Published Autumn / Winter 2010
It does not seem like too long ago since Bank financing for property purchases or business loans secured against property was commonplace and easy to obtain.
Indeed, at the height of the property boom making secured loans was big business for the Banks, with them aggressively chasing business on terms and rates that would have seemed ludicrous in the past.
Property values and the financial environment were such that Banks took the risk of lending significant amounts at high loan to value ratios, and at low margins. Banks lent more and more supposedly safe in the knowledge that interest rates would remain buoyant and if a borrower defaulted they would be able to recover the full amount they lent by repossession and sale of property over which they held security. Then came a different kind of crunch.
The “credit crunch” saw base rate along with property values plummet. Banks with loan books full of property backed funding found themselves in trouble. Many loan to value covenants were breached and Banks faced the prospect that repossession and sale of properties taken as security may not cover the whole of the loans issued. In addition, the base rate fell so low that low margin term loans that had been so attractive to customers were in many cases unprofitable for the Banks.
As a result Banks have wanted to reduce their overall exposure to property. They have done this by trying to call in loans, extracting more from loans already advanced and by being more cautious about making new loans. Where they are prepared to advance new loans they tend to now only do so at higher margins with higher arrangement fees. They also normally impose more stringent vetting, reporting and monitoring requirements.
How should customers manage their banking arrangements?
As regards existing loans, Banks have often been looking for an opportunity to renegotiate terms or to call in loans (to increase their liquidity ratios). It should be remembered that Banks can only operate within the existing agreed terms of the loan agreements they have with their customers. Where a customer moves outside of these terms, the Banks can and normally do use this as an excuse to:
- require more security to reduce its risk,
- increase the margins of an existing loan and/or increase arrangement fees,
- freeze any revolving loans, or
- require customers to repay their loans completely.
With regard to new loans, both businesses and individuals are, in many circumstances, finding it much more difficult to obtain Bank finance. Problems with their existing loan books are influencing Banks’ view on new loans, with some refusing to make further loans in the property sector altogether.
In a nutshell, all of this spells problems for those seeking new finance. Businesses need to make sure that they are fully aware of and do not breach the terms if they are to avoid new terms being imposed by their Bank. You should review loan documentation and make yourself aware of terms that you agreed that might put you at risk, for example, covenants regarding the value of assets provided as security, provisions making a loan potentially repayable on demand, and the nature of any personal security that has been given. By being aware of these terms and managing your business accordingly you can reduce the Bank’s opportunities to use an unwitting breach to change the terms of your loan arrangement or call your loan in.
As for those seeking new finance, Banks argue that the fall in the amount of loans being made is due to a lack of demand for credit, as businesses scale back investment and cut costs in difficult times. However, the picture that the Federation of Small Businesses (“FSB”) is getting from businesses is very different, with many saying they are still struggling to obtain credit from the big Banks and the FSB arguing that “even if credit is available the terms are often unattractive”
Following the measures that Banks have been taking over the last 2 years, they are now returning to profitability. They also say that they are allocating more money to lending as a result of pressure from Government. As a result, the chief executives of the UK’s largest Banks have joined together to create a taskforce in an attempt to increase lending to credit-starved small businesses. The aim of the taskforce is to examine various industry-led proposals to stimulate lending and drive the private sector recovery.
In addition to the taskforce, the new Commission on Banking is to spend the next 12 months assessing the structure of the UK Banking industry, focusing on the issue of lending. Whether the Bank taskforce or the Commission’s findings will make a difference remains to be seen. Until then, all businesses can do is try their best to weather the storm and, where you do have to deal with Bank finance issues, be prepared!