Raising a Bank Loan

Bob BerryBoots Professor of Accounting & FinanceNottingham University Business School

Today I’m going to….1. Talk you through the activities of one small

company over the last couple of years, emphasising their response to rejection of a loan application.

2. Look at Project Merlin and the most recent evidence on the availability of bank finance.

3. Look at how you can improve the probability of a loan application being successful.

The case study company.

1. A small business consultancy.2. Clients are typically large plcs including some

banks.3. Turnover typically measured in tens of millions of

pounds.4. There are generally relatively few clients/projects

at any one time.5. Finding the next client/project is a constant

preoccupation.

The financial problem …

1. 2008/2009 saw the company facing a potential “project gap”.

2. An approach to their bank (a long-standing business relationship) had not been successful.

3. Maybe it was a bad proposal, or maybe the bank wasn’t really open for business.

4. Thankfully the impending cash crisis was several months away.

5. Still time to put a survival plan into operation.

The financial solution …

1. More attention given to cash flow forecasting.2. This highlighted the need for discussions with

suppliers about payment terms.3. It also highlighted the importance of staff

salaries:i. High fixed cost.ii. Bonus element limited to staff involved in marketing.iii. Annual bonus “no more than a Christmas present”.

4. Actions taken:i. Recruitment freeze.ii. Underperforming staff “let go”.iii. Everyone shifted to a low fixed, high variable salary system.

5. Easy? No! Necessary? Yes!

Now some external finance …

1. A new application for external finance was constructed.

2. “Who has an interest in keeping us in business?”3. Successful bid to a non-bank source of finance.4. A professional bid from a company anticipating,

not reacting, and one which had already put its own house in order.

Life goes on …1. Marketing efforts were not reduced.2. Staff knowledge and skill updating were not cut

back.3. 2010/2011 new projects, but new problems:

i. Understaffed!ii. Impending cash flow problems if expansion goes ahead.iii. Existing clients are altering payment terms.

4. The decision has been taken to “Expand!”5. The company’s bank is now keen to help. Why

not? The problem is timing of cash flow, not the existence of cash flow. Low risk lending.

Banks change their tune ...

1. “It used to be the case that if it was a good business proposal we would lend against it. Now if we can lend against it, it is a good business proposal.”

2. The run up to 2007 involved a (bonus driven?) acceptance of risk by banks.

3. Now banks are very risk averse.4. I’ve recently heard of banks, acting as

purchasers of services, opting for high fixed price contracts rather than variable price contracts with a good probability of coming in cheaper.

Is bank finance currently available?

1. Barclays TV advert. “80% of loan applications from small businesses are successful.”

2. A source “close to” Business Secretary Vince Cable: “What bothers him, on a very regular basis, is that when he is going round the country, he keeps getting the same complaint – that the cost of loans is too onerous, which puts businesses off even trying to borrow.”

3. Is that what is happening? Only the few good proposals that can cope with the high rates of interest charged by banks are being put forward.

The government has a solution …

1. The government thinks the problem is not a lack of demand for bank finance, but a shortfall in supply. Risk averse bankers don’t want to lend.

2. The government has a solution: “Merlin’s our mainstay and Witchcraft is the name of the product.” (A slight misquote from Oliver Lacon, Cabinet Office in John le Carré “Tinker Tailor Soldier Spy”)

3. OK. I’m being flippant, but Merlin is the basis of government’s attempt to bring banks and SME loan applicants together.

Merlin …1. HSBC, Barclays, RBS, and Lloyds (with a bit of help

from Santander) have agreed to make £190 billion of credit available to businesses in 2011 (compared to the £179 billion lent in 2010).

2. Of this, £76 billion will be made available to small businesses (compared to the £66 billion lent in 2010).

3. These levels form part of the performance targets that banks’ Chief Executives must achieve to earn their bonuses.

4. Merlin also requires the banks to control bonuses and become more transparent. Santander opted out of this bit.

Merlin to date …1. The Bank of England is charged with monitoring

the agreement and with publishing quarterly assessments – the first of which was published last week.

2. In 2011Q1bank lending to small firms was £16.8 billion rather than the £19 billion promised.

3. The overall lending target was very nearly reached, £47.3 billion rather than the £47.5 billion promised.

4. Is the glass half full (only a partial quarter) or half empty (a gross rather than a net figure)?

Is it supply or is it demand?

1. A recent Federation of Small Business survey says that 44% of its members who approached a bank for credit were refused. But the survey also says that only 16% of members had approached a bank.

2. Another survey by the EEFederation says that the availability of bank financing has improved but that the cost of credit has also increased.

3. Quantity up and price up is possible. The banks are pricing in a higher risk of default ….for everyone!

How to proceed …1. Don’t rely on Merlin. The agreement is for one

year only, and it stipulates that loans will be made on commercial terms and be subject to demand.

2. Don’t sit around and wait for the money to arrive, put your house in order and apply.

3. A tidy house requires:i. Financial planning with a heavy emphasis on cash flow forecasting

and management.ii. Evidence that existing operations have been revised with cash

flow in mind.iii. A strong loan case.

What do banks look for?

1. Character.2. Ability.3. Margin.4. Purpose.5. Amount.6. Repayment.7. Insurance.

1. Person/purpose.2. Amount.3. Repayment.4. Security.5. Expediency.6. Remuneration.7. Services

Key points …1. It is clear that people and project are both

important in the loan application process.2. It is clear that the bank wants reassurance about

cash flow stability and marketability of assets.3. It is clear that the circumstances of the bank are

relevant to the success of any application.4. You can maximise the chance of success, but you

can’t guarantee success.

The components of a loan application …

1. There are two sides in a negotiation.2. You must provide:

i. Evidence of a competent management team (Personal)ii. Evidence of past financial performance (History).iii. Project data (Project).

3. The bank lending officer (BLO) brings along:1. Experience and seniority.2. A job description.

4. A senior BLO ranks like this: Personal =1, History = 2, and Project = 3. A junior BLO ranks like this: History = 1, Project = 2, and Personal = 3.

5. The job description might not give the right to say “Yes.” Someone more senior might be needed.

What about the numbers?

1. Provide:i. Forecasts and assumptions relating to the project proposal.ii. Audited accounts for the last 3 to 5 years.iii. Information to bring the audited accounts up to date.

2. Be prepared to discuss as well as deliver the material. You need to be ready to cope with “What if?” The obvious “what ifs” should have been dealt with in the documentation.

3. Be prepared for site visits in some circumstances.

4. Don’t expect the BLO to do your work for you.

It is all about risk…1. At the most basic we are talking about cash flow

variability against a fixed interest charge and marketability of assets if things go wrong.

2. Think about the sources of risk, and what the bank will be comfortable with.

3. For example, a mineral extraction proposal consists of “existence” risk, “extraction” risk, and “market” risk.

4. Think back to the case company. “I’m not sure exactly when the cash will come in.” is a very different statement to “I’m not sure whether the cash will come in.”

Don’t be too optimistic …

1. Most systems are capable of generating extreme outcomes.

2. Past fixes deal only with particular causes.3. Ask how you would cope with the most extreme

event you have already experienced.4. Then remember that the worst thing that has

happened isn’t the worst thing that can happen.5. At the moment, there is a big difference between

your company and a bank. You accept the inevitability of risk while a bank tries to avoid it.

Questions please …