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The Current Commercial Lending Environment
November 19, 2009
By: Tom Broughton & Paul Schabacker
Despite the challenges facing the banking industry today, credit is available to many companies, but careful planning and close communication with your banker is crucial. Organizations that are profitable and well capitalized may see relatively few changes in their credit renewals. Companies involved in investment real estate, speculative home building and land development will find credit especially difficult to obtain due to the broader economic climate. The significant numbers of businesses finding themselves somewhere in between have an opportunity to maximize their chances for a favorable credit renewal by knowing what to expect in commercial banking and proactively communicating with your banker. On new requests and at renewal, you are likely to see some changes in your existing lending relationships, including interest rates floors, higher spreads and enhanced deposit relationships. Rate floors are the result of basic economics; banks cannot earn enough spread over deposit costs to make a living with Wall Street Journal Prime Rate at 3.25% and other indexes which are even lower. Many borrowers believe they are being penalized for the mistakes and bad decisions of their bank and other failed companies when they pay a higher rate. However, in our case, it is simply the cost of doing business that requires rate floors. It is not unusual to see banks raise the borrowing index in this environment too. For example, if you were borrowing at prime, you may see your rate go to prime + ½% with a floor on renewal or a new request. If your operating results are poor, then you are more likely to see your rates increase. Your bank may also be more insistent than in the past requiring that you maintain your primary deposit relationship where your primary borrowing resides. Banks may ask you for more information than they have historically as a result of a recessionary environment and in response to pressure from regulatory agencies and external auditors. These requests may include personal and corporate tax returns, proof of liquidity, regularly updated receivable agings, interim financial statements, and cash budgets.
If your results are deteriorating, the best thing to do is fully disclose your position and plans for improvement to your banker. The bank may request additional collateral, new or enhanced guarantees, and/or new or stricter covenants. The likelihood of these requests increases as your results decline. Requests for additional collateral usually revolve around diminished value of the current collateral package and reduced debt service ability. Requests for new or tighter covenants are also put in place to provide protection against further deterioration in borrower financial condition. Some examples of covenants include minimum tangible net worth, maximum leverage, minimum debt service coverage, prohibitions against additional debt, limitations of capital expenditures, and limitations on distributions and other forms of owner compensation. Covenants should be achievable. I have heard numerous stories of other banks charging substantial fees for covenant waivers, so be careful there. You will need to negotiate those terms in good faith with your bank recognizing that poor results heighten the risk profile of your business and they may reasonably call for some of these types of changes. Your banker can be very helpful, if he or she is fully informed. Conversely, if you hide from your banker or fail to fully disclose your position, don’t be surprised if your banker takes an adverse or aggressive approach with you.
Remote deposit technology, which allows a company to make deposits from its office without physically going to the bank, is the greatest advance in banking technology in recent memory. It has leveled the competitive playing field among banks. By removing the barrier of physical convenience, there is an opportunity for increased competition among banks for the business of quality companies. Since there is no need to go to the bank to make deposits, there is no need to patronize a bank simply because they have an office nearby. The two primary barriers to acceptance of this technology are concerns about the handling of currency and the cashing of employee payroll checks. Strategies exist to mitigate those concerns in most situations. Businesses of moderate size will find this technology affordable and will see enhanced efficiencies. Remote deposit, and other treasury management products, can improve your commercial banking process. You should discuss the entire range of bank services with your banker to ensure that your business is benefiting from the most competitive rates and fees possible.
If you are having a different experience with your bank, you could consider discussing your issues with another financial institution so as to gain another perspective on the relationship. Above all, communicate honestly with your banker so that he or she can assist your business. In many cases, commercial banking is a more rigorous process than it was a few years ago. However, working collaboratively with a banker that understands your business can provide better results and build a stronger relationship for the future.