Author: Keith Parry, relationship director of Barclays Corporate.
Topic: Market conditions; motor retail from lender’s perspective; access to funding; keeping your business in good shape; finance types and sources; terms and conditions and funding costs.
Keith Parry has worked with Barclays for more than 30 years, and for the last 10 he has headed up their motor retail team, managing a portfolio of larger dealer groups and helping develop Barclays’ proposition for the sector.
The following is taken from a speech Parry made at the AM Financial Conference in Novermber 2011. For more on AM events go to www.am-online.com/events
How does a bank view the motor sector?
Debt versus equity is what we call balance sheet gearing and a measure of how much money is in the businessand where it comes from.
So, it is really whose capital is at stake and a measure of the owner's stake in the business compared to outside lending and of the outside stake in the business.
Clearly the more that is in balance, the more stable the bank will see the business.
The motor sector is a very capital intensive business; stock levels are high and require finance.
So generally speaking, there is always a lot more debt in the business than equity and so you know that balance is quite unusually high in the debt to equity ratio.
Profit margins; clearly in any business, profit margins are important. As we all know, the motor sector is one of those areas where profit margins are generally low.
A commentator would say 3% is an inspirational return on sales; I have to say I don’t see many businesses achieving 3% return on sales in the sector, certainly at the moment. But clearly if profit margins are low in motor sector like in many other sectors they are as well, then the susceptibility to turnover changes can be quite significant.
Industry cyclicality: this is an industry that tends to move with the economy; it can be very cyclical.
2008 was probably an unfair example of this really, because that really was unprecedented, but it tends to follow that if the economy is under a bit of pressure, then performance in the sector comes under pressure as well.
I have never come across a sector where this is so important, where the relationship between the supplier and the dealer really does mean so much and it is so important to ensure that relationship is right and everyone is on an even keel.
Many business sectors are affected by regulation. The Block Exemption Regulation and environmental legislation a few years ago - which for a short period of time at least, really hit the 4x4 sector - and credit legisation has an impact on the sector. So these are all things that a bank will be looking at.
Important considerations when thinking about financing the business
Stakeholders in the business: who are the main stakeholders?
Clearly the shareholders, the directors and the employees are key stakeholders. But also so are the OEMs and the funders and in motor sector you may well have quite a few funders. The important point here is what is important to each of those stakeholders and what are the relationships with these close stakeholders like?
Ensure that all the stakeholders do share your vision for the business, your understanding and that everyone has got common goals and it is moving in the same direction.
This is really an important one for banks as they don’t like surprises so when you are thinking about your approach to the business and funding it, openess is really important and making sure that everyone, especially your funding group, are on side and engaged early if there is anything you are considering thatis going to affect that stakeholder group.
Understanding what the sources of capital available to your business is important as well.
What are the sources of capital, what is that shareholders stake? Is it appropriate and when you are looking at funding the business are you getting the structure right, is the amount right?
Debt remains the cheapest form of capital for a business. That is not to say just go out and borrow to the hilt and bust the business. But you do need to try and be in a position where you can at least optimise the amount of debt within the business for that reason.
What sort of factors are important considerations for a bank?
No surprise that management is top, not the finance. Finances are important, but it is not top of the list, management always is for me.
I did quite a long stint with Barclays’ credit team through the last recession and there was a lot of analysis done over why businesses failed and bad management was always top of the list.
A bank will always want to meet the management team and understand its track record, probably even how they have dealt with previous challenges and how they fared through the last recession or through difficult times as well. Again this is about the key stakeholders - who are they, What are their aims for the business and are we all heading in the same direction?
Trading track record clearly is very important.
In an ideal world if you are a bank you want to see a steady performance and constant profitability; clearly that is unrealistic in the real world, there are economic cycles and it can’t be that way, but how has the business performed through difficult times, against its peers, against its targets and against the markets generally?
One thing to say about that specific to the sector: if we are looking back at, say, a three or four year track record, we do understand that 2008 was a very unprecedented and difficult year you may well show a loss for the business. But we understand that, our credit teams understand that, so that is not an issue.
A balance sheet
Clearly this represents the strength of the business - the make up of the business; the asset base, everything.
It also gives an indication of the ability of the business to withstand shocks. We talk about various shocks in the industry; the economic cycle the product cycle, but you know, a strong balance sheet will enable a business to see itself through those cycles and that is what we look for.
And we also consider the extent to which the balance sheet is built up by profits that the business has earned over the years and actually retained in the business over the years rather than just make profits and spend money in other ways perhaps.
Another very key one is cash flow management and liquidity.
Businesses don’t fail through lack of profit; they fail through lack of cash.
Cash management in this sector is so important. We see some very lumpy cash flows understandably, but management of that is absolutely critical.
Banks will lend debt based on the ability of a business to generate cash which it then uses to repay that debt. So cash flow analysis is key and in a lot of cases we do see business that are rightly focused on profit and loss but perhaps less so on the cash side and it is a critical one.
I include liquidity as well because in times like this when the banking market is tough and access to finance is being challenged in a lot of cases, liquidity is important.
How much have you got available for the business and facilities? How much head room do you have in those facilities to cope with short time crisis if they do occur?
In a sector where lending is important, borrowing facilities are very important.
You will have access to a lot of different lenders and sometimes it is not such a bad idea to make sure that you use a few of those so that you have a balance of risk in the funding markets so that if one lender does change their approach you don’t have your eggs all in one basket.
Very important to banks. We like information, we like to know how a business is doing; we feel that businesses should know how they are doing very quickly, so we like to be able to see that information as well.
So the information needs to be timely, and accurate and you know, that goes through from budget to the monthly management information that you produce as part of the ongoing management of the business and if you are preparing a business case for a new investment in the business or some additional funding, then clearly that budget, along with the assumptions behind it, become very important and the business case behind that for the investment.
Keeping the business in good shape: this is really to make sure, that when you are looking to approach a bank for finance, the business is in the best shape it can be.
Clear strategy and plan is very important. A bank will want to know where you are looking to take the business. Share the management information with the bank as early as possible and the thoughts and plans supporting it.
Key Performance Indicators
There could be hundreds of these for the motor sector and we do come across an awful lot of them; but I think that different KPI’s will be important for different businesses, and again it is important to share with your bank what are you key KPIs for your business.
Keep the focus on the top five.
Your bank probably should, but won’t have time, to assess the business across hundreds of KPIs all the time.
They will be focussed on profit and loss, balance sheet, cash and maybe half a dozen of the key performance measures within the business.
Balance of risk
This is what I call profit pools. You have got an opportunity to balance risk across the business in so many areas.
In the core business you have got new cars, used cars, service, parts, possibility a bit of hire contribution, all sorts of areas where there are different profit margins in different areas of the business, so to some extent if they are not all firing on all cylinders at the same time, you can pull and push levers in business; but also across different brands, because as we know, brands go through model cycles.
It is always good to have a brand that is performing well when another is probably in the model cycle.
Also geographically, you can spread the risk to some extent as well.
The more you can show that spread of risk in the business the better it is for your funding proposal.
Balance sheet and cash management
Strong balance sheets with retained profits, evidence of good and appropriate cash management are essential for any business to be able to show.
I would expect your bank, if they are switched on to the sector, to be talking to you about BER changes in 18 months time to understand the nature of the relationship between with your main stakeholders in the business and with the OEMs, as well as relations with other funders.
If you do nothing else through these challenging times, talk to your bank regularly and if they are not talking to you, make sure you are talking to them, to keep them in the picture; open and regular dialogue is very important, and you know good, honest communications on good or bad news, is equally important.
If there are challenges in the business one thing we do find often is that management teams are quite reluctant to seek help probably until it is getting a little bit late.
Sources and types of finance
Working capital: clearly a very important part of funding the business and general working capital facilities are normally provided by way of a bank overdraft facility.
Generally speaking it shouldn’t be used for funding stock. Banks like to see overdraft facilities fluctuating in and out of credit, you using the facility and then repaying it, and swinging it all the time.
Of course there are exceptions and there will be cases where stock is funded through an overdraft, but they would tend to be the exception rather than the rule.
Usually an overdraft facility of that nature will be linked somehow to the amount of debtors in the business.
Stock funding line; In particular unit stocking lines, there is probably a smaller number of these providers outside of the OEM arena now, but they should be used appropriately and preferably with a degree of head room if possible.
I don’t come across it very often in the sector. This is where you have quite a large debtor book and you
can put a specific funding facility against it. It works best when that debtor book is well spread, with lots of different debtors in relatively small amounts. This is probably why it doesn’t work best in this sector as a general rule, but if you have got a very large parts business or similar, it could well be a source of finance that you hadn’t thought about.
This is where specific finance against the fixture and fittings, plant and machinery assets in the business can be used for, especially in the service bays with ramps and items like that, or if you are doing a new showroom fit out it is possible to get access to specific asset finance on some of the items you need.
Generally speaking it is a relatively short term measure, probably to a maximum of three years, but could be a bit longer on some of the assets.
Applicable where you do actually own property assets and you can get access to longer term finance against those property assets. Typically these days up to about 70% of the value, sometimes a bit more by exception, sometimes maybe a bit less.
Cash flow lending
In the boom times up to 2007 cash flow lending was available. It is effectively just a loan with no security where the bank lends against the strong cash flow it perceives are in the business.
It is not around much these days and the market has tightened up on it.
Then there are other loans available: oil loans from some of the oil companies; possibly grants and clearly support from your OEM partners.
The small print
Think carefully if you have got a loan. If you negotiate a loan agreement with your bank, carefully about the term of the commitment.
If it is an overdraft facility it would usually be for 12 months and it would usually be on demand, so that the bank can recall it at any time.
If it is a loan, you will want a longer term to repay it.
Bear in mind that at the moment, most banks will put a three year repayment date on a loan because the cost of capital beyond that is excessive.
You can access longer term loans, but it will cost a lot more.
The repayment profile of your loan will still probably be 10-15 years, if that is the agreement you have got, but the bank and you will have a right to review the terms of it after about three years.
You might come across this. If you agree a new loan with your bank, understand what terms you will have to satisfy before you can get access to the actual money - this is what the conditions precedent are. They might be a valuation on a property or something similar.
If there is new security, what is the cost of taking it, what are the requirements in terms of valuation and how might it impact on other lenders?
Security can get very complex in this sector if you actually involve too many lenders and it can restrict your ability to do much in the future.
What does your bank want and how are they going to monitor you against the information you provide?
These are tied into term loans and are financial targets that you have to achieve to retain the loan:
interest cover, debt service cover etc. Understand them, understand the way they are calculated, the definitions of them, and make sure you are confident you will be able to meet them because if you don’t the loan can be called in.
The cost of capital for banks has gone up significantly. Banks have got to keep more capital, which costs money. They can’t access cheap finance in the short term markets any more, because banks don’t trust each other any more. They think they are all going to go bust, so they have got to raise capital from else where which is more costly.
That is why you are seeing banks asking for higher margins on debt.
Arguably I would say that debt was too cheap in 2005-2007, but I think we have got to find the right balance here, but yes, the cost of borrowing has increased.
Interest margins will be higher than you are used to; it would probably now start with a two, possibly even a three, where as previously it might have started with a one.
What fees can you expect to pay?
Arrangement fees on a new loan or bank facility? Yes.
Anywhere between half a percent and one percent is reasonable.
And you might pay other fees like valuation fees and legal fees. Remember this last point though, it is a negotiation.
Banks won’t want to just lend these days, they will want other business off you, what they call ancillary business because it is valuable to them, and it doesn’t carry a cost of capital, so use that in your negotiations with your bank, and be prepared to negotiate because it is not just a one way street.
In summary, despite everything you read in the papers, banks do have money to lend.
Barclays has definitely increased its borrowings to business in the last couple of years, and we are continuing to lend new money to existing customers and new customers.
However, credit quality is the key.
No banks are rushing to lend money against poor credit quality which may in the end result in bad debt for them, because all that will do is start the cycle over again.
Cost of funds does remain a challenge; we are very alive to this.
It peaked in 2009, in the early months, and then it started to come back down again and we have situations where we had to increase customers margin that year and managed to reduce them again last year, or early this year.
At the moment the cost is going back up again, and I think the sooner we get the Euro issue resolved, so we all know where we are the better.
If you are talking to your bank and negotiating facilities do ensure the terms and conditions are right for you.
Spend time to understand them and make sure they are right for you.