Bank relationship managers. Help them to help you

This is the third of our four-part series with Mick Hall, partner at banking advisory business, Velvet Pig. Mick shares insights on how to deal with your bank during these unprecedented times.

How banks assess business funding applications

This is the third of a four-part interview series with Mick Hall, Partner at debt advisory and banking advisory business Velvet Pig. In this article, Mick shares his expertise on how COVID-19 has changed the way that bank managers assess business funding requests.

Right now, banks are facing challenges around the high number of loan deferrals. April figures show that there’s about 750,000 combined business and personal loans worth $250b that have been deferred. When the legislative temporary protections are lifted in October, the bank’s relationship managers, who’ve been busy dealing with these hardship applications, are going to have to turn their attention to business owners seeking additional support.

To do that, they’ll need to understand, analyse, assess and, in some cases, negotiate new debt funding solutions that are mutually acceptable to both the client and the bank. These discussions will require a lot of detail and the decision could potentially take weeks. However, how you manage the relationship with your bank through the process may define the outcome. 

What do bank relationship managers look for?

So what bank relationship managers will be looking for when they assess new funding applications? Firstly, they will distinguish between:

• Businesses that were fundamentally healthy pre-COVID and not in a sector or industry that’s been hit hard.
• Businesses that were probably healthy pre-COVID but are now in an impacted sector.
• Businesses that were already struggling with their financial position pre-COVID. 

There’s going to be a heightened reliance on detailed forecasting and the assumptions which underpin those forecasts. Historical performance will remain important for shoring up a business’s ability to maintain focus during a cycle. On the qualitative side, management stability is also important. If your business has a demonstrated history of managing a business through a cycle and hitting forecasts, it’s going to build confidence within the bank’s risk and relationship teams. 

And finally, the security structure and level of security cover will be a greater consideration in the risk assessment process as uncertainty around earnings forecasts remains. There will be a level of caution exercised by banks over a range of asset classes. For example, property valuations will be impacted due to rental abatement and slowed tenancy rates. If banks are holding those properties as securities, that’s another level of scrutiny they are going to apply on the security cover.

Assessing business credit risk

Many business owners are unaware of the criteria used to assess business credit risk. Historically, the framework for assessing the creditworthiness of the borrower and the suitability of a loan for a specific purpose came down to five c’s: 

• Character: the credit history, the business history, the reputation, and the credit score of the borrower or the business. 
• Capacity: the ability to service a loan from cash flow sources. 
• Capital: the amount of contribution that the business is making to a particular transaction in terms of equity or cash. 
• Collateral: the security and the level of liquidity of that security. 
• Conditions: something that’s imposed by the bank to protect their interest around how they structure, how they price, and any covenants which are attached. 

In the last decade, the five c’s have been replaced by a lot more detail and analytical credit rating and credit scoring frameworks.

Now, the focus for banks is assessing the:

• Probability of default: the customer’s ability and the willingness to meet a debt commitment when it’s due.
• Loss given default: the loss a bank is likely to incur after it realises its security position in the event that repayment doesn’t occur, or when there’s an event of default.

These two measures provide you with a risk grade which is ultimately what determines the bank’s ongoing support to a particular customer request. It will also influence pricing, terms and conditions. In the pre-COVID world, risk grades were determined upon a new borrowing or restructure request and then typically reviewed each year. In a post-COVID world, risk grade measures will happen more often. In particular, if there’s evidence of financial distress, material deterioration of financial performance, or industrial or economic developments, it will send a trigger to the bank. Risk downgrades have an impact for the bank because it means the bank must put more capital aside and, to do that, they need to get a better return for the money. If they do offer the business funding support, it will come at an increased price or a more onerous repayment program. 

In our next and final article in this series, Mick reveals the 20 key considerations that a credit assessor looks at when completing a credit risk grading.

In the meantime, if you’d like to discuss your financial business plan or need help with your accounting, please call 1300 656 141 or leave your details on our contact page. We are here to support you. 

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About Velvet Pig

Velvet Pig is a debt advisory and banking advisory business. Its team has spent more than 50 years in banking, primarily working in institutional and corporate finance. Contact Mick on +61 481 034 939 or mick.hall@velvetpig.com.au 

About BridgePoint Group
BridgePoint Group, led by managing director Neil Parker, is an advisory group that provides expert advice to SMEs across the areas of accounting, taxation, legals, strategy, growth, superannuation and corporate advisory. Contact Neil on +61 422 120 921 or neil@bridgepointgroup.com.au

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