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No Playbook for the COVID-19 Recovery

Global E&P Analyst Series (1 of 3) - Australia

East & Partners first Research Note in this three part series delves deeply into corporate’s behavioural response to the COVID-19 crisis versus how they navigated previous bouts of market instability. The insights are presented by regional business banking product market across Australia, Asia and Europe.
As Australian businesses adapt to the concept of operating under ‘COVID normal’ conditions for longer, asset and equipment financing emerges as an important indicator of business confidence and resiliency.
The key question is, what will occur when record government stimulus measures are rolled back through H1 2021? Will enterprises continue investing for growth? Or will we see CFOs and corporate treasurers aggressively ‘tighten their belt’ in response to uncertain trading conditions?
Capex Under Pressure
The Australian Bureau of Statistics (ABS) reported that total new capital expenditure (capex) fell by 5.9 percent in Q2 2020 following a decline of 2.1 percent in Q1 2020. This was impacted mainly by plant, equipment (P&E) and machinery over buildings and structures, declining by 7.6 percent in Q2 2020 following a 3.1 percent contraction in Q1 2020. Although business sentiment has improved somewhat through Q3 2020, significant variance exists by state and sector. Victoria has been hit significantly harder than other states while industry sectors exhibit a clear ‘K’ shaped recovery as some verticals prosper and others languish.
Asset & Equipment financing represents an integral part of new capex growth, improved productivity, innovation and working capital management. Although business credit growth has been limited to sub five percent in the last five years, Equipment Finance represents a critically important element. As a proportion of total borrowings, equipment finance represents a quarter of total borrowings on average (26 percent).
Equipment Finance as Proportion of Total Borrowings
% of Total

Source: East & Partners Australian Asset & Equipment Finance Program

Microbusinesses rely heavily on key methods of equipment finance such as Operating Leases, Novated Leases, Chattel Mortgages, Finance Leases and Hire Purchase agreements, reaching as high as 37 percent of total borrowings. The average percentage of asset finance over total borrowings for institutional enterprises is almost five times lower at 7.6 percent as a result of access to a broader range of sophisticated debt funding methods for capital expenditure.

"As the recovery gets under way the shift in focus will increasingly be
needed towards economic reforms that boost productivity growth,
investment and limit the scarring effects on the economy”

- IMF Mission Chief to Australia, Harald Finger

In the months leading into COVID-19 enforced shutdowns, East & Partners research revealed equipment finance volumes were forecast to expand by over eight percent through 2020, matching the previous full year 2019 prediction. Forecast asset financing volumes were returning to levels of positive sentiment not witnessed in the last decade before COVID-19 hit in earnest in March 2020.
New volumes were driven ‘bottom up’ with small businesses continuing to drive confidence as natural disasters and COVID-19 impacted agriculture, tourism and services sectors in particular. Microbusinesses predicted asset finance volumes to increase by nine percent, almost twice as strong the Top 500’s outlook of five percent.
The main influence on businesses asset finance decision making process is cash flow support. Cash flow needs are the key underlying reason for sourcing asset and equipment finance market wide (88 percent), nominated ahead of liquidity and working capital constraints (37 percent) and removing assets from the balance sheets (40 percent). Interestingly it appears businesses are getting on top of legacy assets, declining in prominence to a post-GFC low of 21 percent.
When the Stimulus Pump Runs Dry
The Australian government initially raised the instant asset write-off threshold from A$20,000 to A$30,000 in late 2019 and expanded the number of enterprises who could access the scheme to firms with turnover under A$50 million (Lower Corporate). In response to the COVID-19 crisis, new rules for the Instant Asset Write-Off scheme were extended to the end of 2020 with eligible enterprises able to instantly deduct the cost of assets worth A$150,000. The scheme was radically expanded to allow businesses with A$500 million in annual turnover to deduct asset purchases worth up to A$150,000.
In short, as part of the 2020 federal budget geared to combat the COVID-19 fallout, the government is allowing businesses to write off the full value of assets acquired after 6 October 2020 if first used by the end of the 2021-22 financial year.

“The biggest item in the budget was the instant asset write off
for firms with turnover of less than A$5 billion worth $27 billion.
It is very much aimed at encouraging business investment.
The economy needs all the help it can get from fiscal policy”

– NAB Group Chief Economist, Alan Oster

Despite the significant expansion in the scheme’s scope, awareness of the accelerated depreciation provision has been disappointingly low, corresponding to a relatively poor take-up of the initiative leading into the pandemic. More promotional activity is required to spread the message among Microbusinesses and SMEs in particular, arguably the segment with the most to benefit from the initiative.
Greater promotional activity championing the benefits from upgrading old or outdated plant equipment now, bringing forward those complex decisions is sorely needed given it is currently the number one driver for sourcing new equipment finance for one in five small businesses market wide (21.1 percent).
Although the overarching benefits of the scheme remain underutilised by small businesses at large, it will undoubtedly prop up asset finance demand through the next two years and intensify competition between incumbent market share leaders, CBA and NAB, fast growing providers such as BoQ, captive financiers and non-bank providers.
The billion dollar question remains how businesses will return to normal debt servicing arrangements and what impact this will have on overall business credit and capex growth. New data from the Australian Banking Association (ABA) confirmed that deferred loans across the majors have fallen 45 percent from the peak. In October, seven percent of enterprises reported that they were still deferring loan repayments, more than halving from the 16 percent of firms in May according to the ABS.

"The growth trajectory of banks' loans losses remains uncertain,
given the moderating effect of government support and bank forbearance,
coupled with uncertainty over the pace of the economic recovery"

- Moody's

Up to one in four small businesses currently collecting income support would cease operations today if the measures were removed immediately before any improvement in trading conditions according to the Reserve Bank of Australia (RBA). The RBA’s Financial Stability Review also found that at one in ten SMEs in the hardest hit industries still do not have enough cash on hand to meet their monthly expenses.
Past Crises Comparison
In the wake of the global financial crisis, it took over four years for asset financing forecasts to return to positive levels. Although the same liquidity constraints are not present in the current crisis, the unique nature of supressed revenue and supply chain disruptions is arguably more damaging and bodes poorly for a rapid ‘V’ shaped recovery to take place.
It must be said that is not all ‘doom and gloom’ as businesses seek to adapt quickly to the ‘new normal’. For example, due to the ongoing risks and social distancing requirements related to COVID-19, CBA held its first ever virtual annual general meeting (AGM) and the rate of financial services digitisation is accelerating.
The declining length of primary equipment finance provider account lives confirms the behavioural shift taking place as customers increasingly ‘multibank’ for equipment finance. In 2006, 71 percent of firms maintained their asset finance account with their primary provider for under five years. As of 2020, only six percent of firms have held an account with their primary equipment finance provider for 0 - 5 years.
Leading into the GFC, businesses were comfortable shopping around for a new equipment finance provider. As credit markets tightened however, this impulse petered out quickly and took the better part of a decade to recover to current record high switching levels, with almost one in three enterprises planning to switch equipment finance provider in the next six months, up from only one in five in 2012. How deep and long will customer churn be impacted on this occasion as the prospect of an extended COVID-19 recovery faces key decision makers?
Next month East & Partners second Research Note in this series addresses how Asia’s corporates are plotting their way forward in 2021 and beyond through fast-tracked digitisation. Who will win the race?

Customers Planning to Switch Primary Equipment Financier in Next Six Months
% of Total

Source: East & Partners Australian Asset & Equipment Finance Program

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