Our Case Study this month looks at the changes in credit reporting in Australia, and the impact that this had on our client, Allan. These changes have been rapid, and we are just now starting to see firsthand the real-life impact this can have on businesses and individuals.
The Changes
In September 2019 Australia moved to Comprehensive Credit Reporting (CCR). In the past the system was based on negative reporting, meaning whether you had defaults or judgments on your credit record. While the lender could see how many enquiries had been made, they could not actually tell whether you made your payments on time or not. Now all major lenders are required to automatically report on the credit behaviour of home loans, personal loans and credit cards. Now lenders will see whether you made your home loan payment on time, or how many days you were late, or how many times you were late paying.
This has changed the credit reporting landscape. The idea was that good borrowers, those that always make their payments on time, would be able to negotiate better deals with their lenders. The flip side of this though is the availability of credit at all if you have been a bit slow making your loans payments in the past.
Background
Allan was the director of a steel reinforcing company. In May, at the urging of his accountant Allan made an appointment to meet with us. It was clear that he was reluctant to do so and just wanted to focus on the operational aspects of the business. A major debtor was disputing payment, and this had left the company in a bit of a cash bind. As a result, the business had incurred a debt to the ATO of $380,000. Allan owned his family home and an investment property, with equity in both.
When faced with these types of unexpected problems a lot of people just stick their head in the sand. They just want to trade on and keep going. If they work hard enough it will all work out in the long run. If push came to shove, Allan said he could borrow against his properties, make an up-front payment to the ATO and put the rest on a payment plan.
We provided Allan with comprehensive written recommendations at no charge, and with no obligation. Allan decided not to engage and to trade on and just keep working harder.
Some Months Later
Allan had been working hard and had been cutting costs where he could, including his own drawings. Allan had reduced his tax debt to $290,000 but this had been at the expense of some creditors. The Tax Office however were not satisfied and sort further substantial reductions, so Allan had finally decided to go with Plan B and to source financing on his properties.
Due to his own reduced drawings he had been late on his home loan payments for a few months. No big deal. The payments got made. So what if they were a week or two late sometimes?
Turns out those late home loan payments mattered a lot. They were all auto reported to credit agencies. The result? Allan’s credit score collapsed from nearly 900 to under 500 within a few months. Generally, an “average” credit score in Australia is around 550. If your credit score is under 500 you would be in the bottom 20% of the population and will find it hard to get credit.
Turns out lenders were not that interested in Allan anymore, now that his credit score had gone from excellent to below average.
Back to de Jonge Read
By the time Allan went back to his accountant he had moved on to investigating fintech loans. Now, we discussed these loans in our last newsletter. Unsecured (except for that personal guarantee that lets the lender put a caveat on your house). High interest rate. Short term. Easy approval. Fortunately, Allan met with his accountant before he signed on the dotted line.
Another meeting with de Jonge Read was arranged, and this time Allan was ready to truly deal with the company’s issues.
Strategy
Allan engaged our firm in October to develop a strategy to address the company’s financial position. The business was viable but had been struggling under the burden of legacy debt brought about by the failure of a debtor to pay. The way things were heading, the company would face legal action by the ATO, potentially leading to the loss of employees’ jobs and Allan’s ability to pursue his interest in the industry.
While our original advice remained valid, there had been some changes. The most significant change was in relation to the reporting of ATO obligations. Under a payment plan with the ATO it is a requirement that the taxpayer meets the agreed payments and pays all current obligations when due. Now Allan was under a lot of pressure, and he had been tardy in lodging his BAS for a while. This had a costly effect for Allan.
A commercial business restructure where the assets of the business are sold at commercial value to a related entity was decided as being the best course of action. This course of action will allow the debts of the company to remain with the company unless they are personally guaranteed. To facilitate this, business assets and goodwill were valued by a licensed valuer and sold to a new trading entity for fair commercial consideration. All staff were re-employed by the new entity. All employee entitlements were assumed by the new company and offset against the purchase price of the business. Allan reached agreement with his trade creditors in relation to personal guarantees and ongoing business relationships. The old entity was finally liquidated.
Outcome
The cost to Allan of sticking his head in the sand for a few months was twofold and substantial.
Allan lost the option of refinancing with a tier 1 lender by trying to trade on in an untenable situation, therefore defaulting on loans and causing damage to his credit file;
Allan did not report all PAYG and superannuation when due. As a result he received a Director’s Penalty Notice (DPN) for $80,000.
Whilst our strategy allowed Allan to successfully trade the business on the outcome could have been substantially better if he had acted on the initial advice.
Should you have clients or associates that you know are struggling with financial issues, our team of Strategists would be pleased to discuss options that are available on how to best design and implement insolvency strategies. Call us now on 1300 765 080.