What lessons have emerged for both bankers and borrowers, from the recession which had so hard an impact on the UK economy?  Receiverships grew from around 1500 in 1989 to a peak of 5750 in 1991, before falling back.  In addition, both commercial and residential property values have dropped sharply: the fall in commercial values is close to 40 per cent. 

Not surprisingly, given this background, the Big Four clearing banks saw a four-fold increase in provisions.  Both banks and potential borrowers can learn valuable lessons from more general experiences during the recession.  On a macro level, the following are some of the issues: 

It is easy to justify a business case using statistics.  You simply pick the ones that fit the conclusion you want and ignore the rest; even if you consider them all you have to make a judgment, which is not always easy to get right. 

It is not only corporates and their bankers who have difficulty in interpreting economic data; professional economists also have difficulty - their opinions often differ, and many of their forecasts are incorrect; so take advice from more than one source and always consider the opposite point of view. 

Do not underestimate competitive threats. Businesses must react to what competitors are doing as well as anticipating their strategies.  Doing this can be much harder when recession contracts the overall market. 

Recession has also taught that internal company pressures can be great.  Pressures within an organisation to achieve targets, in whatever form, are heavy and increasing.  While targeting is fine, it must be focused on the right areas and regularly reviewed.  Focusing exclusively on the wrong areas, such as market share, sales volumes and short-term profitability, without fully evaluating the consequences, has caused significant damage to many companies.  There can also be a tendency for companies to focus on short-term profits growth by dressing up their accounts through creative accounting, instead of addressing core problems. 

But what should borrowers and lenders focus on when looking at the future?  Greater prudence is needed.  Banks see a lot of business plans.  Almost without exception, they show companies increasing sales, gaining market share, raising margins, increasing profitability.  It is not possible for every company to do this.  Banks would much rather see a business plan that is realistic or slightly conservative than one which is over-optimistic.  More planning and regular updating of plans is also needed - both in terms of longer-term strategic planning and detailed short to medium term operational planning.  Without proper planning, a business cannot know that the decisions taken on a day-to-day basis will fit its longer-term objectives. 

As part of the planning process, more sensitivity analysis is needed to ensure that business plans are robust and can cope with issues like rises in interest rates and reductions in sales and margins.  In undertaking sensitivity analysis, it is easy to obtain the results you want by sensitising down to your bottom line, whatever that may be - minimum return on capital employed, say, or repayment of a loan.  The temptation is to stop there; but what happens if you go further?  As part of the sensitivity process, there is a need for more contingency planning.  KEY RISKS NEED TO BE IDENTIFIED and plans drawn up to cope with risk when it becomes reality. 

HEALTHY CASH FLOW 

Expect your bankers to look very critically at cash flow in your business -where cash is generated and where it is being used.  The banker's prime objective in most financing is to ensure that enough cash is generated to pay interest and repay debt.  Banks want to see the source of their exit.  THE QUALITY OF OPERATING CASH FLOW IS THE KEY TO GOOD LENDING - NOT PROFITABILITY AND NOT ASSET VALUES, which can fluctuate with market demand.  This suggests a need for greater mutual understanding and a two-way flow of information between bank and borrower.  A borrower approaching a bank for finance should be prepared to answer detailed questions about the business.  In future, banks are likely to require more due diligence work before they lend. 

The depth of work will depend upon the situation and the perceived risk to the bank.  In some situations they would require due diligence completed by independent sources before lending. 

SHARING INFORMATION 

Banks are looking to develop a better understanding of their customers' businesses, so borrowers should really be prepared to share information - both at the time when the borrowing is put in place and on a continuing basis.  Banks will normally expect to see a regular supply of management information - they need to hear bad news as well as good.  Early advice of an actual or potential problem gives bank and borrower time to work together to solve the problem in a manner satisfactory to both parties.  Belated advice can often leave both parties without the precious commodity of time.  If borrowers can meet the bank's requirements for THOROUGH AND PRUDENT BUSINESS PLANNING, DEMONSTRATE GOOD CASH GENERATION and are willing to SHARE INFORMATION, they should not have difficulty in presenting a good case for raising bank debt. 

So what financing options are available?  How will the supply of loans match up to demand, and what can be expected by way of new requests?  Requests are likely to fall into two broad categories: 

Working capital to support increased trading levels (likely to be a reality for most manufacturing businesses) 
Capital expenditure, either to bring existing equipment back up to standard, because investment has suffered during the recession, or to invest in new plant and equipment to support higher levels of turnover. 

In addition, there will be other requests to fund investment in new products and markets, and acquisitions. 

This is against a background of limited demand for company products, with recovery taking time to work its way through to increased sales and profits.  Balance sheets have been weakened by exceptional redundancy and closure costs, revaluation write-downs and high gearing through trading losses.  However, there is competition among the banks for good business.  Banks have suffered from falling income streams as a result of writing off bad debts, non-performing loans, perceived reluctance from corporates to borrow, and some corporates taking advantage of a buoyant equity market to raise fresh capital from existing shareholders.  As a result, there is HEALTHY COMPETITION FROM BANKS TO LEND FOR GOOD QUALITY PROPOSALS. 

So what options are available to companies when approaching their banks for finance?  Historically, banks have provided significant funding on overdraft.  This can have drawbacks from the banks' and the borrowers' perspectives.  Overdrafts by their nature are repayable on demand and subject to frequent review.  They do not provide certainty to borrowers.  From the bank's standpoint, overdrafts are difficult to control, have no defined repayment programme, and tend to be fully utilised.  So banks will be seeking to LEND INCREASINGLY ON A STRUCTURED LOAN BASIS, probably committed over a term against covenants linked to the borrower's business plan. 

They will also be looking to link the life of the loan to the life of the asset financed and will expect to achieve repayment from cash flows generated by the assets funded.  OVERDRAFTS are INCREASINGLY LIKELY TO BE RESTRICTED to SHORT-TERM TIMING DIFFERENCES linked to the working capital cycle of the business; lenders will expect utilisation to fluctuate accordingly.  In some circumstances, banks will encourage their customers to raise finance through specialist lending vehicles.  Leasing or invoice discounting are obvious ways of matching liabilities with assets. 

Despite the impact of the recession, banks, as noted, are open to write quality business and will compete to win it.  In defining quality, they are looking to lend to corporates who exemplify the principles discussed earlier.  But what other factors does a bank look at when making a credit decision?  It will FOCUS ON THREE KEY AREAS: management; non-financial analysis; and financial analysis.  When assessing management they look at (for instance) background, track record, how people work together, whether there are any dominant members of the team, succession, management reporting systems, ambitions and strategy. 

Non-financial analysis focuses on the industry and sector in which the customer operates, competition and the customer's market position. 

A bank will undertake financial analysis based on the historic financial information, and will also look for detailed projections supported by a THOROUGH BUSINESS PLAN, incorporating a CLEARLY DEFINED CORPORATE STRATEGY.  The focus will be on robust cash flows, capable of repaying debt, after undertaking realistic sensitivity analysis and implementing contingency plans in the event of key risks materialising. 

COMPETITIVE PRICING 

Remember what was noted earlier; banks will compete for quality business.  This is already evident in both the syndications and bi-lateral loan markets, where pricing for good quality business is lower than it was 12 months ago.  Banks are prepared to consider balanced propositions and will not price to recover previous losses.  They want to back viable businesses and they want to work with borrowers as a partnership.  Moreover, the potential supply of finance will exceed demand.  Because of all this, pricing will be competitive.