MONEY LAUNDERING, manipulating Libor, hiding transactions with rogue states and failing to stop money being channelled to drug kingpins and rogue nations – when it comes to scandals, banks have really given Fifa a run for its money.
While football’s governing body has often found itself batting away allegations of corruption and has been facing demands from its leading sponsors that claims of bribery be taken seriously, the similarly scandal-prone banking sector still retains the loyalty and – more surprisingly – also the satisfaction of its finance director clients.
Indeed, tensions between company finance directors and their main relationship banks have receded over the past three years, even as the banks themselves have been engulfed by a mixture of individual and collective scandals involving instances of wrongdoing, regulatory failings and, in the case of the Co-op Bank, catastrophic failures of corporate governance and internal controls. In fact, FDs are less likely to switch banks, or change the number of banks they use, than they were three years ago, according to the latest Financial Director Banking Relationship survey.
Amid the previous financial crash in the 1990s and during the midst of the latest recession in 2011, Manchester Business School and Financial Director produced a series of surveys to investigate the state of the relationships between finance directors and banks. In this issue, we have taken a fresh look to see how sentiment and lending conditions have changed over the past three years.
In this year’s survey, we asked FDs, CFOs and financial controllers from 200 UK companies about their bank relationships, causes of stress, the areas in which they felt under-served, their financial position post-crisis along with a series of qualitative statements about the service, attitude and approach adopted by their main relationship bank.
According to the latest findings, only 6.7% of respondents said they were very likely to switch their main relationship bank within one year – compared to 7.9% in 2011 – and 77.7% said they were unlikely or very unlikely to change banks, compared to 75.8% previously. The scores were much the same when the question was whether finance directors would change the number of banks their companies use, while deciding to switch remains an incredibly rare occurrence, with 78.2% finance departments retaining the same relationship bank for at least five years.
Is this loyalty down to general levels of satisfaction with how banks are performing, or do businesses stick with their banking partners because the alternatives aren’t much cop and the costs and problems associated with switching are just too onerous?
Asked to select the reason they did not intend to change banks, an impressive 74.7% explained that their loyalty was due to general satisfaction with their bank, an improvement on the 54% that cited loyalty as their reason for staying put in 2011. This can, in part, be put down to improving credit conditions and the fact that banks are gradually turning the lending taps back on.
At the same time, companies’ financial positions have improved since mid-2011, which will undoubtedly have affected sentiment. Since 2011, every metric by which FDs were asked to gauge their financial strength – gearing (debt/assets), interest cover, gearing (debt/secured assets) and profit margin (EBITDA/total assets) – has improved.
According to the latest SME Finance Monitor, which surveys 5,000 businesses every quarter about past borrowing events and future borrowing intentions, about 69% of SMEs in Q1 2014 reported making a profit in their previous 12 months of trading, up from 64% in Q1 2013, while there was a decline in the number of SMEs with a “worse than average” risk rating, down from 56% in Q2 2013 to 47% in Q1 2014.
Gross lending to SMEs began to rise last year with banks arranging £12.4bn on new lending to SMEs in the final quarter of 2013, while Bank of England data shows that gross lending began to rise in April last year and has risen every month for the past 11 months year on year.
“Access to finance is growing overall and conditions are easing. If you are an established business with a good track record, customer base and business plan you are much more likely to get finance,” explains Irene Graham, executive director for business lending at the British Bankers Association.
Nevertheless, some 68.5% of respondents also cited negative reasons for sticking with their current bank. About 15% said the cost of switching was too high, while a quarter thought that changing banks would complicate transactions and 21.3% considered one bank to be much the same as the next, a deterioration on the 13.2% that felt other banks to be the same in 2011. Clearly, the various mis-selling and rate-rigging scandals have had their effect.
The perception of similarity – particularly between the Big Four lenders – has given rise to a new crop of challenger banks that, along with various reforms, have shaken up the market. New entrants, such as Metro Bank, which launched in 2010, are becoming stronger. Britain’s first new high-street bank in more than 100 years, it expects to make its first profit in 2015 and is planning to float on the stock market a year later.
Last year, the bank’s lending rose 350% – about half of which was to small businesses – while in May it launched its bid to enter the SME finance sector after acquiring SME Invoice Finance and Asset Finance in August 2013.
“In terms of customer growth, my book has grown 298% in the past three years,” says Jason Oakley, managing director for commercial banking at Metro Bank.
Explaining how the bank is gaining a foothold in the market, Oakley says it recruits people “with a really strong service-oriented role” and that its “core ethos” is understanding its clients’ business and their objectives for growth.
No strain, no gain
Relations between banks and finance directors may have thawed of late, but stresses and strains will always be there. And one thing the survey bears out is that terms of credit – whether through the imposition of restrictive covenants, restrictions on the amount of credit or the introduction of higher or entirely new fees – remain a much bigger bugbear than the relationship elements of banking. At the end of the day, it comes down to cold hard cash.
For instance, Gordon Stuart, chief financial officer TMF Group, says the back-office outsourcers revised its financing strategy by replacing its term bank facilities with a high-yield bond – not because of the relationship with its main lenders but “because there was a better a structure we could achieve.”
TMF’s bank facilities “looked good on paper”, with decent rates, Stuart explains. However, he felt the cash wasn’t in the company’s control, while the business’ balance sheet would be subject to “mandatory sweeps” whereby excess free cash flow is used to pay down outstanding debt, rather than distribute it to shareholders.
“The acquisition facility we had in place wasn’t there for the long term. It had to be used within three years and became an amortising loan. A year into a loan, we were too busy integrating previous acquisitions,” he says.
Stuart is hardly alone in his consternation. Of those surveyed by Financial Director, 20.7% and 20.1% said credit restrictions and the imposition of restrictive covenants are as important or very important causes of stress with their current relationship bank.
Other irritants for finance directors were the removal of local managers, quality of service and security or collateral requirements.
One survey respondent mentioned their bank’s change of approach to its credit approval process as a cause of strain due to its “potential impact on margins”, while another respondent complained about “changes in appetite to grant credit facilities” and cuts to funding limits which “reduced our appetite to grow by acquisition”.
“We need long-term credit for property projects. They will offer shorter terms,” said another respondent.
Indeed, 46.2% of respondents cited the availability of long-term credit as being important or very important in restricting their company’s growth, compared to 40.4% that cited cost and conditions of credit.
“[Banks] will only consider funding if secured, which is not always possible for an expanding business,” said another finance director.
According to the SME Finance Monitor, credit conditions have eased in recent months and the lower borrowing rates are starting to feed through into cheaper lending rates.
But the restrictions imposed over the past three years have led to companies turning to alternative forms of finance to fund their business. While crowd funding still remains in its infancy (see page 28), many businesses are turning to options such as private equity, asset managers and retail bonds.
“Personal guarantees are wanted on most forms of credit. Therefore, credit has often been sourced elsewhere,” explains one respondent.
About a quarter of finance directors said that they used private equity as a source of finance, with 12.5% turning to investment houses. At present, only 28.5% of finance directors claim to use alternative non-bank funding, although this is set to rise as alternatives become ‘less’ alternative and more mainstream, with 45.5% of respondents claiming they are considering increasing their borrowing from this source.
But at a time when traditional banks are making a comeback to the lending markets, why would a company seek out alternative forms of finance?
“What tends to strike a chord with the chief executives or company boards is the tenor of debt available from alternative lenders – usually up to ten years, a term that banks simply can’t offer to corporates,” explains James Pearce, head of direct lending at M&G Investments.
“This enables a company to align a proportion of its debt with its long-term strategy and liabilities, or finance longer-term investments to enhance future growth of the business.”
According to Shaun O’Callaghan, UK head of debt advisory at Grant Thornton, the proliferation of non-bank lenders is a “once in a generational change in the financing market”.
“Previously, only large corporates were able to access products that brought a multitude of benefits, such as longer maturities and non-amortising tranches which allow management to reinvest more cash back into their business to grow,” he explains.
For Stuart at TMF Group, the preferred option was tapping the bond markets. “The bond has given the business more control over what we do with our cash, as well as removing short-term targets that could restrict strategic choices we wanted to make for the business,” he says.
However, bank finance and alternative funding do not need to be mutually exclusive. About half of finance directors said that they are considering alternatives as a way to diversify their funding sources, compared to 12.5%, who said it would give them greater flexibility, and 12.5%, who said it is the result of a former provider withdrawing facilities or raising their fees and commissions.
At the same time, banks are ramping up their focus in this area. “Banks are very keen to lend to the mid-market (firms of £8m EBITDA). I see them being innovative on deals – they recognise that they have got to compete with non-bank funds,” explains O’Callaghan.
Indeed, David Tilston, group finance director at Innovia, which recently completed a €342m (£276m) high-yield bond issue, explains that it was “easier to get better covenant” terms at a similar price to what a bank would offer by issuing the bond. However, he adds that the business continues to use its main banks “to cover working capital and other ancillary needs”.
Pearce at M&G investments adds: “Non-bank finance can complement the shorter, more cyclical traditional bank facilities, resulting in a robust and diversified funding structure designed for the long term.” ?
There were 200 respondents to Financial Director’s Banking Relationship Survey, including FDs, CFOs and financial controllers from businesses with a turnover ranging from less than £10m (49.7%) to more than £1bn (4.7%). About a quarter of responses came from companies with worldwide annual sales of £10m to £50m.
The survey was sent to companies with headquarters domiciled in the UK, and the largest proportion (31.6%) of these was based in London. Most industries were well represented – production and manufacturing was the most heavily represented (20.2%), followed by business services (13.5%), professional/technical (12.4%) and public sector (11.9%).