Your business banking relationship will become much more important over the next two to three years compared to the last five. How you handle it may mark the difference between success or failure, thriving or struggling.
Business has been great in Houston and the gulf coast as the oil/refining boom has fueled demand for services and kept our regional economy growing. Many businesses have doubled revenues and quadrupled profits from 2005-2007. From 2002-2005 most business, large and small, enjoyed healthy profits and growth. They became cash-fat with little need to borrow from banks. The bankers’ biggest problem was stirring up some business. They had herds of healthy businesses to lend to, but few takers as businesses had more than enough cash flow and balances to support operations – even growth. That was one of the major drivers of the private equity buyout boom and the sub-prime mortgage boom. Bankers turned from commercial lending to a huge and steady business making loans to buy up businesses and funding mortgages in an easy money cycle. The sub-prime bust has really hurt the banks, and financial markets worry about all those private equity leveraged buyout loans. Bankers will be more careful in the next 2-3 years. We have a real credit crunch now. It only shows where businesses borrow- and that has been little over the last five years, so it only shows up here and there. But it is showing up – first in residential and commercial real estate deals. Business lines come next.
Suddenly, “underwriting”, the financial discipline of evaluating the risk in a loan and pricing and limiting the loan accordingly, is back in full force, with a strong dose of conservative risk avoidance. Where 100% financing was available for residential and some commercial real estate, now banks want a big loan to value cushion. Real estate prices are coming down. Not because of the buyer/seller market, or comparable prices, or lack of demand. Bankers and their now nervous appraisers are valuing property 10%-20% less than before the bust. They may quote a 90%-80% loan to value ratio – but with the depressed appraisal, they end up with a more comfortable 70% loan to value ratio. They’re being careful – a good thing. But you have to be ready for it, or it will trip you up at a bad time.
When it comes to commercial lending, something a lot of younger bankers have not been doing much of. The underwriting department becomes critical – the final say in the terms of the loan. The underwriting department is not your banker. Your banker is a technical marketing person. The underwriting department and loan committee determines what lending relationships are a “go” and the terms. Where banks have competed vigorously for relationships (that didn’t borrow all that much), they will be viewing the future more skeptically, looking for the risk, worrying about a recession. Learn what the underwriting department is looking for. Make their job easy, and your borrowing becomes easier.
Your business will very likely need sound and regular commercial lending credit lines, increasingly, over the next 2-3 years as we enter an uncertain, perhaps “choppy” business environment – a recession. Many small businesses are running at capacity and growing. Cash flow will slow as financial markets tighten, and uncertainty about a recession looms. Great customers may pay a little slower, cancel or delay orders. You’ll need to use the credit lines. You need to focus now on keeping that open and flowing. And, you need to carefully evaluate (“underwrite”) the business you pursue. Taking on business that pays slow or doesn’t pay, and financing it with debt can wipe out a business in a tightening slump. It’s been a while since that has happened – the last recession was 8-10- years ago. But it will happen soon.
So, dust off and relight the banking relationship. Get your financial reporting and self-analysis in order. Know what the bank’s underwriting department is looking for, and give it to them. I’m not talking about window dressing. I’m talking about complete and consistent financial reporting and forward cash flow planning that lets you and a banker know what is going on. In uncertain times, a little certainty and clarity goes a long way to creating a comfort zone –a reliable risk assessment. Bankers like that. They react to uncertainty by not making the loan, or curtailing it, and placing tough loan covenants and financial monitoring in place – or calling a loan. That’s bad. Businesses that embrace the reporting and keep up with their own financial monitoring and reporting will have smoother access to needed commercial lending. It’s like mowing the grass. Does the banker see a well-kept landscape, or weeds that can hide all kinds of trouble? You will find the housekeeping helpful as well. Take your bearings. Where is you business heading in 3-6-12 months? Don’t be overextended. Have your credit lines in good working order.
Why does a lawyer/CPA talk about commercial lending? My clients are business-owners, and healthy businesses make good clients. More often than not, helping clients build, buy or sell businesses, bumps up against the lending need. Solving that is can be the deal-maker or the deal-killer in tougher credit times. That part has been easy the last five years. It will get harder – more important. We will have a recession sooner or later. It usually comes when most people are still hot on the current boom. Recessions weed out the risky, the fragile, the overextended, the unprepared. Recession rewards strong businesses who are prepared. Those with cash and sound banking access emerge through recession on their feet, with less competition for the next cycle.
Love you bankers – you are going to need them.