Jim Stoynoff, President, Synthesis Solutions LLC
Much has happened in the commercial credit markets as a result of the Great Recession, but it comes as no surprise given the conditions that existed before the credit crunch.
Prior to 2000 there were fewer banks in metro areas like Chicago and their lending criteria were typically conservative. Borrowers had fewer choices and less negotiating leverage when seeking business financing. What followed was a rapid increase in the number of bank branches and the entry of many new players to the market. Case in point, there are now 128 commercial banks and 1547 branches in the Chicago land area (FDIC report, June 30, 2010). As competition increased a growing number of banks began to relax their lending criteria in order to capture more market share.
For example the traditional 5 C’s of credit normally required to obtain a loan were often not fully adhered to:
- Character (integrity)
- Capacity (sufficient cash flow to service the obligation)
- Capital (net worth)
- Collateral (assets to secure the debt)
- Conditions (of the borrower and the overall economy)
Greater availability of liberal credit gave borrowers, and even those of marginal credit worthiness, more options to choose from. As the scales tipped in their favor they were able to negotiate more liberal terms with willing lenders. Once on board with a bank if a borrower did not fulfill one or more of the loan agreement covenants (referred to as “tripping a covenant”), lenders often looked the other way, lest the customer go to a competing bank willing to take the risk.
Banks had essentially abandoned conservative lending practices, giving rise to a wild west mentality that would allow riskier lending in order to capture and retain more customers. It was inevitable that these practices would lead to severe consequences, as we are now experiencing.
After The Bubble Burst
Since the near collapse of the credit markets, banks are understandably imposing much tighter lending criteria. Some examples: a borrower is now expected to have excellent personal credit and must meet all of the 5C’s criteria. The debt to equity ratio of the business must be significantly lower to avoid over leveraging, which helped get us into trouble in the first place. Loan officers no longer have the authority to approve loans up to prescribed limits without committee review. Loan committee approval and more periodic reviews of loans are now mandatory. Today, tripped covenants are more likely to result in amendments to the loan agreement that impose stiffer conditions and higher fees. In a worse case scenario the loan could be called and the borrower obligated to pay the full indebtedness to the bank in as little as 30 to 60 days
Where’s the Money?
While a return to more responsible lending was long overdue, in some cases the pendulum may have swung too far in that direction. Prior to the recession lenders typically looked for ways to do business with a borrower. Now they are more focused on finding reasons why not to lend, thereby stemming the flow of much needed capital to the market. To a large extent this is impacting the recovery and the unemployment situation, particularly since small business plays such a significant role in our economy and collectively employs the majority of non-farm workers.
Neither a substantial infusion of capital by the Fed nor the SBA’s recent commitment to guarantee up to 90% of bank loans to small businesses have proven adequate incentives for banks to ease requirements and increase lending. And although they have boosted their marketing efforts, this has not correlated to a significant increase in lending. The bigger marketing push is simply needed to fill the funnel with more prospects, in order to identify the small number which can meet today’s stiffer lending criteria.
There’s no doubt that credit will eventually be unfrozen, hopefully sooner rather than later. The process will be a slow one, as in any sustainable recovery, and it will also require more lender confidence. However, as lender confidence levels return it’s also likely that a few years down the road we’ll again face a disruption of the credit market, if for no other reason because of the competitive nature of the lending eco-system which is unlikely to change appreciably.
It should be noted that community banks have generally adhered to appropriately conservative lending practices throughout this period, despite fierce competition. Being privately held they are not subject to the expectations of underwriters and thousands of stock holders seeking a gain in market share, even at the expense of unjustifiable risk.
In contrast community banks are typically owned by a limited number of principals who generally have significant amounts of their own capital at risk in the bank’s loan portfolio, and possibly personal guarantees for additional operating capital borrowed from other sources.
What Savvy Businesses Are Doing
Although borrowers have no control over these market cycles they can take steps to assure uninterrupted credit availability. If a business can always meet more conservative lending criteria it will be viewed by lenders as a “preferred” borrower in all economic seasons. This is true regardless of whether it has its relationship with a community bank or a larger national bank. Additionally, developing these credit credentials makes good business sense because even if a credit facility is not needed, improved financial performance will increase business value.
Beyond financial performance however there are other elements of a banking relationship which must not be overlooked, for example, building the banker’s confidence in the firm’s leadership and management, sound strategic planning and borrower transparency, to name a few. (For more insights download this complimentary report: 7 Ways to Work with Your Banker in Good Times and Bad.
Firms interviewed for this article still find themselves in survival mode and inundated with the consequences of the recession. Their day-to-day attention is focused on dealing with financial challenges, putting out operational fires and struggling to help their sales people cope with the rejection they experience in today’s market. However, these firms also recognize the importance of improving their borrowing capacity. While addressing their everyday challenges they’ve also begun improving their financial performance in order to meet more rigorous lending criteria, both for today and for the future. They are doing this now to insure they will have the credentials needed to access more capital to grow their businesses as the economy recovers.
They’re speaking with different banks to understand lending criteria and expectations. This is helping them identify how their financial performance needs to change, and to develop a tactical plan to achieve those goals. Meeting with different bankers also gives them insights into the diverse cultures among banks. In today’s market bankers welcome such opportunities because they need to connect with more prospects in order to find the “gems in the rough”, and to also identify and track firms that are working towards meeting their lending criteria.
What You Can Do
Today’s standards are admittedly tougher, but they are nevertheless essential goals to strive for. Start by talking to bankers and use the information gleaned to develop a tactical plan for improving any weaknesses in your company’s financial performance. Guidance from knowledgeable and trusted advisors will also be very valuable. Keep an open dialog with those lenders that impress you as being a good financial, service and cultural fit for you. This also gives them the opportunity to learn more about you and your company, increasing the likelihood that they will to do business with you when conditions are ripe.
Building stronger financials and addressing day to day challenges are not easy tasks; however they are being undertaken by firms that recognize the need to look beyond today and to strategically position themselves now in order to survive future credit crunches that are sure to come. In any event borrowers will be competing for business credit and those that meet stricter criteria will be the winners.
To compete requires a solid and achievable plan for improving financial performance, a focused commitment on your part and the support of your entire team. Do it! Sooner rather than later.
Jim Stoynoff is a seasoned entrepreneur who has helped hundreds of growing companies to finance and to improve their day-to-day operations. Jim can be reached at 312-920-1700 or jstoynoff@Synthesis.Biz.
Also visit www.Synthesis.Biz