SMEs and banks need to get on with each other
It’s an economic imperative that banks and SMEs get on with each other. But alas, since the GFC, it’s all too obvious a cornerstone relationship of the national economy is under strain. Equally obvious therefore is the need to relieve the tension in everyone’s best interests. But how?
Facing the new reality, that’s how.
The current lending environment for many SMEs has become the new normal. Businesses generally need to improve financial management to ensure they’ve strong business models in place. These should aim not only to free up cash flow, but also to provide evidence of solid financial performance that has become the banks’ new criteria for lending to the SME market.
Shareholders require banks to make a profit, as do shareholders of any other business. But a problem for banks right now is that it’s costing them relatively more to buy the money they can offer for business loans than it used to cost a few years ago.
Many managers of SMEs will admit privately that banks, in rigorously scrutinising clients’ business plans these days, are merely doing what they should always have been doing, rather than casually dispensing loans as they’ve done in the past.
The banks' reality
If nothing else, bankers have been jolted back to reality as the number of business collapses continues to climb – a record 10,757 Australian businesses going belly up for the financial year ended on 30 June 2012 That’s 752 more collapses than at the height of the GFC.
Construction and retail sectors accounted for 30% of failures. Poor strategic management, inadequate cash flows and trading losses were the most common causes of insolvencies from which, according to the Australian Securities and Investment Commission (ASIC), 98% of creditors received less than 11c in the dollar.
After consideration of administrators’ reports, ASIC has decided to put 10% of them aside for possible investigation of insolvent trading, failure to keep proper financial records and breaches of directors’ duties.
Adrian Brown, who heads ASIC’s insolvency team, says we’ve just had four successive quarters of more than 2,500 administrations per quarter, something he doesn’t recall happening “in recent times”, a situation where 85% of the failed companies were SMEs holding assets valued at less than $100,000.
All in all, it’s scarcely any wonder that when bank managers look at figures like these, they’re disinclined to lend what’s become expensive money, unless they believe a loan is good business for them.
The reality for SMEs
Managers of SMEs appreciate – albeit with varying degrees of reluctance – that banks have needed to be more prudent with lending than they have been in the past, especially given the current economic environment.
But it’s what business managers see as banks’ lack of transparency and communication about changing lending conditions, that annoys them. Perhaps this newsletter will go some way in bridging the information/expectation gap.
They say notification of changes and likely or impending changes would at least give business managers timely opportunities to amend practices to suit banks’ requirements.
In the majority of cases secured lending is pretty much the only form of lending banks will countenance these days. Goodwill, cash flow, and profitability lending is a thing of the past. If any cashflow lending is being entertained the banks more than likely will request stringent guidelines be followed and one should ensure that cashflow forecasts etc are spot on as you can be rest assured that they will be reviewed and monitored by the banks.
Indeed, since the GFC all lenders have reviewed their credit portfolios to increase levels of security – even for existing loans.
Many an asset value has declined since the GFC, and there’s a substantial weight of anecdotal evidence that banks have increased loan-to-value ratios (LVRs).
It’s often the case that not only have owners of SMEs been required to use personal assets to secure loans, but as successive valuations indicate that these assets have decreased in value, lenders are requiring businesses to reduce debt levels to accommodate increasing LVRs. Almost inevitably the result is major decreases in businesses’ cash flows.
Making tough times even tougher for a business manager can be a lender’s requirement to support additional security with personal and director guarantees – previously in many instances not considered necessary. Frequently there’s now also a mandatory requirement for key-person insurance, which can be expensive.
The end result of all this, is resentment by many business owners at, in effect, having to hand over all their available security to a bank, thus making it virtually impossible for them to switch lenders -- a doubly irksome situation as competition in the banking sector lessens. Foreign banks’ presence in Australia in the SME market space is nigh non-existent and major local banks have been busy absorbing second-tier lenders in mergers.
It's all about information
It was always important but now it’s critical. The very future of a business that’s seeking bank finance can depend on representations made on its behalf. Presentation is everything, and Macks Advisory is always happy to help with this.
In any event, herewith are some tips for a successful loan application:
- Understand the lender’s requirements before making the application (for example how much equity may be needed to secure the loan).
- Are there covenants required for the loan? Be sure your business can accommodate these before applying for it.
- Ensure financial information is accurate, provides adequate detail for credit assessment, and includes detailed budget forecasts.
- The prospective lender will want to see you will have adequate cash flows to cover possible increases in interest rates and fees.
- Express a willingness to keep the banker well informed regularly about your business activities and industry trends (and make sure you do).
Once upon a time, not long ago, experienced branch managers of banks could often successfully argue with head office to win a loan for a long-time client. That has always been and will continue to be a challenge.
And here’s the rub
It’s a quandary.
Sure, today a loan application can be a rigorous procedure. But have no doubt the bank wants you to be able to pay back the loan and retain your business long-term as a client. It is to both parties mutual advantage.
Sure, stricter loan conditions are restricting many a successful business in its ability to expand on its own territory or to finance an acquisition.
And sure, a good argument can be made that this is a quandary hindering the post GFC recovery process.
And so we reiterate. SMEs and banks constitute the core of the Australian economy. Each needs the other and the country needs them both. Surely therefore here is powerful incentive for them to improve a relationship that’s taken a beating in the post GFC’s new reality.
Perhaps what’s needed is better communication and transparency from banks, in tandem with businesses’ better assemblage and maintenance of quality information that’s more likely to get them what they want from the banks.