Relationship banking – taking SMEs from black swan to phoenix

We know that Australia has so far coped well with the coronavirus Black Swan, thanks to a large dose of good management and a dash of good luck.  The level of legislative change, formation of new government policy and mobilisation of the bank and non-bank sectors has been truly remarkable and extremely well targeted.  Without the government and finance industry support, many companies would have had no option other than to file for voluntary administration.

As the CEO of a fintech business lender, in the space of a little over 8 weeks I have encountered heartbreaking stories of SME clients experiencing decreases of 50-100% in revenue and suffering emotional and financial distress.   

At the same time, not one of these clients has been paralysed by fear or stuck their head in the sand.  Small business owners in general care about their staff and are resilient.   Pretty much every client I have spoken to cannot wait to relaunch their businesses when Stage 3 restrictions are lifted, and many are using this time to explore a number of business options.

First among these is the business strategy.  We advise our clients to go over their business plans to find ways to:   either refine and focus the current offering, or pivot into new business opportunities; negotiate supplier terms on a case by case basis; improve debtor collection; run down existing inventory levels; reduce expenses; launch online portals to generate sales; negotiate rent relief with landlords and close stores; and in general get “lean and mean”.

The majority of SMEs in Australia have 3 major expenses – wages, rent and finance costs.   To manage these during the pandemic-induced business downturn, SMEs need to use some or all of the following measures:

1. Cashflow scenario planning – modelling the impact on revenue and expenses to determine cash burn and possible solutions.
2. Government assistance – exploring all available State and Federal government assistance packages to support wages/rent, and government grants to fund expanded manufacturing capacity.
3. Insurance – there are business interruption clauses, but anecdotally many clients have been told by their insurers that it excludes pandemics.
4. Cash is king – focusing on the cash conversion cycle.  Exploring equity and debt liquidity options to act as a buffer during these volatile times. Approaching their bank for a 180 day deferral of principal and interest repayments is recommended.

Phoenix phase

As restrictions begin to ease, we’ll hopefully move from a black swan event to a phoenix event, as businesses rise with renewed vigour to thrive through another cycle.  SMEs across Australia will be seeking the funding needed to rebuild inventory levels, hire staff and spend on new equipment and marketing campaigns to rebuild their revenues back up to historical levels.

When applying for a business loan, there are generally three approaches conducted by banks and non- banks in the marketplace:

1. The major banks conduct fundamental credit analysis on largely historical financial information (so a largely rear vision mirror approach to the business) sometimes supplemented by a cashflow projection for a limited view of the road ahead. Their analysis hones in on a range of financial ratios that are seen as an indicator of the health of the business and the likelihood of servicing the debt. Determining the sustainable EBITDA (Earnings before Interest Tax Depreciation and Amortisation) of a business is important.  The major issue being that COVID-19 has significantly impacted the performance of businesses now and into the foreseeable future, to the extent that financial practitioners joke about the concept of EBITDAC (EBITDA after Coronavirus). In particular, banks request evidence the business has no tax arrears at a time when a majority of businesses have deferred tax liabilities and EBITDAC is materially lower than the prior year.
2. Some Fintechs focus on Algorithmic credit assessment involving the use of bank statement and external credit bureau ratings to make a decision. Again, this is difficult when clients’ operating revenues decrease to a trickle and they seek working capital.
3. Relationship Banking is essentially a combination of fundamental credit analysis and algorithmic lending with the overlay of experienced credit personnel.  Dealing with an experienced business banker is paramount at times like these so that the reality of the business situation and possible solutions can be discussed, tested and implemented.

SMEs looking to move forward with growth funding will be doing so at the same time as their cashflow is being squeezed by slow debtor collection and deferred tax liabilities. Pre-pandemic research commissioned by financial services firm Scottish Pacific, found businesses with an annual revenue of $1-10 million have been hardest hit by delays, waiting on average 66 debtor days. Larger firms with $10-20 million in revenue are waiting 40 days to be paid.   With Covid-19 hitting business, it’s highly likely payment times have been dragged out even further.

The model applied by the major banks has severe limitations in this scenario. 

Banjo has championed Relationship Banking, and built a strong and successful portfolio as a lender on this basis.  Using Relationship Banking, the focus of the analysis will shift more to a forward-looking view using the cashflow projection. Aged debtor and receivable listings will also be important to factor into the receipts, with assumptions of extended timeframes for payments.

Provision of Australian Taxation Office and Business Activity Statement reports will allow the lender and borrower to quantify the amount owing and facilitate discussions for repayment arrangements to be implemented.

Finally, we’ve heard often in recent times to “never waste a good crisis”.  As a lender, we believe that means encouraging clients, even in the good times, to always be preparing for the unknowable, and thinking about modes of recovery.

Guy Callaghan, CEO of Banjo Loans