Access to affordable, long-term sources of finance has been a major challenge for organisations in the current downturn. But as banks continue to levy higher charges on facilities, organisations need to give serious thought to the implications of these new costs on long-term growth and their financing options.
The key question is whether increased fees and charges from banks will continue indefinitely. Or if the trend towards higher and additional charges will subside when the economy becomes more stable. In some ways it's a catch-22. Over lending to businesses and individuals in the boom years clearly contributed to the economic turmoil in which we now find ourselves. However, finance and investment is now needed so that organisations can position themselves for growth and fuel economic recovery.
Although few would agree that banks should return to the old way of doing things, the current lack of credit from banks and higher costs will have a negative impact on the capability of organisations. Paul Danos, Dean, Tuck School of Business at Dartmouth comments: "I believe that the downturn was greatly exacerbated by the uncertainty in short-term and mid-term financing. Because companies could not be assured of financing they curtailed plans for expansion and growth. This downturning spiral in the expectation of financing is depressing economic activity and prolonging the recession. Restructuring of balance sheets to better match these new uncertainties will play out for months and years ahead."
As well as a lack of funding, businesses face higher costs as banks increase charges on their facilities. Don Elgie, Group Chief Executive, Creston plc outlines some of these: "Companies need to remain within their existing banking covenants otherwise expect 3.5 per cent over LIBOR and a 3 per cent arrangement fee. Consequently, acquisitions are off the agenda unless funded by existing cash resources."
Mike Starkie, Group Vice President & Chief Accounting Officer, BP plc adds to this with his personal view on the credit situation: "Unless you are a blue chip borrower, you'll have noticed how expensive facilities have become. As the private sector competes with the state for finance, and banks try to rebuild their balance sheets, corporates are feeling the squeeze, which will further damage the real economy for a long time. But there is worse to come. As banks fail to change their ways and government continues with the policy of trying to maintain asset values which cannot be supported by available income, there will be another crunch and this time the state won't be able to prop up the system as it can't borrow or print enough money."
Bank fees started increasing in late 2007, exploded after Lehman Brothers' collapse and continued to rise thereafter. Clive Watson, CFO, Spectris comments: "Geared pricing is becoming the norm with margins typically ranging north of 200bps even for investment grade corporates. Furthermore, banks are becoming increasingly imaginative in how to levy additional charges and not just for amendments. We came across one well known bank incorporating a utilisation fee in its pricing."
Will the situation change? There are mixed feelings as to how the trend for high charges will play out. Don Elgie predicts the situation will ease, but says: "No, I predict it won't change meaningfully for at least two years as banks rebuild their balance sheets with high margin business."
Clive Watson does not expect a reversion to pre-credit crunch liquidity levels nor pre-Q3 2008 pricing any time soon. He says: "There is a need for banks to repair and strengthen their own balance sheets. There's no doubt in my mind that this represents a major structural change, requiring a different approach as large companies critically review their capital structures reducing their bank debt facilities in favour of other instruments, bonds and equity for example. Similarly, new sources of financing are becoming available as other non-banking financial institutions seek to fill the now attractively priced liquidity gap created by the banks. Over time, equilibrium will start to return but I think it is highly unlikely that we'll return to the pre-2009 pricing and multiples. On the other hand, it's also the case that institutional memories can be awfully short and without further regulatory intervention, who knows what might lie ahead."
Organisations face a significant challenge in terms of financing for the foreseeable future. As Martin Hall, Chairman of the Money Advice Trust and Associate Criticaleye says: "Companies face a long squeeze on financing, especially small businesses without a pool of shareholders to fall back on. Banks have a dilemma. They are still haunted by fear of bad debt, yet only they hold the key to recovery through financing both cash flow and investment. Signs of recovery elsewhere or even more government underpinning seem to be the most likely agents of change."
We have a number of Criticaleye insights to help you address some of the issues of financing in the current climate.Reforming Financial Markets outlines the Treasury's proposals for reform and provides a useful overview of how banks will be regulated in the future. For those looking for ways to manage their cost base more effectively, please see the film of our recent Criticaleye Forum Strategies for the Downturn: Rapid and Sustained Cost Management. Also see the discussion on banking at a recent Criticaleye CEO Breakfast. At this event, CEO Breakfast - May 2009, participants discussed the need for banks to start lending again, weighing up the risk of doing so with the investment needed for innovation and growth.
I look forward to seeing you soon,