Business lending is shrinking as banks continue to favour home loans over business
loans in their short-term approach to capital use and returns. It is stifling the economy and it is a major frustration for businesses that are seeking capital to fund their growth. In their recent submission to David Murray’s financial system enquiry, Industry Super Australia confirmed that the amount of commercial lending for every dollar of residential property lending has plunged from $3.84 to $1.62 over the past 25 years. The land of opportunity has become the land of property.
How do borrowers navigate these changes? Communication between borrowers and lenders is the key to a successful banking relationship. Bankers do not like surprises. As a borrower, be proactive and provide financial information that is both timely and accurate. Prepare and deliver on financial forecasts and projected financial covenant ratios. These add to a borrower’s credibility and offer opportunities to negotiate during the loan renewal process. Additionally, business owners should stay focused on their core business and have a solid business plan with contingencies in place.
So businesses who are seeking funding need to carefully consider the way they frame their finance proposal to their banker, positioning it in the best possible light. A professional, well-thought out application with strong supporting documentation is critical. Understanding what banks are looking for will help you get it right first time and improve your chances of success.
Banks typically look for three major elements when they assess your business’ credit risk. These are commonly known as ‘The three Cs’.
Communication between borrowers and lenders is the key to a successful banking relationship. Bankers do not like surprises.
The first critically is ‘character’.
Bankers will assess your character by reviewing a range of documents that provide information about your history, track record and experience in business. They are seeking to understand your commitment to a relationship with the bank. Considerations include:
- Have you been able to meet your forecasts?
- What is your repayment history like?
- Do you do what you say you will do?
The bank will also want to see that you have plenty of ‘skin in the game’. Are you contributing enough to your own cash or equity to the purchase or new project?
The second thing a banker will look for is ‘collateral’.
Here the bank ‘credit department’ reigns supreme. They will be seeking all the first mortgage “bricks and mortar” security they can get their hands on supported by a mortgage over your equipment, other assets of the business and personal guarantees from directors. Think twice about pledging all of your assets if you can avoid it as it limits your borrowing options in the future.
Thirdly, a banker wants to look at your ‘capacity’.
They need to know that your earnings are sufficient to pay the loan back without creating distress. When you apply for the loan, you will be asked to outline all of your income, and provide comprehensive financial data on the business. These will include cash flow and profit and loss forecasts and a robust business plan.
Once you have satisfied the ‘three Cs’ there remains much devil in the detail. Your ranking in this area will determine how much negotiation leverage you have around some very important final points namely:
Covenants – These are the ratios and conditions that the bank will monitor to ensure satisfactory performance of your loan. They may include the ageing of your debtor’s maximum, stock levels and interest cover (the number of times your net profit exceeds your interest bill). Breaking these covenants give the bank the power to charge penalty interest rates and even call in your loan. So it is sensible to ensure they are achievable. While it is important to monitor them once in place, practically they are usually regarded as a guideline by the bank and a lever to deal with relationships that have deteriorated beyond repair.
Security – We live in difficult and uncertain financial times. While it is necessary to ensure the bank has ‘sufficient’ security, do not be overly generous. Look to exclude the home and personal assets where possible. Maintaining separate banking relationships for business and personal loans can give you options and keep each bank on their toes.
Repayment terms – Interest only terms take the cash flow pressure off your business by excluding the additional burden of the extra loan portion payment particularly in the early period of the loan. Banks however are keen to see a start to the repayment of their loan and are reluctant to extend interest only beyond two to three years.
Even if you satisfy the three ‘Cs’ and all other lending criteria you may experience variations between banks so it’s important to get some advice. Some banks have particular industry focuses (and usually specialised products to match) and others will seek to reduce their exposure to a type of business purely because the bank has a high total exposure to that area they are seeking to reduce on a pure risk balance basis.
In a challenging borrowing environment a thorough understanding of how banks assess your position; a well thought out finance proposal; and careful consideration of the terms will give you the best chance to obtain the finance you need to ensure business success.