‘Economic turmoil can help the best businesses thrive’
BANK WILL STEP UP DESPITE OTHERS PULLING BACK, SAYS OAKNORTH EXECUTIVE
CLEARLY, a lot has happened since the chancellor, Kwasi Kwarteng, unveiled his growth plan last month, which has had a significant impact in the way banks support SMEs.
Some will have withdrawn indicative loan terms offered to businesses earlier this month, while others will have implemented a pause on all new SME [small and medium-sized enterprises] lending.
Relationship managers and credit analysts will be dealing with multiple mixed messages coming down through blurred reporting lines, without any clarity on the front lines about what to say or do with customers, or what the bank’s strategy is with regards to lending. Too many entrepreneurs have experienced the “20 weeks to a ‘no’” when it comes to borrowing and unfortunately in times like these, that only gets worse.
Despite many lenders retrenching the market caused by the current macro headwinds, I fully believe with great challenge comes great opportunity.
The best businesses thrive in times of economic turmoil – this is something I’ve heard time and again from OakNorth’s co-founder and CEO, Rishi Khosla, since I joined the bank six and-a-half years ago. Since then, we’ve seen Brexit, Covid, and the world is now facing a recession.
As I wrote1 a few months ago, difficult times lie ahead, and there are several factors that could make this recession more challenging than its predecessors. Economies worldwide are still recovering from Covid-19 which has led to a global supply chain crisis; the Russia-Ukraine war has strained food and energy supplies, causing prices to soar; our new leadership in the British government is currently tackling the cost-of-living crisis; and Brexit has led to labour shortages across several industries. Many of the businesses being impacted by these challenges were launched in the past 12 years – the longest bull market in history – so have never operated through a downturn and therefore may feel unequipped to deal with the uncertainty that lies ahead.
Yet despite this, I remain optimistic, as I know a number of businesses will grow through this period, enhancing and increasing their market position, just as we saw through Brexit and Covid. The pandemic intensified the need for portfolio diversification – for example, hotels with outdoor space are well-located to benefit from the staycation boom, and those that offer spacious rooms with selfcatering facilities were able to turn on the trading tap much sooner than those that didn’t.
Hoteliers know that to compete and ensure they are future-proofed for any further Covid disruption, diversifying their portfolio will be essential.
An example of a hotel business we’ve worked with, and which is clearly embracing this is the Arora Group, led by renowned businessman, Surinder Arora. The group, which has historically been known as a specialist airport hotel owner operator, has diversified into the country house hotel market. In December last year, it acquired the Luton Hoo Hotel, Golf & Spa from Elite Hotels, and in January this year, it opened Fairmont Windsor Park, a luxurious countryside hotel an hour from London.
I spent over 16 years at RBS and was there during the last recession, so I witnessed how the 2008 financial crisis brought with it a perfect storm that changed the landscape of financial services forever. Regulation was overhauled to facilitate new entrants such as OakNorth and encourage more competition in banking, leading to the birth of dozens of fin-techs and neobanks. And the demise of trust in traditional financial institutions made consumers all the more open to considering these new entrants. Indeed, fin-tech, the crown jewel of the UK tech sector, was borne out of the ashes of the global financial crisis. The question now becomes how long will this recession last and how deep will it be?
Historically, when facing an economic downturn, decreasing interest rates was the key tool in central banks’ toolbox to stimulate economic activity. This time, however, that tool is unlikely to be used as central banks use increasing interest rates to tackle inflation. The current uncertainty around interest rates has already caused widespread market disruption and this is likely to continue for a while.
So, what does it mean for the economy? Rising costs due to inflation, lack of consumer confidence due to the cost of living, and rising interest rates which makes the cost of servicing debt more expensive. All of this puts pressure on consumer and business’ cashflows. Borrowers who have over-levered themselves will now face real difficulties in raising capital, especially as their funders seek to protect their own balance sheet. As past recessions have shown, in a downturn, lenders tend to tighten their lending criteria and suck liquidity out of the market. So, they should expect harder access to liquidity as lenders price in a higher macro risk premium; some of this has already been seen in the wider mortgage markets.
Funders, meanwhile, will benefit in the short term from rising interest rates, but credit defaults will start to impact this. We’ve already seen credit default rise since the start of this year, and the expectation is they will continue to widen. Funders will therefore be looking to proactively manage their troubled credits and will provide less leniency on covenants than they would have been willing to in the past. They will become more cautious and focus on existing clients and their back book, rather than originating new loans, so there will be limited liquidity to new markets. In other words, most banks will be focused on protecting the downside, rather than playing for the upside.
At OakNorth, we plan to do both. We will be working with our existing borrowers to help them through the current challenges and future proof their business to protect against things such as energy and interest rate rises. We will also continue originating new loans, going out to market to find new relationships we can forge and businesses we can support.
We see this as an opportunity to prove the strength of our credit process and the businesses we lend to, but also to step up at a time when many other funders will be pulling back from the market.
1. https://thedrawdown.com/https://thedrawdown.com/article/commentfund-forecast