Knowledge Base - Banking & Financing
New Banking Realities
The rules for borrowing money from banks by small and mid market companies seem to have changed forever. The financial crisis of 2008 precipitated by the dramatic decline in real estate values have left many banks dealing with major losses and a need to rethink their entire credit strategy.
Even the banks that weren’t directly affected got the message; risk is not a good thing for a bank. Because of their internal profitability issues and the cost of increased regulation, banks have little tolerance for risk and in many cases lack the capital to make new loans.
For banks, raising new capital is coming at a relatively high cost. As a result, new loans are being made only to customers that receive the highest credit scores and who the bank judges will be a profitable addition to their portfolio.
Here is a summary of how we see this new reality affecting small to mid sized commercial borrowers.
- Interest rates more reflective of risk – In the past, the difference in interest rates charged to a well run, profitable business and one that always seemed to be operating on the edge was very nominal. Perhaps only ¼ point. This rate difference will grow dramatically as rates are based on the banks internal scoring of the credit.
- More asset based lending with detail reporting – In an effort by banks to control risk, many businesses will only be able to borrow on an asset basis. The amount available to be borrowed is tied directly by formula to the value of the collateral. The big change is the detail reporting that is required. A report of collateral values each time a customer draws on their line and detail month end reconciliations will be required. This additional reporting by the customer can come at a big cost, sometimes approaching the cost of the loan’s interest.
- Banks will reduce line of credit availability – Customers that have line of credit availability they do not use will find their bank only willing to renew at a lower level. While the customer likes the flexibility the higher level provides, this uses up the bank’s capital for something they are not getting paid for.
- More SBA guarantees – More banks will take advantage of various government guarantee programs to lower their risk. For the customer this can mean a longer rate lock. However, a SBA loan comes with increased application costs and reduced flexibility for the borrower should circumstances change down the road.
- Less flexibility on personal guarantees – Banks ask for personal guarantees, not because they want your house, but because they want you working with them if the going gets tough. The personal guarantee reduces the risk that a customer will walk away from a troubled situation. We expect that the lack of a personal guarantee will be a deal-breaker for many customers that in the past were able to negotiate a limit on their guarantee.
- Banks more critical of what’s behind a personal guarantee – The guarantee will need to have value. A $1 million net worth may work if you want to borrow $500,000 but not if you want to borrow $10 million. Banks want to see more than just real estate equity behind the guarantee.
- More requests for 2nd mortgages and other hard collateral like investments or life Insurance – Banks will not be satisfied with just the inventory, receivables and personal guarantee. More customers are being asked to provide additional collateral to provide cushion for the bank in the event of a business failure.
- Banks will be reacting quicker to problems – Don’t be surprised if your bank places restrictions on salary levels of owners, major shareholders and their family members if the business falters.
- Personal conduct and reputation of owners more important – While this has always been important, we expect to see banks backing away from owners who they feel lack credibility or who exhibit questionable ethics.
- Banks evaluating financial management of customer – The quality and timeliness of the information a bank receives is directly related to the quality of the customer’s financial management function. Banks are looking not only for projected Income Statements, but also projected Balance Sheets. Businesses that have been unwilling to invest in timely and accurate financial information will find it harder to borrow in the future. At the risk of sounding self-serving, this is an area that Part-time LauberCFOs economically address for their clients.
- Banks avoiding industries they consider risky – Businesses in industries that are susceptible to seasonal or cyclical swings may find it more difficult to find financing on historic terms as lenders will not be willing to take on this additional inherent risk.
- Banks need more than your loans for your account to be profitable – We see a growing attitude among banks of “if you want our money, we need your business in our insurance, investment and other subsidiary companies”. We expect less tolerance for the business that would prefer to have depository relationships with other banks and shun the banks ancillary services. The higher your deposits are the better it is for the bank. This helps their required capital ratios.
- Higher fees – Like the new reality in the airline industry, the trend of larger “user fees” for bank customers will continue to grow.