ARE YOU READY FOR THE CREDIT CRUNCH? (22/05/08)
2008 is becoming a challenging year for most businesses. In this article we look at the likely impact of the ‘credit crunch’, the recent Budget and other challenges for the year ahead
After years of economic growth, with house prices increasing by 200% since the Labour Government came to power in 1997, there has long been an expectation that the economy would slow down. The current ‘credit crunch’, with banks reluctant to lend to each other and supplies of mortgage funds drying up, was certainly not expected.
The origins of the problem lie in the US with widespread irresponsible lending to people who have little prospect of making repayments (the ‘sub prime’ market) and these mortgages being packaged up by the lenders and sold on to other institutions. Unfortunately, a number of the British banks have purchased these mortgage packages and are now desperately trying to find out how much they have actually lost.
The effect has been to create a climate of suspicion among the banks as to whether any British banks are so exposed to the mortgage losses that they could themselves fail. The rate of inter bank lending (the LIBOR rate) has increased to reflect what the market perceives as a risk, and investors are reluctant to purchase packages of mortgages which the banks sell on to raise funds.
Many years ago, banks and other lenders such as building societies used to operate with deposits and loans broadly balanced, with any (relatively small) surplus or deficit being made up on the money market, with such inter bank borrowing being at base rate. In recent years, the expansion of credit and the mortgage market has led to a number of institutions specialising in lending (some with actually no deposits whatsoever) and these have been particularly hit by the shortage of funds in the inter bank market and the increase in the rates being charged.
With the three month LIBOR rate being close to 6%, and Base Rate being 5%, an institution charging its mortgage borrowers 5.5% but having to pay 6% to get its funds from the market is going to make an immediate loss of 0.5% - even before its overheads are taken into account. Northern Rock was one such institution which specialised in lending – and look what happened.
The recent announcement by the Bank of England of the £50 billion funding for the banks will certainly help. However, the current problems within the banking sector are such that they will take a long time to resolve, and the very low lending margins seen in recent years may be a thing of the past.
So where does this leave individuals and businesses in 2008? Individuals looking to purchase property, remortgage or who are coming to the end of fixed-term deals are finding mortgage rates much more expensive as lenders ensure they have a margin over the LIBOR rate. Lenders are also concerned about possible house price falls and are frequently demanding a higher deposit, or charging an even higher rate. On the other hand, institutions are so keen on attracting funds so that they do not have to go to the inter bank market and can “balance their books” between deposits and loans, that they are paying interest to savers at rates well above Base.
Although we cannot recommend specific mortgages or investments, we can provide general advice to clients on their financial situation and make introductions to advisers who have up to date knowledge of the market. If you are looking to remortgage or have funds to invest, please contact us and we can help you get the best deals available in the market at the present time.
For businesses the challenges in 2008 are slightly different. Costs have increased, fuel prices being a well-publicised example, and despite Government promises of a reduction in red tape, nearly all businesses have suffered an increase in regulation and associated costs. In addition, the environmental targets place further cost burdens on business, especially those relating to construction. As an example, the rate of landfill tax has increased from £24 per tonne in 2007 to £32 per tonne this year, with an announcement of a further increase to £40 per tonne in 2009.
With the increased cost base, companies also have to face the prospect of a possible recession, falling consumer confidence and the prospect of a General Election in the next two years. One result of the uncertainty of the attitude of the banks following the credit crunch has been the number of institutions who are seeking to lend at a margin above LIBOR rates, or increasing their margins generally if they are lending over Base Rate. Banks have so far continued to be very supportive of business, but there are fears that this support may dry up.
The key to dealing with banks in difficult economic times is to maintain a regular dialogue and to provide information; under no circumstances should one adopt the ostrich technique of burying one’s head in the sand! Banks want to see businesses continue (after all that is how they make their money) but need regular information to ensure their loans are secure. If the customer stops talking to the bank, they naturally assume that something is going wrong.
We have good relationships with all the major banks: senior personnel from these institutions come to see the partners on a regular basis to talk about the latest products which the banks have for business and to discuss their approach to lending generally. With these relationships, we can help and advise clients to manage any business difficulties, using our understanding of the information banks need to continue to support businesses and by helping with the production of management accounts and other financial information. If the relationship with a particular bank has broken down irretrievably, or the rates charged are uncompetitive, then we can often introduce an alternative lender.
Whether or not there is a recession, 2008 certainly will be a challenging year for business. But, with the right advice, there are still opportunities for business growth. Our message is clear: if you have any issues regarding the above or general enquiries about how to maximise your business potential against the current economic climate, speak to us at Burgess Hodgson.
The Budget also provided some challenges for business in 2008. Our Budget article can, however, be found on our website at www.burgesshodgson.co.uk
• also enclosed with your copy of the Spring Bulletin is a copy of our handy tax tables, detailing all the must-know changes as a result of the Budget 2008. If you, or your colleagues would like further copies, please call us on 01227 454627 or email email@example.com.