Banks are no longer fixated by assets. So what do they look for these days when considering how much they should lend?
'Ten years ago - and perhaps not quite so long ago as that - it was a matter of ascertaining that the assets were there to back the loan.
We didn't ask too many questions about where the repayments were coming from. It was pawnbroking,' says a Big Four business manager. 'If only it had been,' rejoins a Big Four senior banker. 'At least the pawnbroker is sensible enough to lend only a fraction of what the asset is worth. And he won't accept an asset unless it is highly liquid.'
The lesson has been learned, however, and according to the banks, recent years have seen a revolution in the way in which they deal with business customers. No doubt there are still a few pawnbrokers lurking around, but in general the banks these days recognise that when they're providing a loan, they need to look at the business as a whole, not just its balance sheet.
The revolution goes further: banks are trying to be less arrogant. Says the same senior banker quoted above, 'Five years ago, we'd have said to a prospective borrower, "And send us management accounts every quarter.
We want them within 10 days of the end of the quarter. In triplicate." Not now. We still want the accounts, although we tend to manage with one copy. But we have a genuine discussion about why it's in both our interests for us to have them. We used to have management courses about accruals. Now we have courses about how we behave.'
Of course, the vast majority of business borrowers are very small businesses.
At Barclays, hairdressers, fish-and-chip shops and anyone else who can get by with less than £50,000 of total borrowings is looked after by Small Business Services.
That's 2,000 people spread across the high-street branch network. This is a mass-market business, calling for straightforward systems and controls.
'You've got to keep it simple,' says David Lavarack, head of the division.
'In essence, it's a matter of one and a half times interest cover, and are they repaying on time?'
Lavarack's opposite number in the 'mid corporates' market - defined as borrowings of £50,000 to £100 million - is David Weymouth, director of Corporate Services. Here, it's more sophisticated. Borrowers are dealt with by teams comprising a leader and, say, five managers and five assistant managers. Staff get more specialised training than they used to and have a lot of information at their disposal. 'We have developed our industry information beyond all recognition,' says Weymouth. 'We have tried to equip managers to understand the different risks in the different sectors.'
In order to assemble the sectoral knowledge, Barclays, along with Lloyds, has introduced Lending Adviser, a US software package which amalgamates on a centralised basis all the bank's business loans and borrower performance information to give an overall view of how any particular sector of the economy is faring and to establish the bank's exposure, industry by industry.
Lending Adviser also analyses individual loan propositions, comparing them with norms for individual industries, and telling the manager which ratios to emphasise in which sectors.
An example of this greater sophistication is Barclays' follow-up on the collapse of the Net Book Agreement in 1995. The move altered the economics of the book trade, especially so for independents competing with a local Waterstone's. Lending Adviser told Barclays where it had bookshop customers and provided an immediate profile of their borrowing. The system enabled required ratios to be stiffened for new business and performance monitoring of existing business to be sharpened. After Dunblane, Lending Adviser was directed to sift out Barclays' gun shop customers. It turned out there weren't any.
Part of the banks' reappraisal has led to a fundamental switch from overdrafts to term lending. George Farrow, who does the same job as Weymouth, but at National Westminster, counts the changes. 'A few years ago, probably about 80% of our business lending in this area was on overdraft. In 1995, the figure was 51%. Last year, 45%.' Term lending is correspondingly up, and the fastest growing product is the fixed-rate loan introduced two years ago and now accounting for 15% of advances. Farrow insists that, 'Term doesn't mean straitjacket. Repayment schedules are matched to the borrowers' cashflows. Look at our gnome loans. A garden centre wants some money. All its cash arrives in June, July and August. Fine, we say - repayments will only fall in those months although, of course, they're higher than they would otherwise be. The rest of the year, you get a repayment holiday.'
Farrow says NatWest made 210 'highly tailored' fixed-rate loans last year, including one to a school whose repayments correspond to the months when fees are paid, and a Buddhist monastery where repayment is geared to the growth of the congregation.
NatWest too, he confirms, has segmented its business customers into large and small. 'Two years ago, corporate managers dealt with everything from gold card applications upwards and had targets across the piece. Now, anything remotely retail is passed on. The corporate people concentrate on the serious lending.'
The shift to term lending, apparent at all banks, hasn't attracted applause everywhere. Last year, after its two-yearly bank survey, the Forum of Private Businesses (FPB) thundered, 'Businesses with overdrafts had a more positive view of their banks than those without. This flies in the face of current bank policy of moving away from overdraft lending to fixed-term loans, a strategy which may be counter-productive ...'
'I don't want you to think we're at loggerheads with the banks,' says Nick Goulding, the FPB's head of policy.
In fact, its Bank Performance Index has risen sharply since 1992. 'Term loans suit banks because they're less expensive to monitor than overdrafts,' he says. 'However less expensive means less involved. We want banks to be more involved. Yes, they get the management accounts, but do you really think they read them? And what happens when the customer wants to repay ahead of schedule? He's hit with early repayment penalties.'
For their part, the banks insist that they don't force term lending onto borrowers who don't need it. The bankers say the big shift to term has come from transferring what was core overdraft. If a facility is £1 million, for example, but never came below £900,000, then it's the £900,000 which will go onto a term basis over, say, three, five or seven years, typically.
The remaining £100,000 stays on overdraft. And term loans are a greater commitment on the part of the banks since an overdraft is payable on demand.
Says Farrow at NatWest, 'The fear about withdrawal of overdrafts was always greater than the reality. But term lending transforms such fear into reassurance.'
Transforms it, that is, as long as covenants are maintained. Covenants are the minimum financial ratios which borrowers agree to maintain when they draw down a loan. If the borrower defaults, the loan might as well have been an overdraft. All the same, the shift to term loans looks to be an improvement from the point of view of borrowers.
During the recession, there were many instances when the bank's right to withdraw an overdraft was exercised on borrowers who would have been able to demonstrate compliance with covenants, had the lending been on this basis.
So in this new era, just how much money should a progressive business be able to winkle out of a progressive bank? One or two favourite ratios are set out in the table below, but there's no simple answer, and, apart from property lending, probably never was. All the banks emphasise that for ambitious loan applications, projections and the existing balance sheet are not the first concern. 'The first stop is a view of the quality of management and the quality of their planning,' says Weymouth. Borrowing capacity also depends on the nature of the business. If you've got blue-chip customers, there'll be virtually no limit on how much invoice discounting you can do. Meritorious propositions for which customers just can't put up what the bank sees as their side of the deal will be sent over to the bank's small business equity division; they all have them.
As to cost, there ought really to be nothing to choose between overdrafts and variable-rate term lending when it comes to the interest cost: both would be at the same margin over base rate. However, for reasons best known to themselves, banks tend to be more ambitious on arrangement fees when agreeing the term facilities. The bank will probably propose a fee of 1% for agreeing a term loan. If you pay that, then you need a mirror. Take a good look in it and decide whether what you see there is a weak negotiator or a weak business.
You would be doing very well, however, to get below a half per cent. If you can talk your bank into agreeing an overdraft, on the other hand, you might find even a half per cent fee is a walkover.
Then try them on a quarter.
All this assumes that the bank is not earning a fortune out of you already.
You might raise that subject by asking what your relationship profit category is. Your bank might not have adopted the name, but it certainly uses the concept. It's the answer to the question, 'How much do we make out of Bloggs & Co in a year, taking account of all aspects of income from account charges to foreign currency transactions?' That's really worth focusing on, much more so than the terms of the loan alone.
THREE OF THE BANKER'S FAVOURITE RATIOS
Cash generated to debt
Typically defined as: The bank typically wants:
Cash generated is profits
after tax and capital
expenditure A ratio of one to one. A lower figure and
dividends plus depreciation might be
acceptable for the first year minus increase
in working capital or two as long as the
plan projects that it will move towards one
to one. Debt service costs are interest
payments plus scheduled loan repayments.
Gross interest cover
Typically defined as: The bank typically wants:
Profit before interest
and tax divided by At least 2.5 to one. May occasionally
interest. accept 2 to one.
Typically defined as: The bank typically wants:
Current assets (cash,
stock, debtors) A minimum of one to one divided by current
liabilities (overdraft, creditors due within
one year including tax).