Out of credit: how the banks took away the industry’s overdrafts

‘Do you want to know the most offensive phrase I’ve heard the banks use?” asks the chief executive of a £150m-turnover construction company. “We can get better value elsewhere,” he says, with disgust. “I hear it again and again.”

His bank recently demonstrated its loss of faith in the construction sector by cutting his overdraft by 40%.

Research released today by strategy consultant Roland Berger shows there are many others like him. The study found that more construction and property companies have had unused credit withdrawn than any other sector of the economy.

The compilers of the report spoke to finance directors at 32 of the UK’s largest construction and property companies with a minimum turnover of £250m. The alarming findings are supported by evidence from company bosses further down the chain.

Almost half of the firms interviewed had their overdraft facilities cut; the figure of 44% compares with a pan-industry average of 34%.

The average cut for construction companies was 34%, which was the second highest sector of the economy, while the average interest rate on debt has risen by 0.98 percentage points since June last year, compared with a pan-industry average of 0.81.

Klaus Kremers, restructuring and turnaround partner at Roland Berger, says: “This is a really serious problem. Cash flow is the lifeblood of the construction industry and there will be serious consequences if you take it away.”

One of the results is job cuts. Thousands of jobs have already been lost as work dries up, but 66% of respondents said the lack of liquidity would force them to cut staff further.

According to Kremers, the survey shows that banks have failed to grasp the specific cash flow patterns of the construction industry.

He says: “It’s a cyclical industry. Sometimes an overdraft is needed and sometimes it isn’t. For example, companies may need to buy more materials towards the summer.”

The boss of the £150m-turnover company agrees. “I met one guy from a big name bank who just didn’t get it. Your income and outgoings peak and trough over a month so some days you will be well in credit and others you won’t. You need the credit facility to cover the ups and downs.”

This is a really serious problem. Cash flow is the lifeblood of the construction industry

Klaus Kremers, Roland Berger

He also said banks tended to lump construction and property companies together, despite their different cash flow models and said they failed to distinguish between contractors exposed to lower risk public sector work and those operating in the riskier commercial arena.

He says: “Where you have complicated stuff like PFI you need someone who understands the detail. We have had certified work from Partnerships for Schools and local authorities, but the banks still asked for payments to be brought forward.”

Other bosses point to the aggravating factor of having to dip into overdrafts to use as collateral against performance bonds, which cuts headroom further. And the scarcity of credit insurance has meant more suppliers are demanding prompt payment, increasing the strain on contractors’ working capital.

One senior banker in the construction arena dismisses the suggestion that banks cannot distinguish between different business models but concedes that there is anxiety towards the sector as a whole. “It’s not just main contractors that pose the risk. There will also be questions over the quality of the subcontractors and the supply chain. A recent report by Pricewaterhouse Coopers said eight builders were going bust every day. That’s the climate we’re working in,” he says.

Another construction chief executive gets to the heart of the issue, which is that cash is king. He says: “What we’ve found is that there’s a huge difference between committed spend and cash on the table. The banks are like rabbits in the headlights.”

This climate of fear means relationships forged between banks and clients in the good times have foundered.

While the boss of the £150m-turnover company says talks with his bank have sometimes been heated, Andrew Gay, former chairman of contractor Warings, questions the foundations on which the relationships were built.

Not referring to Warings directly, he says: “The problem is that so-called relationship banking disappeared long ago. Lending was driven by the sales teams within the banks. The reason for all this over-borrowing is that there was no proper relationship in the first place.”

He likens the current situation to a sketch in TV show Little Britain. “Now it’s a case of ‘computer says no’ and they know companies can’t shop around.”

Bankers don’t disagree. Peter Alcaraz, managing director at investment bank Close Brothers, says the credit crisis means relationship banking has “gone out the window”, and produced a new layer of number crunchers – capital allocation committees.

They sit between the bank manager and credit committee, and Alcaraz says they are often responsible for knocking back requests before they can get to the credit committee stage.

Now it’s a case of ‘computer says no’ and they know companies can’t shop around

Andrew Gay, former chairman, Warings

While banks and clients may differ on their new priorities, they all agree the government’s drive to free up lending isn’t working. One senior banker said: “On one hand, the government tells us to keep a certain level of capital on our balance sheets. On the other, it tells us to lend more. Something will have to give.”

This week, the government was set to reveal more details of its asset protection scheme to safeguard banks against toxic debt. Kremers is unsure whether it will be enough to see overdrafts relaxed. And why haven’t previous initiatives, such as a £20bn guarantee for small business lending by business secretary Peter Mandelson last month, made life easier for borrowers yet? “That’s a very good question,” he says.

We have our own problems

Peter Alcaraz gives a banker’s perspective

There are three major issues at play. The first is the massive capital constraint on banks. They have written down their toxic debt but you also have an estimated £300bn of global leveraged buyout debt that has become much less valuable and an unknown quantity of non-toxic debt.

The second problem is the flight of foreign banks from the UK. A lot of the extra funding in the system previously came from Iceland, Ireland, France and Spain, but banks are now focusing much more on their native clients.

The third issue is that banks are completely dysfunctional at the moment. They have new regulations and impending nationalisation to deal with and don’t know what is coming next. About 135,000 global job cuts have been announced, but many of those haven’t happened yet so there is a climate of intense fear.

Peter Alcaraz is managing director and construction specialist at Close Brothers investment bank