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Some observations on the current business/lending environment

3 November 2011

The much used economic phrase “we are living in uncertain times” has undoubtedly begun to affect confidence in the UK economy in 2011. As we know, the last 12 months in the UK have resulted in “flat” growth which has prompted many commentators to suggest that we are now facing a prolonged period of stagnation. Low annual GDP growth (<1%) and low base rates (<1%) for years to come, many believe, will now become the new UK economic environment for the foreseeable future.

That macro position and the “Merlin” targets which some banks have signed up to, are making it continually challenging for many banks to increase their lending books (year on year “net bank lending” is still reducing), whilst simultaneously trying to keep impairment under control.

In recent months, we have undertaken presentations to some bank teams who felt they were not being approached by a number of their better performing customers, as many of them are in fact degearing as opposed to seeking debt to expand their businesses in this environment. Instead, the bank teams were being approached mainly by less viable or cash strapped businesses (including a number looking to switch banks), often seeking a short term increase in facilities primarily as a result of working capital pressures.

We are also aware that a number of strong businesses with cash on their balance sheets are still holding fire on making strategic investments, or increasing their capital expenditure spend, given the ongoing global economic uncertainty and the potential for making an acquisition at an even lower price in the future.

In addition, and particularly at an SME level ,the lack of up to date management information and reliable forward looking projections being prepared by management teams will continue to make a lender’s role challenging. This particularly applies as the bank attempts to establish if there is a viable business going forward, which can adequately service its current and proposed new debt.

On a broader point, we know from our own experience of dealing with businesses in difficulty,  that often underperformance is a result of what we would call “light touch” due diligence being carried out by management teams, often prior to a previous acquisition that they had made. We cannot emphasise enough the importance of your customer undertaking high quality due diligence if they are making an acquisition in the current market. It really is no good finding out after the event that issues exist that could have been identified at the outset, by some deeper and focussed due diligence.

On a positive note, we have at FRP Advisory, particularly in 2011, found ourselves working a lot closer with our banking clients in the area of Pre Lending Reviews (“PLR”). Pre Lending Reviews are a useful tool for credit sanctioners and relationship managers/directors to get deals over the line as they primarily focus on how realistic the forward looking numbers are, and whether the customer’s management team possess the necessary acumen to guide the business through some of its challenges.

An assessment of future viability via a PLR is also helpful when banks are looking at providing EFG funding, as we understand that the Government are now instructing advisers to scrutinise a number of the EFG’s previously provided where the Government 75% guarantees are now being called on by the banks.  In one such case we dealt with, it transpired that the Bank RM did not in fact establish that the business had entered into a Time to Pay arrangement with HMRC in respect of circa £200k’s worth of Crown arrears and they are challenging whether, at the time the EFG was provided, the business demonstrated that it was viable, which may result in the Government refusing to pay under its 75% guarantee obligation. The EFG can be a good opportunity for banks to support the harder lending decisions with the PLR being a helpful addition to the viability debate.

As well as providing a level of comfort for the credit sanctioner and RM/RD, we are finding that PLR’s also enable us, as the middle man between the customer and the bank, to facilitate what may be a sensitive discussion, often in relation to under-capitalised businesses, around an appropriate level of drawings (“lifestyle businesses”) and/or what stake the shareholders ought to have. On a recent PLR that we carried out for one of our banking clients, we were successful in encouraging the shareholders to inject a further £300k into the business at the same time that the Bank agreed to provide an additional £250k onto the overdraft facility; thus satisfying the bank that there was an adequate risk being borne by the shareholders as well as the bank.

In summary, whilst it is clearly a challenging market, there are still really good lending requests being received but not as many as all the banks would like. However, it is bottoming out the difficult deals, having got the appropriate level of information and professional support, which can extend the safe lending opportunities.

Establishing growth in banks’ lending books will be a key factor in driving GDP growth and moving the UK back into a more positive economic environment.

For further information, please contact Simon Glyn using the online form below.