I’ve had a lot of calls over the past 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 banks are reasonable.
The resulting conversations invariably contain expressions such as “usury”, “daylight robbery”, “kicking a man while he’s down” and “I can’t believe the arrogance of these banks!”. While I don’t suggest that banks always behave well, we need to be realistic here: I’ve lost count of the number of times since the demise of Lehman Brothers 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 a 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 over £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 a firm or its partners has often been a prerequisite 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 their 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 in comparison with other sectors (property, retail etc). Unfortunately, that 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’m 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 LLPs, 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 bankers’ 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.
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 perhaps be seen as equally good discipline for both banks and law firms – but don’t expect to feel comfortable.
We all know the banks’ balance sheets have been shot to pieces, patched up and are about to get shot up again.
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 calls from worried MPs and financial directors.
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 those banks that know and understand law firms (you know who they are) to remain supportive and constructive. This is a time when relationships are 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.