All businesses will have some form of relationship with a bank. That may range from frequent contact throughout the year through to no more than touching base once a year for an annual review.
I have always preferred to keep quite proactive with the bank ensuring I give them a quick update on performance every few months.
Having worked with nearly all of the major banks in New Zealand and a few overseas I have found there are the following three overriding points to keep front of mind with your bank:
- Banks do not like surprises. This is where regular communication is critical. Do not sit on possible issues. Discuss as early as you can.
- The bank’s Credit team approves your funding arrangement not your relationship manager. It’s the credit team you are preparing for when reviewing current terms or applying for a loan. Occasionally I have found relationship managers give the impression that the buck stops with them, which it most certainly does not!
- Ultimately the bank wants their interest paid monthly and principal repaid. The whole process when preparing to meet with the bank is to prove to them that this will absolutely not be an issue.
The reasons for meeting the bank in the health care industry, and especially aged residential care and retirement village operators, is generally to review A) the current and forecast trading performance or B) a capital project such as a development or acquisition or C) the relationship needs a bit of TLC. We will look at each individually:
A. CURRENT AND FORECAST TRADING REVIEW
As part of your commitments to the bank, if you have a funding arrangement in place, will be to provide them detailed financial information. This will be year-end financial statements which may need to have been independently audited, and the coming years approved annual budget. This will include a month by month profit and loss, balance sheet and cash flow.
The bank will also want to see how the coming year’s performance will impact the covenants that are in place. Below are three common bank covenants explained.
It is critical to ensure that a defendable budget is put forward that shows strong growth in the business. This then provides proof and leverage during negotiation for the bank to have a look at decreasing their margins or relaxing bank covenants or both.
If during the year the business experiences difficult trading conditions where keeping within the current banking covenant levels may become difficult you then update the above information and get across to the bank as soon as possible and well before a breach.
| Fixed charge ratio | Debt to EBITDA ratio | Equity ratio |
| Measures a business’s ability to cover its fixed charges, such as interest expense and rental expense. A high ratio shows that a business can comfortably cover its fixed costs based on its current cash flow. In general, you want your fixed charge coverage ratio to be 1.25:1 or greater. Potential lenders look at a company's fixed charge coverage ratio when deciding whether to extend financing. | Measures the amount of income generated and available to pay down debt before covering interest, taxes, depreciation, and amortization expenses. Generally, net debt-to-EBITDA ratios of less than 3 are considered acceptable. The lower the ratio, the higher the probability of the business successfully paying off its debt. Ratios higher than 3 or 4 serve as “red flags” and indicate that the company may be financially distressed in the future. | Equity ratio uses a company’s total assets (current and non-current) and total equity to help indicate how effectively they fund asset requirements without using debt. Generally, a business wants to shoot for an equity ratio of about 50%, which indicates that there's more outright ownership in the business than debt. In other words, more is owned by the company itself than creditors. |
B. CAPITAL OPPORTUNITIES
This can be broken into two – 1) Outright acquisitions and 2) Greenfield developments such as a retirement village or brownfield like an extension to an existing facility or extensive facility refurbishment and modernisation.
1. Acquisition
Acquisition will be supported by a sale and purchase agreement, independent valuation and the approved business case documentation. The objective is to be able to educate your relationship manager about the target and provide as much defendable qualitative and quantitative information as practical in a well-researched and professionally prepared business care document.
This speeds up the application process by minimising the number of questions your relationship manager gets from their Credit team.
The business case document will have a wide range of topics covered including the funding requested, evidence of your due diligence, key performance indicators, upside EBITDA opportunity in the acquisition, impact to covenants, identified risks and mitigation plans and a detailed timetable of key dates. You will also need to update the financial information discussed on the previous page and provide to the bank.
2. Developments
I’m going to side step Greenfield retirement village development funding here. They’re huge multiyear capital projects which the banks treat differently to more operational expansion.
Brownfield developments tend to have a timeframe of under a year if you exclude all of the resource and building consent timeframe. The actual build, for say a 20 additional rooms, should be no more than six months. But over that six months a lot of cash is going out of the business with no additional revenue and, depending on the type of build, revenue may even decrease. Over this period, and as the occupancy increases as the new or refurbished rooms are occupied, it is most likely that the business will require banking support.
As with above, a well-researched and prepared business case document will be very important. Unlike an acquisition where due diligence is completed and earnings come on line a day after settlement date, the bank is going to want confirmation of resource and building consents, details of the build program and then importantly the updated financial information which is likely to require at least one further year added to your current forecast of the profit and loss, balance sheet and cash flows. The bank will be wanting to see how long it will take post the developments completion to get back to profitability including the incremental earnings from the additional rooms.
C. RELATIONSHIP TLC
Your bank is there to provide an outstanding service and outwardly care deeply about your business and its services. They provide value to your business and that is why you consider them a vital part of your business success.
But sometimes, and not very often I’ve found, you can get the feeling that inwardly, they’re taking the mickey. If you are not happy with the service, by all means look around like you would if you felt the same about your insurance broker or chartered accountant firm.
Having a look at what the other banks are offering is good practice. It is also good to have developed some positive rapport with at least one other bank even if you are not doing business with them. Banks are great sources for industry gossip.
My experience is that if you are taking a move seriously or that you want to look for funding elsewhere while retaining the transactional banking with your existing bank, talk to them first and tell them what and why you are looking.
I have seen business leaders cut their current bank out of a funding round without telling them and then spring it on them later. Firstly, it is bad manners and disrespectful. Secondly, it REALLY annoys them and can damage the relationship going forward. Finally, it is not a reputation you want to have with the banking community which is relatively small in New Zealand. When credit lines next dry up, as they did through the GFC, you may find yourself without a credible funding partner, paying significantly higher interest, and need to eat some serious and potentially avoidable chunks of humble pie.
So in concluding this article, consider the following as the four main takeaways:
- Keep the communication lines wide open.
- Provide specifics to the bank that are clear and understandable. Where there is a capital opportunity, support a funding application with a well-researched and professionally prepared business case document.
- Set realistic revenue and margin goals that are defendable and include worst case considerations. But also don’t shoot yourself in the foot by being too conservative.
- View every concern or pushback by the bank objectively then adapt and adjust accordingly. But if you think they’re taking the mickey, you know what to do. :-)
We can help:
Whether you have a large capital project, want a review of your current covenants or experiencing a funding squeeze, we have many years of experience working with the major banks in New Zealand and can assist with ensuring you put your best foot forward with your operations or capital loan requests.
Stuart Bilbrough
Peak Care Advisory
Mob: 021 252 5778
Email: stuart@peakadvisory.co.nz
Website: www.peakadvisory.co.nz
