It’s also rare that Ohio Commerce Bank, where Duncan serves as president and CEO, is growing while many community banks report losses. In 2009, assets were up about 9 percent to $73 million.
Though he’s ahead of the curve, Duncan knows the lending game has changed.
“In good times, it’s like nothing can go wrong. You tend to approve loans on what the positives are,” he says. “Today, because you’ve been burned on loans, you tend to highlight what can go wrong especially with small business loans.”
Because banks are reluctant to loan, borrowers need to be more prepared than ever to present their case.
Smart Business spoke to Duncan about how borrowers can attract lenders.
What’s the first thing lenders look at?
The first priority and it is a distant first is demonstrating over the last two or three years the ability to have the profitability or cash flow to service the debt that the borrower is asking for. Regulators today are coming down hard on a transaction if the borrower doesn’t demonstrate the ability to make a payment, and that certainly influences banks’ decisions.
It makes it challenging for a year like 2009 where a number of businesses lost money. That string of two or three years of profitability has been broken. [With] many of the larger banks, because they have to make bankwide, industry-specific decisions, there tends not to be a court of appeals for one bad year. [Smaller banks] are willing to forgive or understand what might be a one-year loss that is not necessarily a trend.
How can business owners demonstrate strength despite a bad year?
What they need to do is demonstrate to the bank that it was a one-year aberration; it was due to the economy, not because of management failings or the industry changing.
[Large banks] basically designate certain industries as being undesirable. The difference with a community bank, we only need three or four new customers a month to make our projections so we can afford to spend however many hours it takes to understand fully the financial statements. It’s not just crunching ratios but some of the dynamics behind it. With companies that lost money, we are willing to spend the time to understand exactly what went wrong and what has management done to get back on their feet, what’s the game plan for 2010-2011.
The owners, more than ever, need to understand their financial statements and also where their business is headed. That’s where a good accountant comes in.
I’m amazed when we ask about significant items on a balance sheet deferred compensation or notes receivable and the business owner doesn’t have a clue. We’re talking about $100,000, $200,000 transactions. That doesn’t give the bank a lot of comfort that the owner is going to make the right decisions or even understand what needs to be done.
Beyond financials, how do lenders identify a strong company?
We tend to look at some nonfinancial factors like the strength and diversity of the management team. We crunch the numbers but we do spend time to visit the facility, meet the management team, make sure that we have a pretty deep understanding of their business, what makes it unique, what are the risks, what has management done to mitigate risks.
One of the other elements that banks will look at is the business model or strategy. If technology has leapfrogged their product or service, then even a historical profitability might not be there going forward.
Banks today are looking at risk factors that can cause problems within what might be a profitable company. Like customer concentration it’s not unusual for small businesses maybe to have two or three customers that constitute a very high percentage of their sales. The risk is if the business loses one such customer, they can go from being very profitable to unprofitable.
The level of debt that businesses have certainly weighs in. You like to see borrowers that are disciplined when times are good; maybe they use some of the profits to pay back their line of credit and not distribute it to the officers of the company. The amount of debt as a percentage of the net worth is certainly something that becomes important to banks in these times.
We also look at the personal net worth and liquidity and credit scores of the owners because with small businesses, there’s a pretty good correlation between how management handles their personal finances and how the business handles their finances.
What questions should a business owner be prepared to answer?
The four questions that a business owner should be fully prepared to answer are: What’s the purpose of the loan? How much money do they need? How long do they need it for, what term? And they need to demonstrate how they’re going to repay the loan.
Until a business has good answers to those four questions, they really shouldn’t talk to the bank. In some cases, the bank is just going to turn them down on the spot because they don’t have their act together. We have a limited amount of time [to] spend assisting a customer to give us what we need.
It’s probably a good idea to meet with the accountant beforehand to make sure you understand what the financials are and have an idea, especially coming out of a recession, what the next year or two might look like.
What should borrowers use loans for?
Don’t look for a loan because of management failure, which would be something like they’re not being diligent enough in collecting their accounts receivable, maybe they have too much inventory or they have unpaid [debt or] taxes. Those are sources of cash that the business should be squeezing out, not a bank.
Banks prefer to have the loan used for a productive purpose that will result in higher sales and profits. If it’s for equipment, that piece of equipment will allow them to be more efficient and get better margins, more profits.
What should a business owner personally be prepared for?
Not that it’s going to happen in every case, but they should be prepared to personally guarantee the loan and possibly pledge personal assets. In many cases, the bank has more invested if you want to call a loan an investment in that business than the owner does, and the bank is looking for a commitment that the owner is as committed as the bank is with the dollars that they put in.
If you have a company where the equity is $200,000 and the bank is lending $500,000, there’s an imbalance. The bank wants to make sure that the borrower is not going to walk away from the transaction. That’s where the personal guarantee and sometimes personal assets come into play.
The people that impress us are ones that understand that the banks are in business to make money also. They’re … willing to provide whatever it is that the bank wants in terms of maybe personal guarantees or assets or maybe bringing more of a relationship to the bank so that … this isn’t just a transaction but a relationship that can foster good profits for the bank during the years.
Commercial lending is a little more of an art than a science. There’s a lot of factors that go in and some certainly are financial, but others are more of the character variety. So any references that you can bring for us certainly have value because we’re very much relationship-oriented.
How can owners prepare for the relationship aspect of the transaction?
Two years ago when I was getting referrals, inevitably within the first minute or two the question would come up: ‘What’s your interest rate?’ Today, that question rarely comes up. The interest rates are so low; if you can’t make a project work on a 4 or 5 percent borrowing rate, you probably shouldn’t even think about the project. But more importantly, businesses are understanding that the lowest interest rate is not necessarily best in the long run.
Businesses today are and should be more mindful of looking for a bank that actually has shown a consistent interest in small businesses. When a business is out there looking for a loan, understanding the bank they’re with and what other alternatives are out there is usually a pretty good first step for them. If you’re taking a small transaction in an undesirable industry to one of the large banks, it probably is a waste of your time and theirs.
How would a business owner decide between a large or small bank?
The amount of money that a business needs is a good place to start. Our niche is loans up to $2 million. If we get loan requests of $4 or 5 million, not that we can’t do it, but when we have to start getting one or two other [community] banks involved, you start to have the same amount of time that a large bank is likely to take in analyzing their requests, which they could do on their own.
Today, it seems like something $2 million and above, larger banks will pay some attention to. That’s not to say that the large banks aren’t making loans under $2 million, but they certainly don’t have nearly as much interest as they would in larger transactions.
That’s where the accounting firm often can help. [Firms] often are plugged in to a number of banks around town. They can be a good first source.
Small business owners have their own network, whether it’s business associates, people at the country club or the health club or whatever. Asking around is not a bad start, if only you can find out a certain bank doesn’t seem to be lending at all or another bank is pretty receptive or, ‘I had this good experience with XYZ Bank,’ or, ‘It took me two months with the other.’
It’s best to come to the bank last as opposed to early. If you have those kinds of conversations with the accountant and friends and business associates and you’re hearing the same banks either to stay away from or to talk to, then you have a better probability that you’re going to have more meaningful conversations.
HOW TO REACH: Ohio Commerce Bank, (216) 910-0550 or www.ohiocommercebank.com