Breaking Through the Refinancing Wall: How did we get here?
IN THE second of a series of articles analysing the ‘refinancing wall’ and access to finance TheBusinessDesk.com, in association with business advisors and accountants Grant Thornton and asset based lender Crédit Agricole Commercial Finance, asks how have we got here?
FOR the past three years, the UK economy has been languishing in a state described in terms ranging from a downturn to full blown crisis.
The recession has claimed many victims, the collapse of large financial institutions, the bailout of banks by the previous Government and, on an international scale, downturns in stock markets around the world.
Unemployment hit 2.8m at the start of this year – with predictions that it will rise further – and the recession has been the longest since the Second World War and has been considered by many economists to be the worst financial crisis in global terms since the Great Depression of the 1930s.
One of the major causes of the financial crisis was a liquidity shortfall in the United States banking system, leading to a property crash, an episode which has been mirrored in the UK.
Driven by caution and unease about their own solvency, banks have tightened their lending criteria, leading to a lack of credit.
And despite governments and central banks responding with unprecedented fiscal stimulus, monetary policy expansion, and institutional bailouts, challenges remain for businesses to rally against market background and have the ability to manage debt.
Ian Marwood (pictured right), corporate finance partner at Grant Thornton in Leeds, believes the beginnings of the crisis can be traced back to relaxed lending practices in the period before the recession in which anything seemed possible as businesses planned for growth.
“What many will see as the worst excesses of the lending boom in the mid noughties was the level of leverage being used in lending facilities,” Mr Marwood says.
“It was not unusual to see debt levels of four times annual profits and on larger more complex deals you were seeing six or seven times annual profits. There were also ‘covenant lite’ facilities, where the ability of the banks to respond to the underperformance of businesses was limited.
“As the recession hit profits the inability of companies to service these debt levels became apparent. Banks also had to address their own balance sheet problems, and capital adequacy rules started to hit the nature and size of facilities the banks were prepared to lend. Typically now banks are uncomfortable when debt levels exceed 2.5-times profits.”
Ian Flaxman, strategic director at Crédit Agricole Commercial Finance, describes previous lending practices as “careless”.
He says: “My view is that, in general, we have experienced over a decade of relatively easy credit and low interest rates. The housing boom, particularly in the United States, was fuelled by what could now be argued careless lending decisions.
“It had been common practice for banks to take parcels of mortgage advances, seen as a secure asset with a known return, and sell these into the financial markets in order to release further liquidity. As the housing market in the US started to decline, the perceived reliability of mortgage-backed assets was challenged, triggering a rapid loss of confidence in the markets.
“Ultimately, the result is a much more challenging environment in which banks have to raise liquidity. In order to prevent a repeat of this situation, much more stringent regulation is being imposed upon the banking sector.
“Although this is necessary and perhaps overdue, the result will undoubtedly be a continued liquidity challenge.”
Mr Marwood said that pressure for banks to lend from government and small business lobby groups also conflicted with the need to apply more stringent credit tests on new lending and as a result the reputations of banks amongst the wider business community suffered.
“Companies responded by being more cautious, ensuring that existing facilities were not disrupted for fear of either withdrawal or significant re-pricing,” he says.
“Banks recognised that the refinancing wall was approaching, and responded by conserving capital to ensure they could look after existing customers. So the normally highly competitive re-banking market became moribund, with only the well capitalised foreign banks in a position to drive new business development.
“Throughout this period companies were applying cost reduction strategies, and managing workforces to survive the worst effects of the recession.
“Balance sheets were once more a key focus, with cash resources being marshalled carefully to fund difficult working capital positions without taking on more debt finance. This trend may well continue with growth strategies increasingly being funded by internal cash generation and alternative funding sources whilst suspicion of the banks remains.”
The property sector has been the most affected by the crisis, with many banks considering themselves to be over-exposed to property coupled with a general reduction in property valuations, Mr Flaxman (pictured left) believes.
And he adds: “Banks will certainly continue to place risk management and careful use of capital resources ahead of growth for the next two to three years.
“During this period, there will be continued pressure on borrowers to reduce or repay debts where their incumbent lender is unhappy with either risk or reward.
“Borrowers with strong collateral for lending will inevitably be much better placed to continue to rely on available credit since banks obviously prefer secured lending and have a lower capital requirement compared to unsecured lending.”
