Trouble at t' bank?
9 January 2009
I have had a lot of calls over the last few months from Managing Partners and Finance Directors of law firms asking for a second opinion as to whether the renewal terms offered by their bank are reasonable.
These conversations invariably contain expressions such as “usury”, “daylight robbery”, “kicking a man while he is down” and “I cannot believe the arrogance of these banks!”.
Whilst I do not suggest that banks always behave well, we need to be realistic here: I have lost count of the number of times since the demise of Lehmans that commentators have said “the world has changed” – but it surely has.
Eighteen months ago, banks were crawling all over each other to lend money to law firms. This, after all, is a sector with a track record of very high profitability and negligible losses so, even with wafer-thin lending margins, this still represented profitable business.
Add to this the prospect of getting a slice of the firm’s clients’ funds on deposit, and the banks were positively slavering. Not only were these funds available in huge quantities (it was not uncommon for a mid-sized firm to have £50m available to deposit), but the margin earned did not use up valuable balance sheet capacity – it was the icing on the cake. Being a lender to the firm or its partners has often been a pre-requisite for the bank to get at least some of the deposits.
Banks are still just as eager - more so, perhaps - for these deposits, bearing in mind the strains on the banks’ own funding positions. However their attitude to the lending part of the relationship has shifted, even if they all proclaim that they are still open for business. Law firms, especially larger ones, are still viewed positively by comparison to other sectors such as property or retail, but unfortunately the sense of invincibility has gone.
I always had a feeling that UK law firms don’t go spectacularly bust, they just fade away or get merged out of existence, but now I am not so sure. There are some fairly heavily indebted firms out there and for some their new business is falling away rapidly. Many firms have now converted to LLP so in those cases the partners do not stand to lose everything, which means there is less to stop them walking away. Banks, on the other hand, have more to lose with LLPs - and there is an old banker’s adage that your earliest loss is your lowest loss - so they may be tempted to take early action where previously they would have relied on the partners to dig the firm out of its hole.
A couple of months ago one senior banker gave me his bank’s prognosis that of the 10,000 or so law businesses in England and Wales: fewer than 8000 are expected to survive this recession. This may or may not be wide of the mark, but it is a fairly stunning figure and indicative of the nervousness that lenders feel: older bankers may have been around the block a few times, but there is a feeling that they haven’t seen anything quite like this.
Inevitably, they are now on the defensive. Nor should we forget the impact of the Legal Services Act, which is likely to marginalise many firms.
Although banks are still open for business, the deal has changed. Even the largest and strongest firms can expect a level of due diligence and ongoing scrutiny that would have been seen as intrusive and unacceptable previously. This may not be a bad thing, and can be seen perhaps as equally good discipline for both banks and law firms, but don’t expect to feel comfortable.
We all know that the banks’ balance sheets have been shot to pieces, patched up, and are about to get shot again. The regulatory framework now is less relaxed and will become even more demanding in future, which will restrict the banks’ ability to gear up on whatever capital they have.
These two factors mean that regulatory capital (i.e. lending capacity) is a scare resource and a whole lot more valuable than is was. It will therefore be sold for a much higher price, possibly up to double the previous margin, and will be protected much more diligently than before.
Overdrafts have always been “on demand” facilities, but term loans will be documented much more strongly in the banks’ favour – the days of “covenant-lite” are a thing of the past.
Undrawn commitments - which, nevertheless, tie up capital - are becoming much more expensive. Security, by way of debentures or partner guarantees, is being sought routinely whereas not so long ago such things were almost unheard of. The banks will also prefer to lend to partners for subscription of capital, especially if capitalisation is regarded as thin.
Which brings me back to those telephone calls from worried MPs and FDs. I suggest you accept that the pendulum has swung the other way and do what you can to reduce your reliance on the bank, if it is making you uncomfortable.
Generally I would expect the banks which know and understand law firms (you know who they are) to remain supportive and constructive. This is a time when relationship is everything, and all the effort you have put in over the years should pay a dividend in good, swift, reliable decisions, even if it costs a bit more. If you didn’t put that effort in, it may be harder to get the bank to see things your way, which might be unpleasant.
Finally, I won’t give you chapter here are a few suggestions on how to get the best out of your bank these days:
• Show that you have a committed, united and disciplined partnership
• Show you are in control of costs
• Demonstrate that you have a strategy for dealing with the recession
• Ensure that financial management is strong
• Reduce your lock-up – target 100 days for the average firm
• Communicate early, regularly and often - no surprises
• Be up-front and honest, especially with unwelcome news
• Provide financial information on time
• Do everything possible to make cash and profit projections accurate
• Develop relationships where possible above and beyond your relationship manager (e.g. credit, senior executives)
• Make your relationship manager’s job as easy as possible – he/she is working harder than ever for less reward.
If you can do these things you can get the bank on your side and produce the commodity which can’t be bought – trust.
William Arthur is a partner in KermaPartners, and was Director of Professional Practices at Barclays from 1999 to 2006.