Dealing with Your Bank

Dealing with the banks is a hot topic at present. In almost every newspaper the media are determined to represent them as both the cause of the recession and the grim reaper for small businesses. This article therefore focusses on how small companies must communicate with their banks.

A Bank’s Business Model

Banks use the money that depositors put into their accounts and lend this to households and small and medium sized businesses. The interest rates and arrangement fees they charge for the loans to these people are used to pay interest to the depositors to cover those loans that are not recovered and to cover the overheads of the bank. In addition the bank also wants to make a profit.

It is important that business owners understand this before they jump to rash conclusions about the role the bank should play in supporting their business. It is also important to note that the bank manager you are dealing with is an employee of the bank who is rewarded for both obtaining clients, adding value to clients and protecting the interests of the bank and the depositors money that they are lending.

As a business owner, the bank is not some all powerful god, but actually a supplier to businesses and households. It is easy to see how banks could be grouped together into some ephemeral group of untouchables. However, they eagerly compete for business just like all of your other suppliers.

There is however some truth to the advert about the fact that they are less willing to hlep once you are a customer – at least there was this time last year.

There is a clear distinction between the money that banks “lend” to businesses and households compared to investments which are made to obtain a share of the ownership in a business. Clearly the ownership of a share in a business does not guarantee the value of that share. Whereas a loan is expected to be paid back in full, at its initial value. This also needs to be contrasted with a grant where the money is “given” as an incentive to do something like employ more people.

Viability of Business

Bank managers often use the term viability as a criteria for business that they can accept on behalf of the bank. This term is often mis-understood by businessmen, because they think it refers to their business. In reality, viability refers to the viability of the loan to the business. This is measured by:

• the likelihood that the loan will be repaid,
• the value of the security that the business and the business owner can provide in the event that they cannot repay the loan,
• the price that the bank must place on a loan that properly reflects the risk of there being no repayment and the likely recovery of that loan from the security provided.

Therefore, when you are considering asking your bank to make you a loan to overcome a particular requirement, you must consider how you intend to meet these viability tests for the loan you are requesting. Colin Mills, Founder and CEO of the FD Centre explains that banks want to know how and when they can expect repayment of a loan. To do this one must provide them with your current financial position which is your balance sheet which sets out what you own and what money you owe. You also need to demonstrate the earnings you intend to make using the loan and the cashflow this will generate. This will show whether the business can afford to pay the price of the loan – the interest payable – and whether sufficient profitable cashflow is generated to repay the loan. Many businesses wrongfully expect this to be a simple exercise. The bank must not only assess the forecast results that you need to produce to support your application, the bank must also assess the strength of the management to deal with any issues that could impact on the “viability” that will undoubtedly arise. An example might be that the sales forecast is not achieved by a considerable margin due to the sales director leaving. They must also assess the likelihood that the management information provided is accurate.

Myths About the Enterprise Finance Guarantee

The Government introduced a new scheme of guarantee to allow the banks to lend to small and medium sized business which they may not be able to lend to if the guarantee was not available. It is important to note that the government has not issued clear guidance on exactly how the scheme works and this is the reason why the banks are reaching different conclusions about how they will apply the scheme. In discussions with Finance Directors from The FD Centre the things that we do know are:

• The guarantee is available to most industrial and service sectors.
• The amount covered is a minimum of £1,000 and a maximum of £1,000,000. The maximum is split amongst subsidiaries in a group or companies under common ownership.
• In 2009 the business pays 1.5% of the loan outstanding as an insurance premium to the government. The sum insured under the scheme is 75% of the loan outstanding. In 2010 this insurance premium rises to 2% of the amount of the loan outstanding. This is paid quarterly.
• The loan cannot be used to refinance existing loans.
• The loan must be “viable” – this means that the bank must carry out the necessary due diligence to confirm that they are reasonably comfortable that the loan will be repaid and that the company can afford the interest and insurance premiums.
• Banks cannot use the government guarantee where the business or its principal owner has sufficient assets to pledge against the loan as security. As under the Small Firms Loan Guarantee, a house in joint names with the spouse cannot be used as security if the spouse does not permit it. This option does not exist if the spouse is also a director of the company.
• All banks are allowed to take personal guarantees and most are looking for a 25% guarantee to cover the amount not guaranteed by the government. This is hurt money to make sure that the owners of the business understand that this is a loan and not a grant or equity. Some banks are looking for 100% personal guarantees because the government may try and limit their exposure to defaults under this scheme retrospectively if the failure rate on these loans is too high. This is adding significantly to the confusion.
• The paperwork for the banks is pretty straight forward and is a 6 page application form. However this does need to be supported with a detailed business plan and forecasts to prove and test the “viability” mentioned above.
• Interest rates are a minimum of 4% above base rates.
• Arrangement fees are typically 1.5% to 2% of the amount of the loan.
• The loan is very likely to be sanctioned but the loan may be drawn down in tranches and could well be conditional on certain performance criteria being achieved, eg. sales, gross profit and net profit. Therefore, it is important that forecasts provided can be achieved.
• EFG loans can incorporate a holiday period on capital repayments of up to 3 years although typically one would expect the banks to agree to shorter periods of typically 9-12 months. The maximum term of the loan is 10 years.

Dealing with Your Bank Increasing Its Prices

It is important to approach your bank as you would your most important supplier. They are important to you but you do have alternatives. If your principal supplier faced a massive increase in his input costs, he would need to have a difficult discussion with you. This is exactly what is currently happening in the bank sector. The view you have to take is whether other banks are going to be able to offer you a better deal – it’s worth asking because that is your best alternative to agreeing a deal with your current bank. Price is normally quoted as a % over base rate. In the good times it was as low as 0.5% for low risk businesses and 3.5% for early stage companies. Unfortunately the spread is more like 2% to 5% because of increased risk in the economy and the difference between base rates and the actual % cost of borrowing money for banks. This may not necessarily mean that the overall cost of borrowing will increase from last year because base rates have fallen so rapidly. The important negotiation point is to obtain a written commitment to reduce the margin when the cost of funds and the base rate fall into line again.

Arrangement and renewal fees are also being pushed up. In many cases these are justifiable because of the work that relationship managers are having to put in to justify renewing the facilities with their credit departments. However, there are cases where managers have charged up to 2% of the facility following a phone call. In such cases you need to complain to that manager and if you do not receive sufficient action then you will need to be referred to the local director to justify the fee.

You will often need an FD or our accountants to handle these negotiations. If you do not have an FD why not consider a part-time FD.

James Nicholson-Smith
The FD Centre