It’s budget time at banks and the next few weeks will be very revealing indeed, as results for the last quarter will be announced. And so will budgets for 2017.
Both will have a critical element in determining bottom-lines, both past and future. And there will be the banks’ view on provisions to be created for bad debts, past and future.
For the future, banks can take two approaches to this aspect of lending. First, grow the loan book at a reasonable pace with a more conservative approach to bad debts, i.e., expect a higher level of bad debts and therefore create higher provisions. Or go for option two — curb loan growth to an extremely slow pace, almost in single digits, and with a lower expectation (and therefore provision) of bad debts.
Need of the hour
The former, slightly more aggressive posture, is the need of the hour to a) prevent the economy from sliding into very low growth rates; b) keep client acquisition for banks going so that 2018 and beyond is not affected (because it will if banks don’t add sufficient number of new clients next year). The CEO of Mashreq has alluded to this in a recent article and emphasised the importance of de-risking in this context as well.
What will banks do? I’m almost certain most banks will follow the herd and take the second route. There are a couple of banks that have the courage to take the contrarian view and they will benefit in the long run.
Some underlying assumptions I am making are that the economy of the UAE will grow, albeit at a low rate; some spend on 2020 will start feeding into the economy by 2Q17; and the macroeconomic environment (as represented by the effect of low oil prices and depressed export markets) will continue to be difficult. A look at the past year and the current thinking among bankers will throw some light on what small businesses can expect in 2017.
What lies for SMEs
Here are some facts. First, numerous small companies with financial and business problems were wiped out last year and owners skipped town. Second, dozens of larger companies who were engaged in serious “kite flying” or “accommodation” (fake) transactions to raise bank debt for non-business purposes suffered the same fate.
Third, many of those companies which had raised increasing amounts of debt with the express objective of defrauding banks also skipped. And lastly, thinly capitalised, over geared but genuine companies, operating in badly affected industries, were also wiped out. Banks, for a variety of reasons, lost money.
So, does this all mean that the Augean stables have been cleansed? That this exorcism by bad debts represents a thorough purgatorial expungement of toxic debt? Many bankers think the bulk of the cleansing is done as evidenced by the decreasing number (and pace) of skips. That things have settled.
This may well be partly true, but there are problems lurking around the corner, certainly not to the same scale as witnessed during the last 12 months, but certainly on the horizon.
Our experience in working with SMES, in assisting them with raising bank finance and advising on restructuring their bank facilities (for those under stress), has been extremely revealing.
First, the challenging environment continues to belabour hundreds of firms that continue to lose money, while putting on a brave but foolish front of being profitable.
Second, innumerable companies (especially the larger ones which show annual sales of Dh100 million to Dh150 million) carry large holes in their balance-sheets, resulting from business losses, diversion of funds and so on, camouflaged by falsified numbers.
Third, these holes are impossible for statutory auditors to detect, even if they had the intention to do so. Auditor firms are supposed to audit books of accounts presented by management and test procedures and practices adopted. They are not forensic fraud investigators, and expecting them to unearth these holes is fallacious and wishful thinking.
Fourth, companies with hollow financials are not necessarily in default with banks. There could be occasional signs of stress, but eternal hope, borrowings from loan sharks and creative accounting keeps the truth at bay.
What should SMEs do?
What does this all mean for banks and their lending strategy for 2017? Based on anecdotal evidence and our own due diligence work conducted for banks, I think we will see defaults among the larger SMEs as the problems have by no means disappeared. This will continue through the remainder of this year and into the next.
Bankers also suspect this and therefore will err on the side of caution. Banks will carry out more due diligence, ask more questions, react at the slightest hint of trouble and will be edgy. Borrowers will not receive the benefit of doubt.
What should SME owners do? Our advice to those we are working with has been to admit there are problems and have open discussions with banks by surfacing issues.
Practicality will determine how this should be handled, but frankly, now is a good time to adopt this strategy. Fear of banks’ reactions is justified, but banks are willing to listen now.
Delaying matters and having the problem explode in your faces later will not buy any sympathy from banks in the near future.
The writer is the head of Vianta Advisors