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Pressure of business

31 Dec 08

The government’s bail-out of the banks had one simple, urgent aim – to kick-start the economy. But are our financial institutions simply keeping the money for themselves without passing on the benefits to those who need it most – the UK’s struggling small businesses?

by Kenny Kemp

The “Prince of Darkness” is not everyone’s favourite government minister. But Lord Mandelson knows that business hates prolonged interference from government.

However, the near collapse of the global financial system required unprecedented political action and the recapitalisation of the UK’s banks has been a significant and successful step towards creating stability. On this score alone, prime minister Gordon Brown and chancellor Alistair Darling got it right with the £37bn bail-out of Lloyds, HBOS and Royal Bank of Scotland.

Now Lord Mandelson, as secretary of state for business, enterprise and regulatory reform, is training a spotlight on the often opaque relationship between

bank and business customer. He knows that the banks and business are two sides of the same coin – now he has the clout to demand strong action.

Lord Mandelson told the CBI’s annual conference: “New Labour orthodoxy – in which I have a PhD – has made the government rightly suspicious of ministerial entanglement in markets. We learned from past experience the perils of ministers substituting their judgement for company boards. Getting too involved in market decisions, we believe, will tend to lead to worse decisions.”

Quite so. But Mandelson knows there are systemic problems when it comes to lending to small and medium-sized business and he wants bankers to return to the old days of being good, plain, boring bankers: “If, locally, the banks are tightening their grip on credit at precisely the time when we need them to start lending again; if the stories that banks are unilaterally reorganising overdrafts or withdrawing them altogether are true; if new terms are being issued by email, with immediate effect, or

48 hours to comply, sometimes without even a face-to-face meeting; if these things are true, then they will mean real damage to the economy.”

The organisations that look after the interests of small UK businesses confirm that all of the above have been the case – but say business customers are reluctant to publicly criticise their banks. That suggests a level of loyalty and tolerance that is not reciprocated.

The banks have agreed to give the government data on business lending, which will give Mandelson’s department a sense of the scale of the problem. He has asked the regional development agencies to report cases of companies in the private sector where access to finance has been unreasonably denied or where the terms on which it is made available are changed without proper justification. Many banks are setting up hotlines so that businesses have someone to talk to.

“We need bank relationship managers to be empowered by their management to act with confidence and discretion,” Mandelson said. “Future profits – including the banks’ own – depend on good lending decisions being taken now.”

But will it be enough? Since October 2008, there has been “massive ministerial entanglement” from the prime minister’s office, HM Treasury and DBERR, the department for business, enterprise and regulatory reform. But as we head into uncharted waters in 2009 – with some predicting the worst recession in 20 years – is enough being done to alleviate the pain for businesses? Mervyn King, the Bank of England governor, said the restriction on corporate credit is very worrying and company finances are facing the tightest squeeze in 30 years.

There has been a flurry of positive activity from the banks. Lloyds TSB and HBOS, whose proposed merger was subject to a Competition Appeal Tribunal as CA Magazine went to press, and RBS, which is 58 per cent owned by UK taxpayers, is trying to assure business customers.

Yet there remains a welter of anecdotal evidence that UK businesses are being forced to pay for the sins of the banking industry. This will be a year of global recession, deflation and bankruptcies. Figures suggest that global total write-downs could be as much as $3 trillion (£1.8 trillion), a colossal figure. This will have a detrimental impact on UK plc.

Eric Daniels, the chief executive of Lloyds TSB, told shareholders voting for a merger with HBOS that risk pricing would have to rise to reflect the extra cost and exposure of businesses. Ultimately, that has to be passed on to the customer.

Daniels has his reservations about the banking bail-out. “Banks will try to repay the government as quickly as possible,” he says. “And one of the ways to free up capital is to stop lending.”

His solution is to allow the banks to reduce their capital reserves – which have been boosted by the bail-out.

Lloyds, with 600,000 company clients with a turnover of less than £1m, has said it will not change the price or availability of overdrafts during the period of agreement as long as accounts are maintained within agreed limits.

Stephen Hester, chief executive of the Royal Bank of Scotland, writing in the Financial Times in December 2008, said: “Without profits, stable capital and a prudent balance sheet, our customers will suffer along with staff and shareholders. This task requires an amount of retrenchment including narrowing of focus to those customer franchises that represent our enduring strengths. We need to cut costs and reduce our borrowing and, yes, that means reducing some our lending, too.”

He said this was not moral pressure, but made commercial sense.

This all appears to contradict what Lord Mandelson is suggesting. It is an equation that is difficult to solve. Yet Hester says: “We are determined to serve customers well in the difficult time ahead, and have made a commitment to government that we intend to meet in letter and spirit.”

Hester and the other senior banking leaders will now have to work more closely with their newest shareholder, UK Financial Investments, an arm’s-length body with Sir Philip Hampton as the chairman.

Barclays and HSBC, which have not required Government cash, have pledged their commitment to UK business – but there is a great deal that can be recouped by banks through stealth.

Gordon Wallace is the finance director of Glenborrodale, a medium-size UK construction company. It is fortunate still to have contracts in the public sector, but the company is in a precarious position. It has been buffeted by the financial storm and has been hanging on for life.

“We’re being shafted because we’re in the middle,” he says. “We’re working for some of the biggest names in the industry who are strapped for cash and putting up their payment terms unilaterally from 30 days to 90 days. There’s been no discussion with us.”

Yet Wallace has to find the wages for his 120 plumbers, brick-layers and electricians.

“I approached our bank, but they have been going through hell too. They couldn’t lend us the extra money we needed at the time, even although we’ve had a strong relationship with them for 20 years. It wasn’t our bank manager who let us down, but the risk committee who didn’t like the idea of lending to another property business,” he says.

Wallace says that one of the firm’s business angels has stepped in with short-term funding to pay the wages.

This has been a typical picture across the UK. But the banks have used this unprecedented position to increase the charges and the cost of funds. Despite what the chief executives say, extra surcharges, arrangement fees and costs begin to creep in.

Frank Harrison, the head of an Edinburgh recruitment consultancy, who does not bank with a bailed-out bank, reveals that his bank manager scrutinises his business plan quarterly.

“I put a figure in my business plan that I had projections for work that have not transpired in the expected time frame because of the slow-down,” he says. “It’s still out there, but I’ve not got in yet. But the bank manager viewed my projections as definite prospects and has recosted my loan facility because he says it is a higher risk. That’s just an excuse to get more money out of my business.”

Many of the banks, led by RBS, have guaranteed the level and price of their overdrafts until the end of 2009, provided the risks have not increased to a level that requires it to look again.

For Glenborrodale, of course, the risk has increased because of the actions of another business, so this will mean more expensive funding – and probably whopping arrangement fees too.

Bruce Cartwright, head of business restructuring at PricewaterhouseCoopers in Edinburgh, urges businesses to be more collaborative and to take suppliers into account.

“We’ve got to get through this collectively,” he says. “Liquidity is the issue for many businesses. To control your own destiny, you have to be in control of your own cash. I don’t think it is right that large companies can take unilateral decisions without consulting further down the supply chain.”

He says that sometimes this can be fixed by an honest conversation between suppliers.

He is also keen to help restore the relationship between banks and business: “There’s been a lot of debate, but banks are in business to make good lending decisions for good solid businesses. That’s what they want to do – so we have to get on with that.”

But there is evidence that banks are still not playing ball – despite their PR spin.

A senior Scottish business adviser said one bank is using a “material adverse charge clause” to change term loans that have been agreed. He says: “I’m dealing with a construction business that is well secured and serviced. It has not breached any banking convenants and has enjoyed an excellent working relationship with its bank for many years. But its facilities are being repriced and costing much more.”

In this case, a term facility of £3m with several years to run was costing LIBOR (London interbank overnight rate) plus 2.5, after the Bank of England’s base rate cut from 4.5 per cent to 3 per cent.

The source adds: “The company was told this was because the bank had a funding gap they needed to bridge by upping the charges. The interest rate cut [to 3 per cent] would have benefited the business by about £50,000; instead, they face an extra £11,000 in fees.

“The customer is faced with an ultimatum – sign the new arrangements or find a new bank. This is wrong. Banking is based on trust. It’s the bank’s failure that has led to a change in pricing – yet small companies are being forced to pay.”

Without question, there is insecurity among people working in the banks. They are expected to perform too – specially when thousands of job losses have been forecast.

One senior financial adviser in Glasgow said that individuals in the banks want to cover their positions and are going to great lengths to bring in extra revenues. “Most business bank people want to hold on to their jobs and show their value to the business,” he says. “That’s only human nature.”

But this means there are issues over the expected merger of Lloyds and HBOS into the new super-bank, Lloyds Banking Group. The Government allowed financial security to trump concerns over competition, but there are likely to be some serious outcomes. Some old-style HBOS customers can expect a rougher time.

Bank of Scotland has reassured its 180,000 small business customers. A spokesman says: “Bank of Scotland is committed to maintaining the link between small business overdraft rates and base rate rather than LIBOR. Small business customers will continue to benefit immediately from any cut in interest rates. Bank of Scotland is committed to maintaining overdraft facilities for 12 months from the date of arrangement or renewal and will not make them repayable on demand.”

But once the full integration of the new bank is completed, some of this might have to change. And it is not just overdrafts but loan arrangements that are the issue for business.

Colin Borland, public affairs manager for the Federation of Small Business in Scotland, said: “Fair access to flexible finance at a competitive rate is more important for small businesses than ever. Demand has dropped dramatically and too many perfectly viable small businesses are being stretched by the unjustifiable late payment tactics of large organisations.

“But the banks haven’t exactly helped. Indeed, when we need them to ease these needless cash-flow problems, we see attitudes towards small business lending harden.”

In the Federation of Small Businesses’ Scottish research, more than one in four respondents had the cost of existing loans and overdrafts increased in the third quarter of 2008. About the same number reported the cost of new credit had increased over the period.

“Of course the banks must lend responsibly,” says Borland. “Of course we can’t return to the ill-advised profligacy of recent years. Of course banks shouldn’t be propping up bad businesses just for the sake of it. We have never suggested otherwise. But learning the lessons from the past should not be cover for refusing to lend to the good small businesses.”

He says the encouraging announcements from HBOS and RBS suggest that this argument is being heeded, but the warm words must translate into action.

Meantime, there is another source of funds. In October, the prime minister announced more cash as part of the ambitious Europe-wide bailout. He called for the European Investment Bank (EIB) to boost lending to small businesses. Darling and Mandelson agreed with Philippe Maystadt, the head of the EIB, the European Union’s lending arm, that additional funds would be used in a rescue package that was applauded across Europe.

EIB loans can support investment up to €25m (£20m) and can be applied for through a company’s bank. But one senior figure in the UK’s chambers of commerce wants stronger representation so that the £4bn of European funding goes to the right places.

“We really need small business representation on the distribution of the European Investment Fund money so that we can ensure that it hits the right targets – and doesn’t prop up the bank’s lame ducks,” says Duncan Walker, president of West Lothian Chamber of Commerce.

“I’m concerned that the money might not go to the successful businesses that need it the most. I think distribution must be done in conjunction with forums of the local chambers and the small business federations. We’ve got to work together with the banks.”

Kenny Kemp is a freelance business journalist.

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