Recently I was invited attend a half day presentation given by a large mid-sized Central European client and their bankers, with the objective of renewing the company’s line of credit. While there was plenty to be concerned about with regard to the performance of the company, the bankers asked very few questions, none of which were particularly penetrating. When the bankers confirmed that the line of credit would be renewed my colleague and I looked at each other in amazement. My colleague was a little quicker to come to a conclusion than I was: “They don’t care about the business; they are amply covered by the real estate collateral that the company owns”. Bullseye.
Could it be then that this is not an isolated incident, but a symptom of how banking is done in Central Europe? Anecdotal evidence indicates that this does seem to be the case. Yet there are exceptions to every rule. For example, after three or four years of collateral-based lending, my own advisory company was successful in persuading our own bankers, Budapest Bank, to drop the real estate collateral to their loan. However, from talking to fellow business owners, foregoing real estate collateral appears to be very much the exception, not the rule.
If one accepts the proposition that lending is essentially collateral based (e.g. mostly real estate, but also share portfolios, and other assets), this brings about difficulties for Small and Medium-sized Enterprises (SMEs), for several reasons:
- First, a company may have an excellent business plan, concept, product or service, management and firm orders, and yet, if lacking the appropriate real estate or collateral, the company may be unsuccessful in achieving financing;
- Given the precarious state of real estate markets where values have diminished greatly over the past year (or, more precisely, in some segments of the real estate market in Central Europe) there has ceased to be a market (e.g. sellers would rather hold onto their properties than sell at the price buyers are willing to pay). This makes valuations increasingly theoretical in nature, given that there are few direct comparables on which to base valuations. So even those companies that do have real estate may be starved for financing, unless they are over-collateralized, compared to their credit ambitions.
So what are the solutions? Other than Government-sponsored programs which offer special loans or guarantees for small businesses, the long-term solution has to come from the market:
- First, SMEs will continue to shop around for banks that will give them the best possible banking terms and banking relationship, and will naturally gravitate towards those banks that tend to manage their SME lending activities best.
- Those banks that insist on real estate-based lending to SMEs will see their market share diminish. Hence there will be a race against time for them to develop lending competencies that are based on understanding businesses, not on taking collateral.
- In the meantime, companies may have to look for additional equity financing if they are unable to raise debt financing.
There are many businesses which are very “sexy” by today’s standards, such as IT, biotechnology, or high technology businesses, which do not require much in the form of assets or real estate. To load these companies up with real estate just to make them financeable would be to make the tail wag the dog. Banks, too, over time, will find that they may be left behind in terms of market share in financing this market segment if they impose a straight jacket of asset financing.
Disclosure: No positions