Banks crack down on small business

Risk margins are being ratcheted up, and at some banks, policies stringently applied despite long term customer relationships. Is it a new era of banking? By PATRICK STAFFORD

By Patrick Stafford

Risk margins are being ratcheted up, and at some banks, policies stringently applied despite long term customer relationships. Is it a new era of banking?

The banks are cracking down on small business. In the last few months, banks are increasing risk margins on small business loans, making it harder for SMEs to acquire credit and stay competitive, claim industry leaders and tax experts.

Banks are also enforcing policies far more stringently and rapidly than last year, and some banks are shocking customers with orders to move on.

For any new clients looking for loans, the answer is often “no”. Gregory Will, partner at PricewaterhouseCoopers says: “Now it is more likely the bank will be negative.”

The issue has come to a head in November and will get worse in December as bank reviews continue. “Two things are happening at present,” says Will. “Annually, banks at this time look at client facilities in terms of funding and how it fits in with the bank’s policies.

“They look at this when financial accounts are ready so they can check the ability of the entity to service the loan. They are also checking covenants and that property values haven’t fallen, and of course the issue at the moment is that property has fallen.”

At the same time as banks are checking financial and property values, they have reassessed their own lending policies in light of the financial crisis, and some are stringently applying policies despite the nature of the business.

Will says one bank in particular that has told certain customers it just doesn’t like the industry they are in, and they “have too much exposure to it” and told them to go elsewhere.

“Customers aren’t liking it,” Will says. “It’s coming as a shock, and of course leading up to Christmas, it’s hard to change facilities. Clients that have been long term clients feel the banks should understand their businesses and not just take a policy approach.”

Sue Prestney, Institute of Chartered Accountants SME chairwoman, says she is also seeing small businesses suffering under the banks’ decisions to label certain industries as “high risk”.

Prestney also says the banks are becoming more aggressive in exercising their rights to increase risk margins than six or 12 months ago.

“Even very sound businesses that might have at one stage been able to negotiate a risk rating of 1% or 1.5% may see themselves at 3%. If you’re not sound, you’d be getting more than that. I’m expecting we’ll be seeing more and more of this as annual reviews come out,” she says.

“It has happened very quickly, and it’s coming as a shock to some people.”

David Knowles, partner and head of business evolution practice at Pitcher Partners, says if companies breach a loan facility, banks have always had the right to increase margins, “but it seems to be a little more commonly done”.

Knowles says banks are also enforcing loan policies far more stringently. He recalls a client that for three years had breached a loan covenant, but for the first two years had only been sent a warning letter.

“This year, they got a letter saying the bank was going to change their margins by 1.5% and enclosed a bill for $5000. I hadn’t seen that before. That was not a small business – it was a medium size business.”

Greg Hayes, senior partner at Hayes Knight, also says banks are probably looking to lend less money than what they’ve lent historically. “What that has allowed them to do is be selective about their lending and take a slightly stronger stance with margins,” he says.

Heather Ridout, chief executive of the Australian Industry Group, also says risk margins are becoming a problem for businesses and that, “a number of our members” have reported risk margin activity.

These experts say a relationship between a business and its bank is no different than any other – it requires communication to stay alive. Businesses need to do their part by meeting loan covenants and repayments, and inform banks straightaway if there is a problem.

Knowles says businesses cannot afford to take anything for granted. “Communication is the number one,” he says.

“It’s human nature that if you’re not informed you think the worst – bankers are no different. The more informed they are the more comfortable they’re going to be. You want to show regular solid cashflow and profitability budgets.

“In the current environment, you really want to be forecasting. So you need to show the usual budgets and cashflows, and provide them with as much info as you can come up with yourself.”

Knowles also says if a business breaches a covenant, banks will use that as an excuse to think twice about their accounts with that business.

“The main advice is to be having a good dialogue with your banker. Talk to them regularly; it’s not in your interest to conceal anything. You want to be proactive and pre-emptive. If you’re going to miss something, then talk to them beforehand. It’s much better than not explaining it at all.”

Hayes also believes businesses need to re-examine the details of their loans and become familiar with the agreements they’ve signed.

“It’s really important for businesses to understand the covenants they’ve entered into. If they’re going to run into problems, they need to talk to their banks well in advance. They must have systems in place where they can identify potential problems,” he says.

“A lot of times issues are protectable, but businesses don’t have systems in place to identify that, or they take a far too optimistic view of what might occur.”

Prestney implores businesses to not give the banks any excuse to lift risk ratings.

“Watch your covenants and make sure if you haven’t met then you explain why. If it’s part of the arrangement that you have to provide the bank with statements, make sure you do that this year.”

But ultimately, she says, it’s about “managing your relationships” to ensure businesses live to see the end of the downturn

“It’s even more of an important factor to stay very close to your bank and make them have confidence. Inform them of what they’re doing and how you’re handling the crisis.”

Will also says to ask around, as some banks are being more strict than others.

“Look for banks with a relationship focus and not a policy focus. They are the ones to be with as they have more loyalty to the customer.”