In the second part of our extensive Q&A with small business chairman for Royal Bank of Scotland and NatWest Peter Ibbetson, he answers your questions on securing bank loans.
In the first part, the man who reports directly to chief executive Stephen Hester answered your questions on the bank’s track record with small and growing businesses
And in part three, he responds to a range of other queries about invoice finance, switching banks, overdrafts and introducing growth funds.
Lending:
Why does small business lending remains in crisis and what is your three-point plan to address this specific issue?
Neil Tierney, Onzo
We have a one-point plan and that’s to be there to support any viable business when they’re ready to invest and when they need to borrow. I’d turn the question more on its head and say businesses need a plan in terms of how they can fund their cashflow requirements. It’s absolutely key when they’re talking to us for the borrowing they’re asking for. We have to be responsible. A lot of the time we would be talking with our businesses around how they put those plans in place; what is their three-point plan? The three-point plans that we say to businesses are ‘look at your cashflow, your profit forecasts and the strength of your balance sheet’. Small businesses fail because they simply run out of cash, so our focus is more on working with those businesses. You could ask what we are going to be doing differently in a year and what are we putting specific focus on to help businesses, which is a slightly different question. We can see that there’s an awful lot to be done in helping businesses understand financial issues.
Financial education is a very important area and we’re doing a lot of work in terms of seminars, working with the British Chambers of Commerce and other trade bodies in helping businesses understand how we look at credit applications and how we help businesses look at their cashflows. We are looking in quite a close way at how we provide advice to businesses online. We’ve put out brochures that have looked at how you look at your cashflow needs, what cashflow’s about, why you need to do it, why we need it, and how we look at that. Looking forward we’re looking to build relationships closely with businesses, so that we can help them get themselves in a situation where they are managing their financial situation more strongly, which then helps us support them.
Is it fair to say that generally the quality of proposals you receive is not of high enough standard?
In the down-cycle what always happens is sales volumes reduce, profit margins reduce, profitability reduces, cashflow gets strained, debtors pay later, security reduces in value, so you actually end up from a banking perspective with more difficult decisions. That’s not to say that the quality of the business has deteriorated, but business is much more strained in the down-cycle. We need to ask more questions than we ask in an up-cycle. We need to ask more questions about debtor cycles. So typically if you see a business where its debtor period has slipped from 30 days to 50 days then the responsible thing for us to do is to interrogate that and find out why and often the business hasn’t worked out that debtors are taking 50 days rather than 30 days. All they know is they’re short of cash. We will tend to ask more questions to help the business to protect itself and understand why certain things are happening within the business. It’s not a question of the business deteriorating in quality, but cashflow becomes quite constrained.
How does the government’s stake in the bank and pressure from the business secretary, Vince Cable affect lending policy compared with other banks?
Robert Copping, Sightpath
We act absolutely as a commercial bank. We’re required to and we make commercial decisions. I don’t think that Vince Cable or I have any different agenda – it’s to help as many businesses as we can. He, I, Mark Prisk, and indeed the opposition party, want to do that. But we must lend responsibly. That’s the most important thing. It would be wrong of us to simply agree every facility that comes to us. I don’t think anyone in government is suggesting that we lend to anyone that can’t afford to repay us. A useful number I always look at is that for every 100 loans we make we can only get one wrong before we as a bank are losing money and that’s not in the taxpayer’s interest, certainly not in the business’ interest and not in the bank’s shareholders’ interest.
What’s the outlook for lending?
The outlook for lending depends very much on businesses. There’s some very clear evidence that demand for business lending has declined during the down-cycle. It always does. Businesses tend to repay the bank back much faster in a down-cycle and we’ve certainly seen that. During 2009 we saw business repayments coming back 50% faster than they’d done in 2008. We’ve also seen the demand for loans reduce quite substantially, which again, you always see in the down-cycle. So we’ve seen something like a quarter less businesses come to us for facilities to invest. And those businesses that come to us tend to ask for a quarter less than they would normally ask for in an up-cycle. A lot of the outlook for lending will depend on the economic recovery and confidence in the business sector to feel that they actually now want to borrow to invest. So there’s some very clear evidence that investment has been down. A very good surrogate for this is white van registrations. During 2009 white van registrations reduced by 40% compared with 2008, so we know businesses have reduced their investment appetite. The outlook for lending is very much around business confidence.
And if interest rates rise, is there going to be any movement on interest margins?
It’s important to recognise that businesses now are enjoying pricing which is at historic lows. Royal Bank, NatWest and I’m sure the other banks as well, passed down the base rate reductions as soon as they’ve come through, which means that our business customers are now paying half for their overall borrowing than they paid two years ago. On average businesses are paying less than 4% for their borrowing now compared with in excess of 7% two years ago. Much of that is a function of base rate reductions. So there is some capacity to take an increase in rate rises, but I think if you look at most of the forecasts we believe that’s not going to be in the short term.
Approximately what percentage of loans are put through the EFG scheme?
Robert Copping, Sightpath
Around about 3% of bank loans are going through the EFG at the moment. So it’s a fairly small percentage of overall loans, but it’s a very important percentage because these are the businesses that haven’t been able to get commercial finance but are seen as being basically viable, so effectively they run out of the security so they’ve not been able to access commercial debt. So they are at the edge of the risk side that’s still seen as viable businesses and are very important. It’s been a very important scheme in saving many of those businesses.
What is your policy regarding the 25% of EFG loans not guaranteed by the government?
Robert Copping, Sightpath
In terms of our position on the 25% that’s not guaranteed, the way the scheme works is that firstly the government gives us a 75% guarantee but that’s on the residual exposure we have. Let me illustrate that. If there is a loan of £100,000 that we make on the EFG basis, we get a 75% guarantee. That doesn’t mean to say we get a guarantee for £75,000. If that business fails the first thing we are required to do is recover as much as we possibly can of that loan. So let’s say we recover £40,000, so £60,000 remains outstanding. It’s that £60,000 that is guaranteed up to 75%, so we would get £45,000 as a guarantee, but would be exposed at £15,000. Many people think that because we get a 75% guarantee we only run a risk of the first £25,000 going wrong. That’s not the case. It’s always the residual amount that we get the guarantee on. We’re always running a risk for whatever that residual amount might be. That links into, so what’s our view on the 25% exposure. We don’t look at that as a 25% exposure. We tend to ask for directors’ guarantees and as a general principle will normally ask for about a 25% directors’ guarantee. Coincidentally, that’s 25%. What we’re not creating there is a £100,000 worth of borrowing, £25,000 directors’ guarantee, and a £75,000 government guarantee because the 25% directors’ guarantee is unsecured; it’s unsupported. This is merely making sure the director of the company is focused on trying to make the venture work. We generally ask for a 25% guarantee on that basis. Many other banks will ask for a 100% directors’ guarantee. We think 25% is normally enough.
As a rule of thumb, what cashflow thresholds does a business need in order to secure a loan?
With cashflow what you’ve got to demonstrate, quite simply every business is different. Just come with your cashflow that’s well sensitised to demonstrate that you can repay the loan. That’s the right starting point for any discussion with the bank. It may be that the bank says ‘you don’t need the cashflow, what you need is a loan over three years’.
How can SMEs secure the best pricing on their loans?
Brush up on your negotiation skills. 98% of the businesses that bank with Royal Bank and NatWest pay less than 7% for their facilities at the moment. We have issued within our charter a maximum fee of 1.5% per annum for any loans. So we think we’re pretty competitive, but shop around and see what the best pricing is that you can get.
Ask a question
Peter Ibbetson and an expert panel will be taking your questions in a live webinar on October 28, 2010 at 2:30pm. If you have questions on how to access finance, go to www.natwest.com/businessknowledgewebinars