Lending has slowed down to a trickle

The audit manager for Peters Elworthy & Moore is Edward Napper he has recently examined the different cultural differences that are involved in getting banking finance. Before the recession bit, there was plenty of bank finance available, and during these good times, it was possible to receive financing within three months. In some cases, conditional offers were made within just two days.

Today however the situation is significantly different, and banks are right at the other end of the scale, making lending very difficult for people. Relationship managers are being afforded much less discretion in who they offer lending to, which is reducing the overall lending situation significantly.

According to Alan Kean of CMAK Finance, local finance brokers: “The average period between first enquiry to loan draw-down has now risen to nine months”. Quite apart from the far greater proportion of loans refused in the first place, this has a real cost to business owners, who are unable to respond quickly to opportunities.

Lending criteria

So what factors are critical to the banks in approving credit? The first is the presence of an established business. This leaves new SME start-ups out in the cold; the most common source of finance for such businesses remains the owners’ equity or private investment from friends or family and, in reality, it seems that the best start-ups can hope for in terms of outside funds is to attract some venture capital interest.

Some help is available from the Government Enterprise Finance Guarantee Scheme (EFG), under which the Government guarantees 75% of the loan where the business has insufficient assets against which to borrow – however, to date the EFG has only really been used by established businesses.

In terms of financial results, banks want to see a profitable track record, typically over a minimum of three years and with little or no significant deterioration (even during a recession), so-called “sustainable profitability”.

Businesses with seasonal or cyclical trading cycles are not favoured and banks will usually apply a generic sector risk, which although very wide, in many cases will still affect lending decisions. There has also been a definite shift from a safety model (loan cover, asset cover, and so forth) to a viability model, which focuses on assessing the serviceability of debt.

Banks will usually start with EBITDA (earnings before interest, tax, depreciation and amortisation). Business owners can estimate their own interest costs, however banks will tend to apply a “stretched” interest rate to reflect uncertainty, so there is often an expectations gap in terms of the cost of funds.

It therefore follows that businesses can sometimes access a better covenant through a fixed loan because stretched rates are not applied. Typically, banks require an EBITDA of between 130% and 200% of annual loan repayments, which will vary according to sector risk and asset security.

Negotiating a loan

Some of these factors will be beyond the business’s control and indeed focus on actual historic data, but there are some basic measures that can be taken to maximise the chances of securing finance:

Owners should first hone a slick and professional presentation from day one and in particular ensure an in-depth knowledge of historic trading results as banks will expect them to have answers to hand.

Attention to detail and to presenting key data accurately is critical. Banks will check personal bank statements to verify information disclosed and any inaccuracy, even from small and careless errors, can register as a black mark and damage the reputation with that bank.

Robust cash flow and trading forecasts are of course essential and owners should present the best business case as banks will apply their own risk factors to substantially dampen predicted results. Chris Mason of CMAK says: “Expect your bank to reduce your forecasts by at least 10%.” So your forecasts will need to stand up to scrutiny.

The importance of close bank account control and a clean credit history is also paramount. Even a single bounced cheque will damage the credit rating and may result in finance being rejected.

Existing borrowings

With recessionary pressures causing many businesses to miss payments, breach covenants or exceed overdraft limits, any leniency from the banks has passed, with heavy financial penalties now being applied, in many cases where technical breaches had gone unpunished in the past.

Indeed, fees for agreeing some change in borrowings in advance are, as a rule of thumb, cheaper than penalty fees, and businesses not adhering strictly to existing agreements should expect only the harshest treatment.

By applying severe penalties the banks are responding to deterioration in the behaviour of the business and what they want to do above all is to deter that behaviour. The best advice is therefore to closely monitor your business finances so you can have early-stage discussions with your bank if there are changes in circumstances.

Some positive signs

In spite of the continuing gloom associated with the Eurozone crisis, there are a few positive signs. In his Mansion House speech earlier this year, George Osborne announced plans for an emergency bank funding scheme to kick-start lending to households and businesses.

Under the Funding for Lending proposals, British banks – facing higher funding costs and under pressure to put more capital aside – will be offered short-term borrowing from the Treasury at low interest rates. The hope is that these measures will encourage lending to businesses by ensuring liquidity is more easily available to banks.

On a regional level, the new Cambridge & Counties bank was launched in June and is targeting established SMEs struggling to get credit from major lenders.

The bank is jointly owned by Cambridge college Trinity Hall and Cambridgeshire Local Government Pension Fund and will lend to SMEs which typically have an annual turnover of less than £25m, and assets valued under this.

Loans will be between £50,000 and £1m and, with over £100m of lending predicted over the next four years, this will provide a new and welcome source of finance for businesses in the regional marketplace.