Project Merlin is no magic fix to lending

Whether it is because they are perceived as architects of the financial crisis, pay gratuitous bonuses, or have returned to bumper profits, the UK’s four largest banks (RBS, HSBC, Lloyds and Barclays) unveiled combined annual profits of almost £25bn for 2010. Bankers make easy figures of hate while the rest of us remain in the economic doldrums. However, the main criticism levelled at banks by finance directors of small- to mid-sized businesses is that they continue to withhold credit from them.

There is a healthy dose of scepticism among finance directors that the deal between the government and the UK’s biggest banks on lending and bonuses, dubbed Project Merlin, will produce the dose of magic needed to kickstart lending to the businesses that need it most.

As part of the agreement, the four biggest UK banks, and Spanish group Santander, commit to making £190bn of credit available to businesses in 2011, of which £79bn has been earmarked for SMEs. This equates to a 15 percent increase on the £66bn lent to SMEs in 2010.

So far, the signs are not promising. Data from the Bank of England for December 2010 showed the net change in loans to businesses fell again, meaning that net credit fell back in all but two months last year. Meanwhile, a survey produced by the manufacturers’ organisation EEF in March showed the cost of credit has been increasing in 2011 too.

“The improvement we saw in lending towards the end of last year seems to have been short-lived. While there appears to have been some easing in availability, the question for many smaller companies is still at what cost and under what terms,” says EEF chief economist Lee Hopley. “It is far from clear that we are on the path to easier access to more affordable finance.”

Therein lies the problem. Project Merlin makes it plain that the banks’ position on lending will be “subject to normal commercial objectives”. This means that while money will be made available, the banks do not actually have to lend it and, more importantly, they can charge what they like to do so.

One FD tells Financial Director that, though he could get funding, the banks “charged the earth”, while another FD of a building products company that recently switched banks to secure a funding package tells a similar story.

“We never had an issue with the facility; it was the pricing structure with which we had an issue,” the FD, who asked not to be named, tells Financial Director.

According to the banks, it is business as usual. Speaking at the launch of the Finance Directors Planning Forum in March, Mark Berrisford-Smith, senior economist in the business economics unit at HSBC, said that he had not spoken to any colleagues that had their “door battered down with people asking for money” and that the banks’ lending criteria are the same as they always were.

“We lend money to viable businesses with good management – end of story,” said Berrisford-Smith.

The eye of the beholder

The definition of what makes something viable is the main point of contention. Banks interpret viability in a conservative way, and their opinion may be very different from the interpretation of SME finance directors.

As a general rule of thumb, the main requirements for a viable business are the presence of a good management team, strong financial controls, a sensible capital structure, a contingency plan and a strong product or service. But the interpretation of what it means to be viable remains a matter of opinion.

“The banks need a lot more convincing that the business is viable, but that is very much in the eye of the beholder,” says Clive Lewis, head of enterprise at the Institute of Chartered Accountants in England and Wales (ICAEW).

Bobby Lane, head of Denver Chase International, the outsourcing operation of accountancy firm Shelley Stock Hutter, adds that there are also discrepancies among, and within, the banks about the definition of a viable business.

“I had two clients in the same industry, which I took to the same bank. One company had a strong balance sheet and supplementary customer guarantees, and the other did not. The credit was offered to the second company,” he says.

But there are things that FDs can do to present their company’s case as being a viable business for receiving bank credit. They should be prepared to provide much more information than they would have done in the past. In making their assessment, banks require ever more information about the management team, the company’s products, a business plan, and balance sheet and turnover forecasts.

According to Lane, the days when banks will lend on cashflow are gone. “We live in a securitised environment, and banks want security,” he says. “You have to have more management information and a clear idea of what is in the business. You have to have the right story and it has to be realistic.”

While some finance directors may raise their eyebrows at such seemingly obvious advice, it does yield results.

“We were able to tell a story that was reflective of a solid business with a decent asset base and working capital that is under control. It was not a great challenge for the bank to say OK,” says the unnamed FD of the building products company.

Ostrich syndrome

Staying in touch with the bank at all times will also increase the chances of successfully getting hold of credit. But this is all too often easier said than done. Whether due to a revolving door of relationship managers or to relationship managers that do not understand a company’s finances, banking relationships are not what they once were.

“A year ago I could predict what questions the bank was going to ask, but now it has become much more difficult,” says Lane. “Gone are the days when being with the bank for 10 years mattered. Now it does not count for anything.”

But such frustrations should not be used as an excuse for not picking up the phone and talking to the banks when problems arise and short-term finance is needed. The key message is that FDs should not wait for the bank to phone them.

“When things go badly, you get the ostrich situation: the finance directors stick their heads in the ground,” says Lane. “Don’t hide from your bank manager – show them what you are doing to deal with the situation. If you can deal with the situation early, then it will not look like Armageddon and you will not have to make that kneejerk decision.”

Lewis at the ICAEW also stresses the benefits of keeping in touch with other bank providers. If the bank is refusing credit even though the business is eminently creditworthy, or the pricing structure of the deal offered is unsatisfactory, be prepared to change providers.

“See what offers other providers will make. I know of at least one bank that has a facility for businesses to transfer into it. Banks are trying to make it easier to transfer,” says Lewis.

However, the FD who recently swapped his banking provider to secure funding on more favourable terms says the costs associated with switching banks can be off-putting for many.

“There is a stigma associated with changing banks, and it would not take much to make it more attractive,” he says. “The cost of the process of changing is a problem if it eliminates any benefit that comes from a better charging structure.”