated a limited analysis of data held by the individual banks in their lending and credit systems together with some high level testing. Data analysis and testing was not however possible in the case of all participating banks or in the case of all the categories of lending data provided The data elements provided in data return were as follows: Exposure - the volume and value of credit activity with SMEs as represented by the level of credit extended to SMEs and across sectors and products (i.e. outstanding credit) New Credit Applications - the level and value of formal application for new/increased credit across products and sectors Approvals and Declines the level and value of positive and negative responses to requests for credit across the sector as a whole and individual product and sectoral groupings Drawdowns the value that customers have drawn against approved credit limits in the period of the Review (loans and finance and leasing only) Overdraft Utilisation Levels the extent to which approved overdrafts limits have been used by customers Flowback the percentage of total lending which is being repaid on an ongoing basis is referred to as Flowback. (loans and finance and leasing only) Credit Quality the value of individual customers whose accounts have been classified as performing, watchlist (i.e. accounts which are 30 to 90 days in excess of their repayment obligations) or impaired (accounts which are more than 90 days in excess of their repayment obligations) 13

16 Approach Adopted Limitations Our review incorporated the analysis of data held by individual banks in their lending and credit systems. The detailed limitations encountered in the analysis of lending to SMEs and the assumptions which we were required to make are set out in Appendix III to this Report. The principal limitations are as follows: Records of enquiries for credit are generally not maintained by the banks. This is changing at present in some banks, but for the review period, we were unable to secure any meaningful analysis of credit enquiries It would appear in most cases that enquiries for credit from SMEs are initially assessed informally by the relationship, lending or branch manager in each bank. These managers form an initial view as to the merits or otherwise of the credit proposal. Using their experience of the lending process and the client s background, the manager responsible advises as to whether the enquiry is suitable to proceed to formal application stage In some cases credit applications are not recorded in full on systems until such time as a lending decision has been made In a small number of cases, and for certain products, where a customer applies for a top up on an existing facility, the value of both the existing and the new credit are included as credit applications and cannot be separately identified Applications for loans and overdrafts which represent approximately 85% of total applications cannot be split in most banks, and as such our analysis has required us to consider both as one credit facility. This is of particular importance given the reliance by SMEs on overdrafts as a form of working capital finance Due to limitations in individual bank lending and application systems, it is not possible to analyse formal applications fully. We could not split applications received by the banks into those received from new customers and those received from existing customers. Therefore we have been obliged to conduct our analysis on a total new applications basis Only paper based systems were in place for some products in certain banks during the period of the Review It is not possible to comment on trends in credit applications arising from renewals and amendments to existing loan and overdraft facilities due to the fact that they are not separately identifiable in most banks. Our analysis of loans and overdrafts is therefore focused on applications for new and increased credit from existing and new customers Each of the systems in place within the banks, which support lending to SMEs is very different and operates on a bank specific basis only. The information contained within the systems are not collected in an easily comparable manner 14

17 Approach Adopted It is not always possible to analyse lending on a product by product basis in all banks as applications for certain products are not separately coded in back office systems In the case of some banks, different systems are used in the same bank, depending on the type or size of the credit facility in question and these systems are not consistently structured even within that bank Data and data models in place across the five banks included in the Review are very different and in many cases data models are not comparable Individual banks do not capture customer trading data in a manner that allows us to perform our analysis by SME category i.e. small, medium, micro. Therefore all of the analysis set out in this section is based on a single category of SME companies only as represented by those companies who satisfy the EU definition of an SME. These differences in systems, lending processes and data models have impacted on our ability to present a detailed consolidated picture of lending to SMEs across the banking sector in Ireland as represented by the five banks included in this Review. We do however believe that the final overall picture and the information presented in this Report is materially correct and presents a clear and, in so far as it is possible, accurate picture of SME lending by the five banks participating in the Review and thus the substantial proportion of credit extended to SMEs operating in the Irish market The participating banks are attempting to address these limitations and have committed to doing so over time. However we understand that this may take a considerable period of time and it may never be possible to fully address the limitations associated with the recording of credit applications particularly the recording of informal applications for credit or enquiries due to a number of factors including the following: The absence of informal application/ enquiry recording systems and business processes in most banks The relationship driven nature of informal requests for credit Lack of clarity and consistency across banks as to what represents an informal credit application or enquiry The fact that informal requests for credit or enquiries are often general rather than specific in nature and may not be fully quantifiable in value terms Sectoral Analysis In order to ensure that data held by individual bank systems in accordance with their own data models and classification rules was comparable and could be collated to form a sectoral picture, we have used Central Bank sectoral codes. Central Bank sectoral codes are those codes used by the Central Bank, and specified at EU level, under which individual banks 15

18 Approach Adopted submit their quarterly returns to that Organisation. These codes are based on NACE Rev. 1 codes 1 The demand study has used standard NACE codes. The NACE Code system is a pan-european classification system which groups organisations according to their business activities. It assigns a unique 5 or 6 digit code to each industry sector e.g. B - Mining and Quarrying - B5 - Mining of Coal and Lignite In order to ensure that the results are representative of the overall SME population, the construction sector in so far as property development and speculative activities are concerned has been excluded. Only companies who support or supply to the construction sector have been included o Hospitals o Churches and religious organisations o Charities o Government (central and other) o Extra-territorial organisations and bodies o Private household lending. Customer Analysis This Review was conducted on the basis of companies falling into one of three categories of SME, as determined by the EU definition of each category, which is set out in the Introduction to this document. The specific sectors or subsectors excluded from the analysis are set out in detail in Section 3 and are: o Non SME related financial intermediaries: non-bank credit grantors, credit unions, collective investment schemes, SPVs asset-backed securities, pension funds o Speculative real estate activities o Speculative construction activities o Educations schools and colleges 1 NACE Rev. 1 ("Nomenclature statistique des Activités économiques dans la Communauté Européenne") was adopted in order to establish a common statistical classification of economic activities within the European Community in order to ensure comparability between national and community classifications and national and community statistics. 16

19 B56 KFNC AI S Review of of Lending to SMEs Demand Survey Summary Results Input for Ulster - Allied Bank Irish Ireland Banks Limited Plc ackground Supply to the Independent of Demand Detailed Credit inancing Context ompany for ey Terms Volume Approach Recommendations Demand Credit Bank of the Information August ntroduction onclusions the of from Reference Financing ppendices ppendix Insurance Business ummary Adopted Activity Survey Review 2009 SMEs III IV II I September 2009

20 Demand for Credit Section 2 Demand for Credit The following is a summary of the main points arising from the demand survey conducted as part of the Review of lending to SME s, covering the period March 2009 September 2009 and as compared to the period of the previous review i.e. June 2008 to February 2009 (The June SME Lending Report): Highlights The demand survey: The demand survey represents a study of lending to SMEs conducted in Ireland examining the issue of credit availability. It was carried out by a third party specialist firm Ipsos MRBI (formerly TNS mrbi) in conjunction with Mazars. A sample of SMEs were contacted and asked to respond to a phone based questionnaire. This sample was selected from a database of over 122,000 companies. The survey was carried out in October 2009 and respondents were asked to respond based on their experience in the previous 7 months Respondents: The demand survey analysed the responses of 1,052 SMEs. The responses can be considered to be representative of the population of SMEs and the sample is statistically representative across all sectors in the economy and across small, medium and micro SME organisations. The profile of respondents is similar to that in the previous Review Trading conditions: Survey responses indicate that SMEs continued to operate in difficult trading conditions in the 7 months to September % of respondents reported a continued decrease in turnover with 45% experiencing a decrease in turnover of 20% or more. A levelling off in the rate of decline in employee numbers is apparent in the 7 months covered by this Report. Volume of demand: 46% of survey respondents made one or more requests for credit during the period of the Review, representing a reduction in the demand for credit in the period of approximately 6 percentage points when compared to the previous demand survey included in the June SME Lending Review. Of those requests for credit 79% of applicants made a formal request (where a customer fills out a formal application form). Only 11% of respondents indicated that they had requested or applied for a non bank form of finance Professional Support: Some 50% of SMEs sought professional advice from auditors, accountants and other professionals) regarding ther financing requirements 18

21 Demand for Credit Nature of demand: The most common reasons for requests for new credit, amongst demand survey respondents, were for working capital/cash flow reasons, to address declines in business revenues and to support a slowdown in debtor collection. The most requested products were loans, followed by increased overdrafts, leasing/hire purchase products and new overdrafts. Seasonal nature of demand: Whilst 43% of companies indicated that trading activity was seasonal in nature, only 24% of respondents indicated that their demand for credit was seasonal, with quarters 1 and 4 and specifically the months January and December demonstrating the highest levels of demand for credit Decline rate: The rate of decline of applications for credit reported by SMEs (based on the demand survey) was 28% across all requests, an increase of approximately 4 percentage points on the June 2009 survey. The decline rate across banks representing the significant majority of applications varied with a range of 17% to 30% with the remainder outside that range. Micro companies reported the highest level of decline at 31%. It should also be noted that the decline rate on requests for non bank finance was 31% Reasons for decline: The most common reasons for decline cited by respondents were Change in bank lending policy as was the case in the June demand survey, however it is important to note that on this occasion decline in business performance was now recognised by applicants as one of the main reasons behind the decline of an application for credit (16%), this represents a substantial movement in the 7 months to September 2009 Drawdown of approved facilities: 13% of respondents whose requests for credit were approved did not (either wholly or in part) avail of the facilities. The main reasons cited were Not needed at present and Cost too high/risk. This compares to a figure of 14% in the previous period SMEs exporting: 17% of respondents indicated that in the last 12 months their business exported goods or services outside of the Republic of Ireland with a total value greater than 100,000 Computer software/hardware industry: 8% of respondents indicated that their businesses develop, sell or implement software and /or hardware. 19

22 Demand for Credit Approach and Overview Demand for Credit The full demand for credit by SMEs is currently not comprehensively captured in any systematic fashion by either the banks or by any statistical or regulatory body. As the examination of demand was a key objective of this Review, it was considered necessary to commission an independent demand survey to capture demand levels, demand factors and experiences. This section sets out the key findings of that survey. Current practical constraints in relation to the availability of demand information include: Records of enquiries for credit are generally not maintained by the banks. This is changing at present in some banks, but for the review period, we were unable to secure any meaningful analysis of credit enquiries In most cases, preliminary enquiries for credit are assessed informally by the relationship, lending or branch manager in each bank. These managers assess the merits or otherwise of the credit proposal and advises as to whether the enquiry is suitable to proceed to formal application stage. As such formal applications for credit cannot be considered as a complete picture of the full demand for credit. Methodology Adopted To satisfy the Review objectives and address the practical constraints outlined above, a comprehensive survey of Irish SMEs was conducted using the same methodology and minimum sample targets as employed in the June 2009 SME Lending Review. This independent demand study was conducted by means of a telephone survey by a third party specialist firm. Both the size and sectoral profile of target respondents was consistent with that employed in the original profile in June 2009 Review, in order to establish a like for like comparison of results and ensure that trends and patterns could be established. About The Independent Demand Survey In response to the deficiencies in credit demand information held by the individual banks, and in an effort to build on previous surveys conducted and to comprehensively assess the demand for credit amongst Irish SMEs across all sectors of the economy, an independent survey was conducted by Mazars The independent demand survey involved the support of a third party specialist firm, Ipsos MRBI. Ipsos MRBI conducted a telephone interview based survey using a questionnaire designed by Mazars with input from the Departments of Finance and Enterprise, Trade and Employment, as well as the Irish Banking Federation 20

23 Demand for Credit The survey sample was derived from an Ipsos MRBI recommended database, which is compiled from multiple sources and updated regularly. At the date of writing, the database held over 122,000 records. The total universe of records within the scope of this Review and from which the sample was selected was approximately 99,000 SMEs 6,220 calls were made in the course of the survey. A number of calls were made to individual SMEs to ensure that the correct person completed each part of the questionnaire. In many cases, a number of conversations were held to complete the suite of questions. There were 403 refusals to participate in the study and only 114 quota fails (i.e. where companies took part but could not qualify for the survey because the quotas for the sector in which they were trading were already reached). As such the survey can be considered to be robust and statistically representative of the Irish SME population across all sectors of the economy The survey also included the Agriculture, Hunting and Forestry sector. This sector may not always have been included in previous SME credit surveys but does nonetheless represent an important constituency of Irish SMEs. 30 respondents in this sector have been included in the final demand study The selection of the sample was conducted in accordance with best practice in statistical sampling. Minimum sample targets were set to ensure that the sample was sufficiently representative of the SME population in terms of both SME size (micro, small and medium) and sector (as defined by NACE codes) The survey also addressed the topic of seasonality and the extent of export activity in which each firm was engaged. The full survey questionnaire is attached as Appendix I to this report and detailed results are presented below. Completed questionnaires based on a telephone interview were compiled by Ipsos MRBI for 1,052 Irish SMEs and provided to Mazars for review and analysis The survey assessed demand for credit from Irish SMEs across all products within the scope of the Review and all business sectors using standard NACE sectoral codes. Demand was assessed for the seven month period from March 2009 to September The survey was conducted in October

24 Demand for Credit Demand Survey Results This section summarises the results of the demand survey as follows: Profile of respondents (including length of time in business, trading performance, relationship with banks and membership of business representative organisations) Requests for credit (including level of demand, nature and seasonality of demand) Approvals and declines Drawdown of approved facilities 2.1 Profile of Respondents Completed questionnaires based on a telephone interview were compiled by Ipsos MRBI for 1,052 Irish SMEs. Length of Time in Business There was no real movement in the length of time of respondents had been in business compared to the prior June 2009 survey. 73% of respondents had been in business for 11 years or more (June 2009: 72%) The results of our analysis of the demand survey in this Section are presented for all banks, rather than just the five participating banks. 60% Graph 1: Customer Profile by Length of Time in Business Time Period of Survey In reviewing results it should be noted that the time period of the June 2009 survey was 12 months whilst the current survey referred to the 7 month period from March to September Seasonality may have an impact on the results of the survey. Percentage of Respondents 40% 20% 0% Up to 2 years Between 2 and 4 years Between 5 and 10 years Between 11 and 20 years More than 20 years 22

25 Demand for Credit SME Category SME Category: To ensure a suitable comparison with the prior survey, the survey included the same representative profile of micro, small and medium companies across each business sector. However, it should be noted that the actual profile of the SME sector contains a higher proportion of micro and small SMEs. Graph 2: Respondent Profile by Size of Business However, it should be noted that the basis of the survey was to collect information across a targeted sectoral profile, and by virtue of the nature of the sector, companies in certain sectors would not be involved in the export trade. Participants who indicated that they were involved in the export of goods and services were primarily based in the manufacturing sector (processing & food, high tech and other manufacturing) 2.2 Trading Performance June 2009 September 2009 Turnover: SMEs are continuing to experience trading difficulties - 78% of respondents indicated that they reported a decrease in turnover in the 7 30% 35% 30% 35% Micro Small Medium months to September % of SMEs indicated a decrease in the 12 months to June Almost 45% of respondents indicated that turnover had decreased by more than 20%, as was the case in the June 2009 Report. Micro and small companies reported greater levels of 35% 35% decrease in turnover of more than 20% that their medium counterparts. Graph 3: Respondent Profile by Movement in Turnover June 2009 September 2009 Computer Software/Hardware Industry: 8% of respondents participating in the survey were involved in the development, selling 16% 10% 15% 7% or implementation of hardware or software for the computer Increased industry. Decreased Remained the same SMEs Exporting: 17% of those surveyed had exported goods / services outside of the Republic of Ireland in the previous 12 months. 74% 78% 23

26 Demand for Credit In the June 2009 survey, 26% of respondents indicated that there had been either an increase/consistent level of turnover, this was 22% in the September 2009 survey Professional Support: Some 50% of SMEs sought professional advice from auditors, accountants and other professionals) regarding ther financing requirements Employee Numbers: Fewer respondents indicated that they had reduced staff levels compared to the June 2009 survey and the trend appears to indicate a levelling off in the rate of employee reduction. The percentage of SMEs who are increasing staff levels remains below 10%. Relationship with Banks: The profile of respondents in this survey was broadly similar to the June 2009 survey. 43% of respondents to this survey were customers of their principal bank for more than 20 years (June 2009: 39%). Banks were not limited to those participating in the Review. Graph 5: Respondent Profile by Length of Relationship with the Bank More than 20 years Between 11 and 20 years Between 5 and 10 years Between 2 and 4 years Up to 2 years Graph 4: Respondent Profile by Movement in Number of Employees Not a customer / only joined / not sure June % September % 0% 10% 20% 30% 40% 50% Percentage of Respondents 36% 57% 44% 50% Increased Decreased Remained the same Membership of Business Representative Organisations: Almost 60% of respondents were members of one or more business representative organisation. The number of members by business representative organisation, recognising that an individual SME business may be a member of one or more organisations is depicted below: 24

27 Demand for Credit Graph 6: Respondent Profile by Membership of Business Representitive Organisations A Chamber of Commerce affiliated to Chambers Ireland Irish Business And Employers Confederation (IBEC) Irish Small and Medium Enterprises Association (ISME) RG-DATA Advisory Board Sector Specific Association (e.g. CIF, IFA, IBA, PIBA, VFI etc) Small Firms Association Other Percentage of Respondents 60% 50% 40% 30% 20% 10% 0% Graph 7: Level of Demand June 2009 September Number of Memberships Respondents to the demand survey who are medium size companies are ineligable to be members of SFA Bank Requests: Amongst participating banks, 90% of those customers who made an application for credit in the period under review, applied to their own bank. 2.3 Requests for Credit Level of Demand: Demand for credit, based on the percentage of customers who requested credit, has dropped from 52% (12 months) to 46% (last 7 months). 79% of those requests were formal requests for credit (where a customer completes a formal application form which is assessed internally by the bank) The profile of formal requests has increased 5 percentage points from 74% in the June 2009 survey. Requested Products: The type of credit product demanded has changed slightly over the two surveys; SMEs are still requesting new overdraft/increased overdraft and loans in large numbers, however the demand for loans as a percentage of total requested products, has increased slightly (by 4% of total applications) whilst the demand for leasing and hire purchase products has decreased (by 5% of total applications). Overdrafts, either new overdrafts or increases in existing overdraft facilities accounted for 44% of requested products in the 7 months to September 2009 (June 2009: 43%). It should be noted that overall demand for credit in the period to September 2009 has fallen as compared to previous periods 25

28 Demand for Credit 60% Graph 8: Type of Credit (Product) Requested Table 1: Reasons for Request for Credit Percentage of Applications 50% 40% 30% 20% 10% Reason Request June 2009 September 2009 Percentage Point Movement 1.Working capital / cash flow 22% 24% +2 2.Decline in business 16% 17% +1 revenues 3.Slow down in debtor 13% 12% -1 0% New overdraft Increased overdraft Loan Invoice Discounting June 2009 September 2009 Leasing or Hire Purchase Other collection 4.Bad debts increasing 9% 9% - 5.Increase in supplier costs 5% 6% +1 6.Expansion 10% 9% -1 Exporting Companies: products requested by companies who indicated they were involved in export activities were broadly in line with those requested by all SMEs i.e. increased overdrafts, followed by loans and followed by leasing and hire purchase products. Nature of Demand for Credit The table below sets out the main reasons behind the requests for credit by Irish SMEs: 7.Property related loan 7% 5% -2 8.New business venture 8% 7% -1 9.Other 10% 11% % 100% It should be noted that more than one reason was given in certain cases in respect of a request for credit. The predominant reason (behind the request by an SME for credit) was either working capital or cashflow based (1-5 above). At 68%, this represents an increase of 3 percentage points on the previous survey. The level of decline which SMEs are experiencing in business revenues appears to be a significant factor in their demand for credit. 26

29 Demand for Credit Emphasis on expansion, new business ventures and property acquisition (6-8 above) would appear to have become less of a driver for new credit in the period of this Review. The reason for making a request can be graphically represented as follows: Graph 9: Reasons for Request for Credit 100% Q1 - Turnover is seasonal in nature Q2 - Demand for credit is also seasonal in nature as a result of turnover Graph 10: Seasonality of Demand Percentage of Reasons 80% 60% 40% 20% 0% Working Capital Growth/Expansion Other June 2009 September 2009 Q3 - Seasonal demand for credit is 20% greater than norm 0% 10% 20% 30% 40% 50% Percentage of Total Respondents by Question Of those respondents who indicated that seasonal demand for credit 20% greater than normal credit requirements, the majority indicated that additional credit of between 21-49% was required. Quarters 1 and 4 and specifically January and December would appear to be the periods in which the highest level of seasonal demand is apparent Seasonality Seasonality: 43% of respondents indicated that their business turnover was seasonal in nature. 24% of respondents indicated that their demand for credit is also seasonal in nature as a result of the seasonal nature of their business. The three sectors with the highest seasonal demand for credit would appear to be the following: Agriculture, Forestry and Fishing Retail, Trade and Repair (Motor) Hotels and Restaurants It is clear from the above analysis that seasonality does not have a significant impact on the demand for credit amongst SMEs 27

30 Demand for Credit Informal Applications 21% of respondents seeking credit did so in an informal capacity. When asked for reasons as to why no formal application was made, the majority stated that an informal request was sufficient due to the repeat nature of their business or the personal relationship they enjoyed with their principal bank. This can be presented graphically as follows: Graph 11: Reasons for Not Making A Formal Application Other No need to (informal request sufficient due to repeat business/personal relationship with bank) 2.4 Approvals and Declines Overall Decline Rate: The rate of decline amongst participating banks was 28%, an increase of approximately 4 percentage points on the June 2009 figure. A decline can be considered as an unsuccessful request for credit. The decline rate across banks representing the significant majority of applications varied with a range of 17% to 30%. Those outside this range can be considered as immaterial in the context of this decline analysis. An analysis of bank data presented in Section 3 of this Report would suggest a decline rate of 13.6% (June %) representing a difference of some 14 percentage points between the declines rates reported by respondents to the demand survey and those recorded by banks. Knew that formal application would not be successful Don't know As a test to see if it would be possible to get request 0% 10% 20% 30% 40% 50% 60% 70% Percentage of Total Informal Applications This would primarily appear to arise as a result of a difference in perception as to what constitutes an application for credit and when and how credit applications are recorded on participating banks systems However, it is our opinion that given the limitations of existing credit application processes and systems in participating banks, on the basis that banks do not record declines in a consistent manner across banks, and following our analysis of bank records, a decline rate of approximately 18% in this and the prior period may be more representative. This is explained in greater detail in Section 3 below. 28