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  • Are Banks Really Lending?

    admin September 22nd, 2011 news

    We have all heard the political rhetoric.  The banks need to lend to small businesses to help stimulate the economic recovery.  Given the blame levied at the banks for the current economic crisis, it could be assumed that they would bow to political pressure and lend, but is this happening?

    Our profession provides us with a unique perspective on this subject. On a daily basis, we speak to Company Directors, operating in a wide variety of different industry sectors. A subject that seems to be regularly arising is that of finance, or more succinctly, the lack thereof.

    It won’t surprise people to know that prior to seeking the advice of Insolvency Practitioners; struggling firms often seek additional finance to “solve all their problems”.  Equally, it would be of little surprise to understand that finance in this situation is very difficult, or in the alternate, extremely expensive, to come by. In truth, it would be entirely unrealistic to expect anyone to lend to a company in financial difficulty, particularly where no tangible security exists.

    However, for the purposes of this blog, we are not so much concerned with the lending above, as with the lending to good performing (relative to the wider economic outlook) or asset rich companies.

    We can all appreciate that lending money has its risks and the calculation of interest to be charged to borrowers is designed to reflect this. But let’s be realistic, the banking industry is designed to adopt a portfolio, thus spreading their risk.  Surely then, the interest rates should reflect the risk of their total portfolio as well as the risk on an individual transaction.  Why then do we see credit rates increasing exponentially, while the official bank rate paid on commercial bank reserves remains at an unprecedented low of a mere 0.5%, albeit the interbank rate is marginally higher.  In addition to the rate of interest, we are also noticing higher set up fees which, whilst not necessarily astronomical, do not assist a business looking to borrow money. Putting this aside, the stringent terms of business utilised by some banks (particularly when factoring in the economic conditions companies are trading in) is nothing short of alarming.

    We have come across a number of cases where the result of bank action, inaction or direct intervention, has had a detrimental and at times, disastrous effect on companies and/or their Directors, a few examples of which are shown below:

    1. Bank A requests that a multi award winning group of companies produce monthly management accounts under the terms of a cross guaranteed loan (Group loan to value 50:50, ie low risk).  If the gross profit falls below a certain level, then the borrower falls in breach of the loan covenants. Having never defaulted on the terms of the loan in the 5 years that the loan has existed, the company experiences unusually high expenses in 1 month (August 2011), reducing the profit margin 0.2% below the desired level. The company is immediately advised that they are in breach of the loan and are forced to seek advice and alternative funding.
    2. Bank B advises a property development company that they would prefer them to find alternative lending arrangements. In the interim they put the outstanding loan on a rolling half-yearly arrangement, so that with the passing of each 6 month period, a new arrangement fee is charged, together with an increase in interest rates. Clearly the resultant impact upon cash flow has meant that the company is no longer in a position to re-finance elsewhere, and is now in serious risk of default.
    3. Bank C tells a Director that liquidating an associated company will breach bank covenant over a loan to a separate (and profitable) company. As a result the Director is placed in an impossible position, whereby keeping an insolvent company trading to protect associate company breaches his fiduciary duties and potentially puts him at risk of personal liability (trading whilst knowingly insolvent).

    Example 3 aside, what we seem to be seeing more and more, is an increasing trend of failing to renew or pricing companies out of existing loans.   This appears to be a particularly harsh approach in conditions where a company has proved its ability to meet previous requirements in accordance with the original facility.  Despite not defaulting on the original loan, companies are left having to repay the balance without any real option of refinance. As you can imagine, this ultimately places a company in a perilous position, squeezing cash flow, creating unnecessary pressure on management and taking key staff away from running the day to day business.

    What we would like to see is a situation whereby banks recognised their role in the downturn, their ability to influence the economic recovery, and accordingly looked for reasons to lend (at reasonable rates), rather than searching for and creating reasons not to lend. There are strong and compelling arguments both for and against positive lending practices, and one can certainly understand the pragmatism adopted by banks in this climate. After all they have spent the last 3 years being pilloried for poor lending practices, and they are now placed into a curious paradox whereby they are being told to lend more money in uncertain economic times, ie high risk lending!!

    The ideal scenario, is a banking system that supports companies and entrepreneurs who have either an established track record or a compelling business concept. This support should not be reluctant or punitive, but a partnership. After all, as a company succeeds, so increases the banks wealth. At this moment in time, all we can see is a one sided arrangement where penny pinching draconian measures, penalise the market drivers (small businesses) to an extent where the risks involved in running a business are dramatically outweighed from the outset.

    It goes without saying that our experiences in this matter maybe slightly one sided, as that the people we talk to have been, or are trying to avoid insolvency whether as a result of bank action or otherwise.  What we can say is that this is an extremely complex issue and one that, on the face of it, is of great concern.

    The image used for this blog is courtesy of Witthaya Phonsawat: http://www.freedigitalphotos.net/images/view_photog.php?photogid=3116