Beware: the lending freeze is coming
Bill Jamieson says there are growing reports of bank facilities for companies being tightened or withdrawn
Central to concern over the credit crisis in recent months has been the potential impact on business and the real world economy. But assessment of the effects on the business sector has been almost completely overshadowed by the near panic over the sharp contraction in mortgage lending and the impact on the level of house prices.
Yet business lending is the vital fuel that supplies finance not only for the grand battleships of the FTSE 100 but also for the vast flotilla of small and medium-sized businesses across the UK. Political concern over the ‘plight of first-time buyers’ looks to have taken precedence over the equally apprehensive small and medium-sized businesses whose payroll and survival prospects critically depend on the bank not demanding back the umbrella as it starts to rain.
So is there a looming credit crunch for the business sector? Banks will insist there is never a shortage of loan finance ‘for the right proposition’ and that business customers have little to fear. Funds will be available for investment and expansion. But there are growing reports – best treated as apocryphal though some swear them to be true – of bank facilities for businesses being withdrawn or tightened; of overdraft limits being cut and banks being much slower and more rigorous in processing loan facilities for businesses.
In truth, lending applications are profoundly influenced not only by the supply of credit but also by the level of business confidence. Plunging business confidence – often a direct reflection of the headlines in the business sections of newspapers when the polls are being conducted – can result in business investment plans being shelved before any loan application is put forward. Many businesses may choose not to proceed because of uncertainty over the likely revenue gains of any expansion, particularly when consumer spending looks under pressure. Battening down the hatches is a common business response as the economy turns down.
So what picture is beginning to emerge for business lending? One early victim of the credit crisis has been corporate merger and acquisition (M&A) activity. This has slowed dramatically in the UK in the first quarter, the number of announced domestic deals dropping to their lowest level in more than a decade. According to accountants Grant Thornton, UK domestic deals announced in the first three months of 2008 totalled just £7 billion in value, a drop of more than 40 per cent on the same period in 2007 (£12.5 billion), and the lowest quarterly value in more than four years. It was also the first quarter that domestic deal numbers fell below 400 for more than a decade, with just 377 M&A deals announced in this period.
David Brooks, head of M&A at Grant Thornton Corporate Finance, says the weakness was an inevitable consequence of a protracted credit squeeze, ‘as the lending environment for all but the most risk-light deals became much more convoluted’.
For mainstream business activity, the picture looks at first more sanguine, but with deterioration evident in more recent data. The company sector has gone into this widely expected slowdown with the overall financial position looking in robust health. Profitability and liquidity have been buoyant, the gross operating surplus of companies up by 3.3 per cent in the final quarter of 2007 to a level 8.3 per cent higher than a year earlier. And their financial surplus rose to £14.6 billion in the fourth quarter, to make a total of £33 billion for 2007 as a whole.
Rates of return were also high, at almost 19 per cent for non-financial sector firms and 9 per cent in manufacturing. Companies were also not reporting a significant impact of the credit crunch on their ability to finance capital spending; lending to non-financial companies was up by more than 15 per cent over the last year. The financial health of the corporate sector can also be seen in continued strong business investment, the national accounts showing a rise of 4 per cent in the second half of 2007. Over the year as a whole business investment rose by 7.9 per cent – its strongest since 1998.
But that was then. Analysts have discounted such backward-looking data as of little relevance in trying to discern what lies ahead in the rolling night and fog of the credit crunch. The fear is that the picture by the end of this year will be very different.
A Bank of England Credit Conditions Survey conducted between 25 February and 19 March reveals that lenders have cut the amount of unsecured credit they were prepared to make available to households and small businesses by more than they had expected three months previously. Credit scoring criteria were reported to have tightened for both credit card and non-credit card unsecured lending, and approval rates had fallen.
Lenders have also reduced overall credit availability to corporates over the past three months. Loan approval rates have fallen, particularly for large private non-financial corporations. Overall credit availability was expected to be cut further over the next three months and approval rates are expected to fall further. As for credit demand, while this was broadly unchanged across large companies, demand from medium-sized businesses had fallen. A net balance of 30 per cent expected lending conditions to change for the worse in the second quarter.
Finally, over the three months to mid-March, lenders reported they had increased spreads on new lending to business, together with higher commissions and fees, with a further widening (and increase in costs) over the next three months. This might be thought to have triggered alarm bells in the Treasury as loud as those triggered by the squeeze on mortgage lending and the reported rises in fees and costs. If so, it has kept quiet about the response.
Recent figures released by the Bank of England suggest that a slowdown in UK bank lending to the manufacturing sector may already be underway. Conclusions need to be tentative because quarterly movements in lending are volatile and can be influenced by substantial, one-off deals.
But in the first two quarters of last year, lending to the manufacturing sector grew by £291 million and £344 million respectively. In the third quarter, there was a decline in lending of £331 million. And in the final three months it dropped by £812 million. Growth in lending to the construction sector dropped from £2.5 billion in the third quarter to just £408 million in the fourth. Growth in lending to the commercial property sector was also sharply down.
The corporate sector has good reason to feel that its vulnerability has been overlooked as the political spotlight has focused on actions to alleviate the residential housing market. However, to despair is a sin, and there are two points that offer some hope.
First, as Bank of England chief economist Charles Bean pointed out in a recent speech, the 12 per cent fall in the effective exchange rate for sterling since last August should help exporters. The fall is of the same order as the depreciation after Britain’s exit from the ERM in late 1992. On the calculus that every one percentage point fall in sterling has the same effect on output as a quarter percentage point cut in interest rates, export facing companies have now been delivered the equivalent of a cut in interest rates of three percentage points.
The second is an assurance from Sir Ronald Cohen, confidant of Gordon Brown and chairman of private equity group Apax, that ‘there is more finance around today than in any recession I’ve seen before,’ and that private equity will be rescuing parts of industry that in other downturns might have gone bust. He may soon find out quite how busy he is going to be.