Limited lifeline
1 Jul 08
Banks won't lend because they can't borrow, companies are having to sell prize assets and the US sub-prime crisis is still sending out ripples. Even the Bank of England's intervention is not a panacea
by Victoria Masterson
Is the Bank of England’s £50 billion rescue package for Britain’s banking system working? The consensus is: not yet.
On 21 April the Bank unveiled a “special liquidity scheme” allowing banks and building societies to swap riskier mortgage- backed assets for safer government bonds in a bid to kick-start crippled money markets.
But there has been little sign of this bringing down the cost of lending between banks, or helping businesses get credit.
Lorna Wyllie, head of corporate services at Wylie & Bisset chartered accountants in Glasgow, tells a familiar tale. “One of our clients has been to the bank for what would have been a routine short-term increase in borrowing or finance for a one-off project. It’s taking a long time and then it’s coming back with a negative response. The banks are taking no risk whatsoever. A couple of clients were offering personal guarantees, meaning no risk at all for the bank, but the answer was still no.”
Wyllie is advising clients to seek other potential sources of funding, including development finance for growing businesses, such as the West of Scotland Loan Fund and Developing Strathclyde, the community finance initiative.
What bank lending is available for businesses? “There isn’t any,” she said. “I don’t think the banks have the money to be lending.”
After reaching 6.9 per cent, a 20-year high, last September, a week before Northern Rock asked the Bank of England to bail it out, the three month bank-to-bank LIBOR (London Inter-Bank Offered Rate) rate fell to 5.83 per cent at the end of April after the Bank’s intervention. It has since crept up again to 5.87 per cent – the Bank base rate is 5 per cent.
Dougie Adams, an economist at Oxford Economics and adviser to the Ernst & Young ITEM Club (which provides independent economic analysis based on the Treasury model) says the situation would be worse if the Bank had not acted and goes on: “If you step back from the credit crunch, what’s going on is a reassessment and reappraisal of risk.
“Lending standards and the approach to lending have been tightened dramatically. That’s a process that, no matter what the Bank of England or anyone else does, we’re going to have to go through because we’ve reached one of those periods in economic history when lending standards have become just bonkers.”
Adams goes on: “It’s the old story that if you don’t really need the money, the banks are willing to lend, but if you’re desperate, it’s very difficult to get. I think the areas it really hurts are at the edge – new starts where you have no track record and small businesses who maybe have a story to tell but have yet to deliver results. I think we’re through the worst, but getting money will remain tough for a number of years, or possibly for ever. It puts more emphasis on being able to present a good case to the banks. Flights of fancy are not going to get money so easily.”
The ITEM Club spring 2008 forecast warned that the credit crisis is going from bad to worse, with the UK facing two years of sub-trend growth. Lending to non-financial companies is up more than 15 per cent in the preceding 12 months and companies had yet to report a significant impact from the credit crunch on their ability to finance capital expenditure, but this is bound to change.
The latest British Chambers of Commerce survey, for example, shows a marked fall in confidence in profitability in the service sector, reflected in weakening investment intentions.
Neil Craig, managing partner at BDO Stoy Hayward in Scotland, has no doubt that businesses are finding it harder to borrow. “I think the banks are looking to get more cash into their balance sheets and lending criteria and new lending are getting tougher. Banks are also looking to restructure current lending, because a lot of companies are reasonably highly geared.”
Craig is advising business clients who see credit tightening to improve working capital management, for example through better credit and stock control, and consider taking costs out of the business.
Compared with the amounts sought in rights issues, Craig believes the Bank of England’s £50 billion is “not material” and the biggest issue for the sector is confidence. But bad press, including allegations of price-fixing at Barclays and RBS and the botched cash-call at Bradford & Bingley, is not helping.
Alex Potter, banking analyst at Collins Stewart, says the liquidity problem is being replaced by worries about asset quality. “I’m not sure if [the Bank’s rescue package] is helping finance costs come down for businesses. Banks are increasingly concerned about asset quality, so they’re pricing up for different reasons.”
Meanwhile, the banks are staring at a possible recession and are nervous.
As the Royal Bank of Scotland sells off prized assets such as Tesco Personal Finance and its insurance businesses, Potter suggests: “It may be that small businesses and corporates have to do the same. The danger there, as RBS is finding, is that there are not many buyers with ready cash.”
Fitch, the ratings agency, says asset quality in the major UK banks’ mortgage, commercial and corporate loan portfolios has been “unsustainably” strong for several years and is under pressure.
In the corporate space, it says areas of growing concern are property lending (specially development finance and house builders) and parts of the retail sector. In the longer term, leveraged finance exposures (drawn and undrawn) could become more problematic if re-financing options remain constricted.
For most major UK banking groups, tighter conditions in wholesale funding markets are more likely to be a constraint on growth than a material drag on earnings, Fitch says. But smaller banks and building societies would feel it harder and lose share to high street neighbours.
At CBI Scotland, assistant director David Lonsdale says the Bank of England’s intervention should help restore capital and confidence in the banking sector. But it is too early assess whether lending would ease as a result.
“So far the feedback from our members is that the banks are now more circumspect about lending both to individuals and to the wider business community,” Lonsdale says.
“CBI Scotland’s latest industrial trends survey reveals an increase in the number of firms saying that the cost and availability of finance is affecting their business, particularly their investment intentions. Anecdotal evidence from some of our members also reinforces the more empirical survey data, with the house-building sector telling us of a dip in the amount of money available for land purchases and major projects, at the same time as prospective house buyers are facing fewer and more costly mortgage products. In saying that, however, banks and other lenders tell us that money is there for good commercial projects, but time will tell.”
George Primrose, senior partner at Condie & Co in Dundee, is hearing similar stories and says developers and general trades are being affected by the tightening of credit to consumers. “It’s particularly noticeable where people are involved in home improvement or housing construction,” he says.
“I’ve one client involved in the home improvement sector whose order book is the lowest it’s ever been. He says that when house prices start to fall, home improvement usually picks up because people start doing up their kitchen or bathroom. But people aren’t even getting money on equity release to do these large home improvement projects.
“Another client is involved in supplying major housebuilders, but they’ve all stopped building and are reducing housing stocks.”
The banks have widened their margins and are making more on arrangement fees and interest rates, Primrose adds. He believes the situation will remain unchanged until the Bank makes at least a 0.5 per cent cut in interest rates.
At the British Banking Association, which compiles the daily LIBOR rate (based on members’ reported rates), spokesman Brian Capon says the Bank’s special liquidity scheme is very welcome and should ease the strain in money markets. But he adds: “Disentangling the factors that feed into the LIBOR rate, such as liquidity, risk and credit premia and future interest rate expectations is very difficult.
“Lenders are naturally taking into account the economic environment when assessing a customer’s ability to repay any borrowing, but banks are still willing to lend where there’s a good proposal.” He added that the latest Bank of England figures show that there is still £27 billion of new mortgage lending in April.
Jonathan Loynes, chief European economist for Capital Economics, says: “The bottom line is that LIBOR hasn’t come down and we don’t know how many people are using this [special liquidity] scheme. Most of the major banks say they would and there were rumours that something like £90 billion had been claimed. But that hasn’t been confirmed. It certainly hasn’t made a significant difference to the interest rate banks are having to pay with the inter-bank rate.”
This is having a knock-on effect on the cost of money across the economy and Loynes concludes: “There’s no sign that it’s going to come to an end very soon. It seems to be a question of waiting for the trust to return between banks, and that’s not going to happen until banks are satisfied that they know where all these exposures are to the US sub-prime crisis and various securities associated with it.
“That looks like being some time yet, because the banks are still writing down exposures and revealing losses.”
VICTORIA MASTERSON is a freelance business journalist.