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How To Navigate Lastwednesday
- 1. How to Navigate Your Banking Relationship in Troubled Waters September 30, 2009 Bill McDermott
- 9. If you choose to wait until your loan matures…
Editor's Notes
- After 30 years in the banking industry, I have never seen such a dramatic shift in the banking industry, banks are being seized by the FDIC, many business owners are having difficulty finding credit to finance their business, leaving them both frustrated, confused and scared about their ability to finance their businesses. What I hope to cover today is a guideline for how to navigate your banking relationship by understanding the financial health of your bank, understanding what your bank may be looking for from you and understanding if those requirements have changed. We’ll also talk about how to optimize your relationship with your banker to create an atmosphere of a mutual proactive approach to the relationship and an understanding of what your bank can or will do when you loan matures.
- The combination of events in the housing industry and in the investment banking community have created a crisis of confidence in the banking industry which has affected the business owner in his/her ability to obtain short term or long term financing. Many business owners are wondering is the ability to find financing based on their condition or the bank’s condition. It may be helpful to check out your bank’s financials on the FDIC web page
- The FDIC does not publish any ratings of the banks, because the regulators consider this information confidential. However, they do publish the financial information for all banks on their web site, updated quarterly. You would want to know your bank’s performance relative to the criteria on the prior slide, capital, asset quality, management, earnings or liquidity. It may be difficult to analyze this information yourself, but if you want to contact me directly, I’ll be happy to help you.
- Your bank asks for financial information at certain intervals depending on the amount of monitoring your loan requires. For some businesses, it can be monthly, but all loans are typically looked at by the bank on an annual basis. The bank will look at your most recent three years historical financial information and will identify any positive or negative trends in any of these areas. Your capital can be affected by profits, losses, distributions or contributions of equity. Asset quality can be affected by stale assets, either AR or inventory. Have there been any significant changes in management. Earnings is affected by any changes in margins or volume as well as increases or decreases in expenses. Changes in liquidity are affected by sales growth or decline or changes in collections or payables. These are all things you bank is looking at whether they tell you or not.
- A great relationship with a bank can mean the difference between a company riding it out or closing its doors. And, the first step to building this relationship is proactive communication. Business owners should make the bank aware of any changes in their business and the market in which they operate. The second step to building a relationship with a bank is to speak the right language. A business owner must know what to communicate and be prepared to speak the lender’s language. Along with an update on operations, the owner should be prepared to speak on several financial aspects such as how quickly the company operations are generating and using cash, and financial benchmarks which gauge the strength of the company’s balance sheet and the effectiveness of current operating income. Typical financial measures include short term–current ratio (current assets/current liabilities), long term–debt to equity (total debt/total equity), sales as a percentage of working capital, return on assets, and gross margin percentage. The future direction of the company is another important topic of conversation with your lender.
- Whenever possible, your banker should be prepared to address your banking needs for the future. You may want to begin this discussion in advance of your maturity date, it’s important to make sure there are no unmet expectations on either side. There have been changes in the banking industry where many of the decisions are consolidated in a central environment and the bankers they employ in the field have little to no authority over your banking relationship when it comes to your line of credit. Try to discreetly find out how credit decisions are made in your bank.
- It is certainly desirable to understand the financial health of your bank in order to understand what they may do when your loan matures. If the bank is unhealthy, they may choose not to renew your line of credit or term loan. They may increase the rate or fee because of some pricing changes they may have to make, they may change the collateral or covenants to decrease the amount of risk they perceive they have in your credit facility. If possible, try to flush out all of these issues well before your maturity. Like business owners, bankers themselves do their own reassessment during difficult economic times and this includes evaluating clients with higher levels of risk. Accordingly, banks will seek additional information to better assess their level of exposure.
- In addition to the maturity, many banks will institute certain types of formula or financial ratios that they expect the company to keep. A formula called a borrowing base is where the bank will loan a % of your accounts receivable this is typically between 75 and 80%, it can exclude AR that is over 90 days aging and can exclude significant client concentrations. Covenants can include changes of ownership or management, it can include certain financial ratios tied to liquidity, leverage or cash flow. Your bank considers the commitment letter that both of you signed to be the primary operating agreement other than the note and your collateral documents. It is wise for you to have your commitment letter reviewed to understand what the potential issues are.
- Many times your note can have language that triggers an increase in the interest rate or an acceleration of the maturity. It’s important to know what your rights or the bank’s rights are with respect to those documents. You should consider having those documents reviewed by an attorney or a banking professional.
- First, I believe relationships are important and are rewarded based on an investment of time and money. I would encourage any business owner to remain loyal to their banker provided that loyalty is reciprocated. One-sided relationships do not last. As I mentioned earlier that there has been a dramatic shift in the banking industry and many banks have internal issues that cause them to take their eye off client retention. If you are experiencing any of these issues, it may be time to get a second opinion
- Have your CPA or bookkeeper prepare a thorough analysis of each account on your balance sheet. More often than not there will be some significant balances that need adjustment. Its very dangerous to be making business decisions about things like AR and inventory when the account balances you are looking are wrong.
- Get with your industry associations and find out what kind of financial benchmarks and statistics they provide. One of the best way to evaluate your financial performance is to compare your results against other companies in your industry. This could be critical information that you may not be performing as well as you could. This may be the wake up call you and your team need to get focused on making your business more profitable
- The process of creating a budget forces you and your team to really think about your business plan and what is most likely to happen next year. It helps you determine what has to happen in order to achieve your financial objectives. It creates accountability. You need to budget down to the detailed account level so you can enter that budget in your accounting system. Then every month you can review you income statement with the budget numbers by account. This will make your monthly review of the numbers fast and easy
- Your budget projects specific revenue and expense categories and arrives at budgeted net income. Your collection of AR, purchase of inventory, loan payments, capital expenditures, accounts payable and other items that affect your cash flow also