Surviving an economic downturn often hinges on a business owner’s ability to secure a commercial loan modification or expanded line of credit, but your chances of success dramatically diminish when you present your case to a veritable stranger. History shows that a banker is more likely to decline your request if he’s unfamiliar with the fundamentals or seasonality of your business or is unsure of your management capabilities.
Instead of waiting to share vital information and build trust with their banking partner, savvy executives act proactively so they can rely on established relationships to weather an economic storm.
“Open communication builds trust, which is valuable in good times and bad,” says Peter Koh, senior vice president and deputy chief credit officer for Wilshire State Bank. “Because trust is the foundation for all banking decisions.”
Smart Business spoke with Koh about the benefits of building a mutually beneficial relationship with your bank.
What characterizes a productive banking relationship?
A good relationship is characterized by an open dialogue and frequent communications, so a banker becomes familiar with your business model and needs. For example, unless you offer a detailed explanation, a banker may decline your loan application if he doesn’t understand that a seasonal downturn is impacting your financials. And unless you take the time to provide adequate documentation and a narrative to support your sales forecast, a banker may conclude that your growth assumptions are a bit too optimistic. Conveying the nuances of your industry and its cycles also helps your banker suggest appropriate services and solutions based upon his experience in the broader market. Remember, bankers have interdependent relationships with their clients, so both parties have a vested interest in mutual success.
How does a banking relationship benefit business owners and executives?
A banker is more inclined to entertain your request for a new loan or modification if he has a deeper understanding of your business fundamentals. And if the business owner has historically met his or her financial obligations and documentation requirements on a timely basis, a banker will be inclined to act quickly on any request. Essentially every banking decision is based on a combination of facts and intangible factors, and a solid working relationship can sway a close decision. It may be natural to avoid contact with your banker when times are tough, but you should view adversity as a call to action. Proactively explain your situation and offer an action plan or an alternate view of your company’s performance so both parties can focus on solutions instead of problems.
What criteria should a business owner consider to identify a suitable banking partner?
Certainly service levels and a bank’s offerings are important, but the decision really comes down to your comfort level with the staff and the banker’s knowledge of your industry and the local marketplace. Historically, community banks have catered to local businesses because their smaller size provides business owners and executives with greater access to loan officers all the way up to the CEO. Plus, your loan application doesn’t necessarily have to be approved by an executive in another city who doesn’t understand the nuances of the local marketplace. And smaller banks tend to be more flexible and less regimented than their larger competitors, so they’re willing to tailor a package of products and services around your specific needs. Evaluate your current banking relationship and upcoming needs so you can create a wish list to help you evaluate several contenders, but don’t overlook the intangibles that create a mutually beneficial relationship.
What are the keys to building a productive working relationship?
Follow these best practices to build a productive working relationship with your banker.
- Be transparent. Turn your loan officer into your secret advocate by supplying copious data as well as industry reports and trade group information, so he has the knowledge and confidence to lobby bank executives on your behalf when you submit a loan application or request for a modification.
- Be open. Invite your banker to visit your company, see the property or attend industry trade shows, so they have first hand knowledge of your operation and critical business fundamentals.
- Be resourceful. Turn to your banker when you need ideas to grow your business or overcome adversity, because this person meets with owners and deals with these problems every day. In fact, your banker is an excellent source for vendors or other experts who can help you write a business plan or even streamline operations.
- Be prepared. Anticipate your banker’s requests and come to meetings with a well-thought-out plan that specifically addresses his or her critical questions. Your banker wants to know how you intend to increase rents by 20 percent when the market is falling or how you plan to acquire new tenants when local occupancy rates have been trending down, so anticipate and be prepared to answer how-to questions.
- Be consistent. Provide your banker with quarterly updates that compare your company’s performance to your business plan, an updated forecast and feedback on the bank’s products and services.
- Be honest and proactive. Approach your banker before a problem occurs, because it’s much easier to boost revenue and profits than to rebuild a broken relationship or lost trust.
Peter Koh is a senior vice president and deputy chief credit officer for Wilshire State Bank. Reach him at email@example.com.
Banks are taking a hard look at their lending practices, and that is making it more difficult for owners of commercial properties to get loans. As loan requirements are tightened and banks remain skittish, property owners will have to work harder to prove they can repay a loan, says Rocco Pirrotta, senior vice president and Commercial Real Estate group manager at Wilshire State Bank.
“The days of property owners being able to refinance every few years and pull some money out of their properties are over,” says Pirrotta. “Borrowers are facing a new reality. Banks expect them to be more familiar with their properties, are reducing their loan to value rates and taking a closer look at finances.”
Smart Business spoke with Pirrotta about how banks’ lending practices are changing and what commercial real estate owners can do to improve their chances of being approved.
How have banks’ approaches to loans changed?
For the past three years, banks have been working on fixing bad loans, restructuring loans and addressing foreclosures. As the market starts to get better in most areas, it’s going to be a difficult transition for banks to put their production hats back on.
Banks are cautious. They don’t want to make the same mistakes that got them into this problem: overleveraging properties, buying into continually increasing values and low cap rates on property, and getting outside of their comfort zones with respect to property types in order to grow their portfolios.
It’s easy after spending three years liquidating and collecting on bad debt to never want to make another loan again, so they are going to be walking a tightrope trying to balance between growing their portfolios but not growing too fast and not falling into the same traps.
How will these changes impact commercial property owners?
It’s a new reality. You’re going to see lower loan to value. In the past, banks traditionally did 75 to 80 percent loan to value on many property types. Now, you’re going to see 60 to 65 percent. That means borrowers are going to have to come up with more money down for purchase transactions, they will not be able to get as much cash out of refinancing existing properties and they’re going to have to find banks that have niche markets for certain property types. Mainstream banks will stay focused on industrial, retail, apartments and office buildings. Banks that will finance car washes, hotels, gas stations, land deals, etc., are going to be few and far between.
That will be offset with lower interest rates prevailing and remaining steady, and owners will be able to refinance existing projects in the four major areas at better interest rates than they have been able to for years.
What kinds of things will banks consider when making real estate loans?
In this latest recession, short-term leases with tenants on retail and office products became prevalent because, during a down time, owners don’t want to sign someone to a long-term lease at a low rental rate because they anticipate things will get better. As a result, many of their leases will be coming up at the same time. Owners are going to have to combat that with the bank by providing operating numbers from tenants to show that the existing tenants are viable and that they can maintain those leases.
More banks will be asking not just for rent rolls but also for accounts payable agings so they can see how much rent is actually being paid. In the last few years, many landlords have made concessions to tenants; while the lease may say the tenant is supposed to pay $2,000 a month, the landlord may only be collecting $1,200 to keep the tenant, so the bank will want proof.
Owners are also going to have to dig a little deeper and come up with better forecasting. How many of the current tenants are going to stay, and why? Can you increase the rent on those tenants, and if you think you can, why? Banks are looking for a more comprehensive understanding of what is actually being collected.
What else are banks looking at?
The condition of the properties is going to be critical, because during down times, people often don’t take care of the maintenance and only do the bare minimum. Now, as markets begin to get better and more financial institutions are getting into the lending game, they’re going to be pickier and want to make sure the property is well maintained and that there aren’t significant deferred maintenance issues.
Before making a loan, loan officers are inspecting the property, and it’s not just driving by and taking a few pictures. It’s meeting with the owner at the property and going through units and asking questions, such as when the roof was last repaired. It’s talking with tenants, asking what they think of the condition of the property. Is the landlord taking care of the property for you? Are you willing to stay? Banks are going to be a lot more involved in the underwriting and functionality of the properties.
They’re also going to be taking a closer look at secondary support. If the property value goes down, or if you lose tenants, does the borrower have sufficient strength to supplement payment of the loan for a period of time?
The bottom line is that financial institutions need to be more disciplined about lending practices and stay that way, and borrowers need to be more realistic about values and leverage of their property.
Rocco Pirrotta is senior vice president and Commercial Real Estate group manager at Wilshire State Bank. Reach him at Roccopirrotta@wilshirebank.com or (213) 427-6592.
Although bankers sounded a bit more optimistic about the commercial real estate market during the second quarter, more than half of the $1.4 trillion in commercial mortgages coming due nationwide in the next five years are underwater and many banks are refusing to renew the loans.
Owners who purchased property at the peak of the market in 2005 or 2006 face the biggest challenge, because commercial property values have since declined by almost 35 percent. Now, they must refinance to deal with looming balloon payments, but few owners can meet today’s stringent underwriting criteria.
“Roughly 90 percent of commercial mortgages require a balloon payment after five years,” says Vincent Shin, first vice president and manager of the South Regional Underwriting Center for Wilshire State Bank. “So owners may need to consider creative financing options to avoid a short sale or foreclosure.”
Smart Business spoke with Shin about refinancing options for commercial mortgage holders.
How has the underwriting criteria changed for commercial property loans?
Prior to 2008, banks considered the underlying equity when evaluating an application for a commercial property loan. Now they’re scrutinizing the underlying cash flow of the business for owner-occupied properties, at a time when many businesses are struggling to turn a profit. In fact, you could say that cash is king. And while bankers used to accept a debt service coverage ratio (DSCR) of 1.0, bankers now want a DSCR of 1.25. To give you an example of the impact, a business owner now needs monthly cash flow of $12,500 instead of $10,000 to qualify for a $10,000 loan payment. Compounding the problem, banks are requiring loan-to-value ratios ranging from 40 percent to 50 percent and high occupancy rates for tenant-occupied buildings.
How can business owners evaluate their situation?
Work with your CPA to determine your debt service ability, so you have a general idea whether you can qualify for a new loan. Do everything possible to boost your company’s cash flow or fill your building with quality tenants by granting temporary rent reductions or improving the property. Then, talk to the current note holder to gauge their appetite for refinancing your existing mortgage. Your current lender will know the state of the marketplace and the approximate value of your property and should help you find a solution to your problem, because the lender has the most to lose if you default or request a short sale.
What are the best refinancing options?
For owner-occupied buildings with outstanding loans of less than $2 million, an SBA loan is your best option. Owners of tenant-occupied buildings should shop around for a deal, because each bank has its own risk tolerance and loan portfolio that influence their desire and willingness to write new mortgages. Drive a hard bargain if your business is flush with cash and use a possible short sale or foreclosure as a bargaining chip to motivate your current lender.
What should owners do if they can’t refinance their commercial property loan?
Beyond a short sale or default, consider these options if you’re facing an upcoming balloon payment.
- Partial principal forgiveness. Some banks may be willing to reduce your loan principal to avoid a short sale or foreclosure.
- Second property. Consider mortgaging another piece of real estate with a lower loan-to-value ratio to pay off or reduce your current loan.
- Offer additional collateral. Sweeten the deal by pledging a second property or offering the bank additional assets or accounts.
- Bifurcated loan. Consider splitting the current loan into two parts and refinancing a smaller primary loan that satisfies the desired loan-to-value ratio. Then, finance the remaining indebtedness under a second deed of trust. For example, if the current property loan is $1.5 million, refinance $1 million through a traditional loan and immediately apply for a secondary loan to secure the remaining $500,000. The secondary loan will probably require a balloon payment down the road.
- Private equity. Refinance through a private equity loan.
- Add partners or investors. Consider bringing in an additional business partner or investor who could provide an injection of cash to reduce the loan principal.
- CRA loan. The Community Reinvestment Act (CRA) was enacted by Congress in 1977 to encourage federally insured banking institutions to help meet the credit needs of their communities, including those of lower-income areas. A building must be owner-occupied to qualify.
Do you have any other tips for business owners facing a balloon payment?
First, start the refinancing process at least six to 12 months before your balloon payment comes due so you can shop the market and improve your company’s cash flow. Use the ramp-up period to clean up your credit report, acquire new customers or tenants or sell an underperforming business unit. Author a business plan, sales forecast and personal profile, because prospective bankers want to see how you intend to pay for the loan. Finally, consider a variety of refinancing options. Owners need to be creative to survive in our current economy.
Vincent Shin is the first vice president and manager of the South Regional Underwriting Center for Wilshire State Bank. Reach him at firstname.lastname@example.org or (562) 345-3102.
More than 90 percent of American businesses are classified as small, but don’t under-estimate their power. Collectively, these enterprises employ more than half of all private sector workers, generate more than half our nonfarm gross domestic product and have created 64 percent of our economy’s net new jobs in the last 15 years.
In fact, the success of small business owners is so integral to the health of our overall economy that back in 1953 Congress created the U.S. Small Business Association (SBA) to serve as their personal advocate.
“The SBA offers owners a bounty of resources to help their small business grow,” says Anna Chung, senior vice president and SBA manager at Wilshire State Bank. “They not only help owners find funding, they’ll even help them write a business plan and navigate the lending process.”
Smart Business spoke with Chung about the opportunities to grow your small business through an SBA loan.
When should small business owners consider an SBA loan?
The SBA offers a number of financing programs to help small businesses grow. Established business owners usually apply for a 7(a) or a 504 loan. A 7(a) loan offers financial help for businesses in many different areas while a 504 loan provides long-term, fixed-rate financing to purchase major fixed assets for expansion or modernization. Although 504 loans can’t be used for operating capital, many owners use the funds to purchase a large building or second location, which helps free up money for expansion by allowing them to lease out the extra space. If you sign a large contract that requires purchasing additional inventory or equipment, call your banker right away so he or she can review your credit history and contract to see if you can finance the purchases with an SBA loan.
Do SBA loans offer better terms than other commercial loans?
An SBA loan is a standard commercial instrument that offers some very favorable terms. For example, the loans feature higher loan-to-value ratios, longer repayment periods and no balloon payments, yet still allow owners to partner with their local banker. Borrowers can purchase property by putting 10 percent down and pay back the loan over 25 years, which is better than most commercial mortgages. An SBA loan is ideal for growth as long as small business owners anticipate their future needs. Because if you wait too long to apply you could end up running out of cash, and owners need to show adequate working capital to qualify.
How does the SBA support banks in granting loans to small businesses?
SBA loans were designed to help small business owners who couldn’t qualify for a standard commercial loan, either because they have a smaller net worth or less working capital. So if an owner has access to other financing at reasonable terms he may not qualify for an SBA loan. The SBA guarantees up to 75 percent of the loan amount, which encourages a banker to lend, but the banker is responsible for meeting the SBA’s strict underwriting guidelines that are designed to mitigate risk.
How does the SBA qualification process differ from other commercial loans?
Owners still need to furnish a business plan, resume and copies of tax returns and financial statements, but these guidelines differ from standard commercial loans.
- Collateral. The loan must be collateralized if the borrower has collateral to offer, because the SBA requires bankers to mitigate risk whenever possible.
- Ownership. If the borrower owns several companies or controls several affiliates, lenders must review tax returns for those enterprises in addition to the owner’s primary concern.
- Down payment. Lenders must determine the source of a borrower’s down payment, even if the funds have been deposited into an escrow account. So owners need to provide documentation tracing the origin of a down payment.
- Tax returns. Owners must supply three years’ tax returns instead of two to qualify for an SBA loan.
- Criminal records and green cards. If a borrower has an arrest or conviction record the loan must be submitted to the SBA for approval. And an applicant’s green card must be validated by the INS before his or her loan is approved.
- Processing time. Most SBA loans are underwritten and approved in 30 to 45 days. But if the owner plans to purchase property, which requires an appraisal or an environmental impact report, the underwriting process may take 60 to 90 days.
Does the SBA offer other support to small business owners?
The SBA provides Small Business Development Centers (SBDCs) which offer owners free and confidential assistance with financial, marketing, production, organization, engineering and technical problems and feasibility studies. Many centers partner with local universities and engage local CPAs, retired executives and consultants to advise small business owners. In fact, the staff can even recommend a banker and help an owner develop a business plan or create a sales forecast to qualify for an SBA loan. The SBA also provides mentorships and free counseling services through a nonprofit organization called SCORE. SCORE has more than 389 chapters and 11,000 volunteers serving urban, suburban and rural areas. Keep in mind that the SBA also offers specialized assistance to women and veterans, so why not unleash the power of your small business advocate by visiting a local office.
Anna Chung is the senior vice president and SBA manager at Wilshire State Bank. Reach her at email@example.com or (213) 637-9742.
Before the financial meltdown in 2008, prospective home owners breezed through the lending process while pursuing the American dream. Now, even veteran borrowers can be stymied by today’s strict lending environment, especially if they rely on previous knowledge and experience to navigate the process. Fortunately, education, preparation and a little perseverance can help novices as well as seasoned borrowers surmount modern obstacles and realize their dreams.
“The pendulum has swung too far the other way and now lenders are looking for picture-perfect borrowers,” says Janette Mah, senior vice president and manager of the Residential Mortgage Group at Wilshire State Bank. “Borrowers can avoid frustration and disappointment by educating themselves on the underwriting process, meeting with lenders and securing pre-approval for a loan before they start shopping for a home.”
Smart Business spoke with Mah about the current mortgage climate and why borrowers need education and preparation to prevail.
How has the lending climate changed, especially in the greater L.A. area?
Lenders are being somewhat cautious because the economy and the housing market are sending mixed signals about their overall health. Unemployment is still very high, the economy is struggling and some areas in Southern California are still working through a backlog of foreclosed properties, which is keeping residential real estate prices from stabilizing. While the federal government will continue to play a role in securitizing long-term mortgages, the future of Freddie Mac and Fannie Mae is up in the air. After synthesizing all this information, it’s clear that homebuyers and lenders must approach the market with caution and diligently assess the risks before finalizing a transaction.
What should borrowers know about the current underwriting rules and mortgage qualification process?
Borrowers can no longer state their income; they must provide sufficient documentation to verify their earnings and assets in order to prove they can repay the loan. In addition, lenders are using a new set of standards to underwrite and evaluate risks, and while the requirements may differ for some programs including FHA loans, these are the general guidelines.
- Minimum credit score of 640 to 660 and a history of financial responsibility and saving. Borrowers can drive a better deal if their credit score is 740 or higher.
- Employment stability.
- Sufficient liquid assets to survive a temporary financial set back.
- Minimum down payment of 20 percent, and the funds must be in the borrower’s account for at least two to three months.
- Total monthly housing costs for principal and interest, taxes and insurance should not exceed 33 percent of gross income, while total monthly expenditures for all liabilities should not exceed 45 percent. Remember, even deferred payments on a student loan will count toward your monthly liabilities.
How can borrowers prepare for the lending process?
First, know your credit score by pulling a copy of your report and taking the time to clear up any issues before you approach a lender.
Second, research the various loan products to identify one that meets your needs. If you plan to stay in your home for more than seven years, then a 30-year or 15-year fixed rate mortgage might be the best choice, while a loan that offers a fixed rate for just five years might be appropriate if you plan to sell the property in a few years.
Third, study the lending process so you’re familiar with the paperwork and the requirements you’ll have to satisfy along the way.
Finally, calculate your income-to-debt ratio and research the real estate market, so you know how much money you need to buy a house and approximately how much you can borrow before you meet with a lender.
What’s the best way to approach a lender and avoid mortgage scams?
Contact two to three lenders to request face-to-face meetings and a quote. While it’s a good idea to survey the market by searching the Internet, borrowers generally get the best deal from a bank where they have an existing relationship. Vet the contenders by asking for their license number and searching for information on the licensing authority’s website. New legislation has granted consumers additional protection from fraud and scams following the crisis of 2008, so now mortgage originators are required to register and undergo a background check in order to comply with the Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act).
Total out-of-pocket costs for a 30-year fixed rate loan should average $1,500 to $3,000 and buyers should ask for a written estimate before agreeing to a deal. Lock in your interest rate for as long as possible so you can boldly tout your pre-approved status to realtors and sellers and negotiate with confidence when shopping for a home. Finally, remember to allow plenty of time when you finally locate the home of your dreams, because the underwriting and escrow process takes a minimum of 30 days.
Janette Mah is a senior vice president and manager of the Residential Mortgage Group at Wilshire State Bank. Reach her at (213) 427-1490 or firstname.lastname@example.org.
Cash is the lifeblood of any business, and most business owners experience the need for an occasional short-term infusion of capital to bridge cash flow gaps, finance bulk inventory purchases or to meet other working capital needs. But after the long recession and credit crisis, many owners are reluctant to take on debt that could prevent them from capitalizing on the rebounding economy.
The solution is a short-term line of credit, or STLOC, which is typically secured by business assets and provides owners a less expensive way to access capital versus other forms of capital such as additional equity injection from the owner or another investor.
“Although business owners should avoid excessive debt, an appropriate amount of short-term debt can help a company grow and allow the owners to maximize return on assets and equity,” says David Song, senior vice president and head of the Corporate Banking Group at Wilshire State Bank. “Despite lingering uncertainty in the overall economy, banks are willing to make short-term loans to well-run businesses.”
Smart Business spoke with Song about maximizing growth opportunities through a STLOC.
When should business owners consider a STLOC?
STLOCs are typically used to finance operating expenses until receivables are converted to cash or to finance inventory purchases until they’re sold and converted to cash. For example, as demand for goods and services rises during a recovery, manufacturers and wholesalers need cash to produce/purchase inventory and finance accounts receivable, while importers need lines to open letters of credit and purchase products from overseas suppliers. Retailers can use STLOC to make volume purchases ahead of a peak selling season, while professional service firms can use the funds to expand by hiring additional employees.
How does a STLOC differ from a long-term line of credit?
A STLOC is a revolving line that is typically used to finance short-term business assets for less than one year, whereas a long-term loan is used to finance long-term assets such as equipment, leasehold improvements and real estate. With STLOC, a borrower can draw on a line as needed within the allowed parameters of the borrowing arrangements and then pay down the debt as cash flow allows. Banks offer various types of STLOCs depending on the business needs, borrowers’ qualifications and industry characteristics.
- Nonformula line of credit. This line is similar to a credit card, because it can be advanced or paid down at the borrower’s discretion as long as the borrower is in compliance with loan terms and conditions.
- Trade cycle financing. This type of line is often reserved for importers that use the line to purchase goods from overseas suppliers. Under this arrangement, trade advances are used to finance individual import purchases, which must then be paid back within the pre-determined terms that are based on the operating cycle of the business.
- Asset-based line of credit (ABL). If a company is highly leveraged and/or growing quickly, bankers often suggest an asset-based line, which allows the business to borrow against a specified percentage of accounts receivable and inventory up to a predetermined amount. The amount available to borrow under this arrangement is referred to as a borrowing base.
Are there risks associated with a STLOC?
While a STLOC can provide access to needed capital, a business owner must be aware that there usually is a set of loan terms and conditions with which the business needs to comply. These terms and conditions require the business to submit certain financial information to a bank within a specified timeframe and maintain financial performance at a level that is acceptable to the bank. Obviously, required payments need to be made on time and it is also important to note that loan outstanding does not exceed the borrowing base in an ABL arrangement. If you stay on top of cash flow, and diligently manage accounts receivable and inventory turnover, you’ll maintain the integrity of your assets and boost your ability to borrow. Noncompliance with loan terms and conditions may adversely impact the business’s ability to borrow.
How can a business maintain the quality of its assets and increase borrowing capacity?
Typically, banks will not lend against receivables older than 90 days or stale inventory that hasn’t turned over within a year. Owners should have adequate staff to monitor collections and avoid excessive inventory build-up. Banks will also look at your customer base to see if sales are dispersed among a large base of customers or concentrated in a few accounts, which increases risk. They’ll also examine the credit worthiness of your accounts and they’ll be concerned if you’re shipping products to delinquent customers.
What do bankers consider when evaluating a request for a STLOC?
A business must demonstrate stable or growing trends, an acceptable track record of profitability, solid credit history and adequate cash flow to service the debt. Bankers will also look for a balance sheet that shows positive working capital and adequate equity levels without excessive leverage. A business will also be asked to provide accrual-based financial statements. Bankers will evaluate the requested STLOC amount and the company’s borrowing needs based upon the business’s operating cycle together with all other business and personal information provided to the bank. As a banker will rely on the accuracy of financial information provided by the business to make lending decisions, the quality of information provided to the bank is vital.
David Song is a senior vice president and head of the Corporate Banking Group at Wilshire State Bank. Reach him at (213) 365-3302 or email@example.com.
Even the owner of a successful business can encounter an occasional financial setback and cash-flow problems, which prevent them from making the scheduled payments on their commercial property loan. But unless they take immediate action at the first sign of distress, they could end up jeopardizing the future of their business and forgoing the equity in their property.
Fortunately, committed owners with a viable business model may qualify for a loan modification, which gives them a chance to regroup or wait out an economic downturn by temporarily lowering their loan payments. However, owners need to do their homework and research their options before reaching a decision.
“Modifications are a great tool, but they’re designed to relieve a temporary situation,” says Seung Hoon Kang, senior vice president and chief credit officer for Wilshire State Bank. “If things don’t improve and owners fail to make the modified payments, then banks have the right to foreclose on the property or force a short sale.”
Smart Business spoke with Kang about the options for commercial borrowers who undergo a financial setback and the best way to approach a lender about a loan modification.
When should borrowers consider a loan modification?
Borrowers who run short of cash because of the poor economy or a prolonged seasonal downturn may qualify for a temporary reduction in their mortgage payments by requesting a modification. Businesses and individuals who own commercial properties such as strip malls, gas stations, car washes, hotels, motels, apartments or office buildings will be considered. But remember that borrowers are required to pass along any reductions to tenants, so everyone has the opportunity to recover. If a loan officer grants your request, your payments may be reduced for up to six months so you can continue operations. However, you’ll be required to repay the concessions once the economy improves, which is why a modification is only an interim solution.
How does a loan modification differ from a short sale or foreclosure?
A loan modification is appropriate when an owner wants to continue the business and preserve any equity in the property. If the borrower owes more than the property is worth, or doesn’t want to revive the business, then a short sale or foreclosure may be the best option. A short sale requires the lender’s approval, and allows the owner to sell the property for an agreed upon amount that is usually less than what is owed. If the bank forecloses, it assumes the property and the borrower will be forced to vacate and concede any equity. In some cases, banks may be willing to permanently modify a commercial loan by extending the length of the note or reducing the interest rate, which is the best solution for situations that are expected to exceed six months.
What should property owners know about the modification process?
Be sure to contact your lender at the first sign of trouble, because the approval process takes about four weeks. Realistically assess your situation and your options, since you’ll have to substantiate your inability to make your payments and the reasons why your business will thrive once the economy improves. Remember that lenders will consider your ambition and sincerity as well as your business plan, because it’s hard to revive a struggling business and long-term survival requires a committed and enthusiastic owner.
What’s the best way to approach a lender about a loan modification?
Make an appointment to meet with your lender and be ready to present your case by bringing a copy of your business plan, P&L and your latest rent roll, if the property is tenant-occupied. You’ll also need to provide a hardship letter that explains your situation and the reasons you can’t make your payments. In many respects, requesting a modification is like applying for a loan, because lenders will be evaluating your business strategy and the competition and assessing your ability to run the business as well as the feasibility of your model.
Why do so many modifications fail and how can business owners avoid a similar fate?
Borrowers frequently overestimate their ability to bounce back from a downturn and what will happen if they fail to make the modified payments. At that point, they lose the ability to control their own destiny, because the bank has the right to immediately foreclose on the property or force a short sale. Sometimes the situation requires more than a short-term fix, in which case the owner should consider other options and attempt to refinance the loan or negotiate a permanent modification.
Do you have any other advice for commercial property owners?
Do your homework and beware of advertisements from firms offering loan modification assistance, because they may paint an unrealistic picture of your chances or provide misinformation just to earn a fee. Listen to your loan officer, because he or she will know the best course of action after assessing your situation. Ask how each option will affect your credit and consider the long-term implications when making your decision. Finally, don’t ignore a financial setback or letters from your lender, because the situation will not go away and ignoring communications gives your lender the false impression that you simply don’t care.
Seung Hoon Kang is a senior vice president and chief credit officer for Wilshire State Bank. Reach him at firstname.lastname@example.org.
After taking a turn for the worse during the recession, it appears that L.A.’s commercial real estate market is finally poised for a rebound. Banks are cautiously considering new loans, life insurance companies and institutional investors are wading back into the market and the FDIC plans to close its Irvine office in early 2012, which points to the improving health of the region’s banking industry.
But high unemployment, rent concessions and shifting consumer preferences could sabotage uninformed investors who inadvertently venture into unstable submarkets. It seems that while investors were napping, the rules changed, and big returns in commercial real estate are no longer guaranteed.
“Overall, commercial real estate is heading in the right direction, but it’s not the heyday of 2005 to 2006 when virtually every investment paid off,” says Rocco Pirrotta, senior vice president and manager of the Commercial Real Estate Group for Wilshire State Bank. “Investors need to do their homework and partner with a creative banker because, this time, your mistakes will definitely come back to haunt you.”
Smart Business spoke with Pirrotta about the opportunities and pitfalls awaiting local investors in today’s commercial real estate market.
Which submarkets offer the best deals?
After falling precipitously during the recession, several submarkets are starting to gain traction. First, the recession virtually halted the construction of new apartment buildings and condos, so apartment vacancies are starting to decline and rents are inching up, which will ultimately increase owner cash flow and may even boost property values.
Second, retail sales were up in the fourth quarter and landlords are granting fewer rent concessions, but consumers now prefer the convenience of one-stop retail centers and success hinges on local demographics as well as tenant mix and longevity. Industrial properties have been steady performers and container volume continues to rise at our local ports, but investors should be cautious about purchasing office buildings, as companies are still reluctant to hire, vacancy rates are high and experts say it will take two to three years to absorb the existing excess space.
Finally, avoid the hospitality sector, car washes and gas stations, because many of these businesses are still struggling.
What’s the key to evaluating prospective deals?
Investors can’t rely on superficial analysis; they must review data and confirm anecdotal market intelligence supplied by owners and brokers to accurately estimate their ROI.
- Rent rolls. Review a six-month collection history to see if tenants are making their scheduled payments and to expose disparities between scheduled and collected rents, which may indicate concessions. On the one hand, investors may be able to boost cash flow as rent concessions expire, but on the other hand, financially strapped tenants may be unable to pay the higher rents and they might request additional concessions if economic conditions don’t improve.
- Tenants. Are apartment dwellers working? Are suitable jobs available in the local area? Do retail centers have financially sound anchor tenants like banks and grocery stores that draw traffic and provide critical services? Centers could be in trouble if tenants rely on discretionary consumer spending, especially in economically depressed areas. Consider the local demographics along with each tenant’s business model and customer base as these underlying factors influence a property’s return.
- Lease terms. Banks have historically preferred long-term leases when evaluating commercial deals, because tenant longevity favors the buyer. Now most commercial leases average one to two years, which could be advantageous if tenants renew at higher rates, but short-term leases also allow viable tenants to negotiate a better deal or shop the competition and defect to other properties.
What else should investors consider before making a commitment?
Investors should ignore the national trends and focus on local economic conditions that directly impact commercial real estate submarkets, since our recovery is lagging behind other parts of the country. They should also spend an entire day at the property to assess the neighborhood, traffic flow, vacancies and competing projects to see if the property attracts an ample number of customers and prospective tenants. Finally, examine the owner’s recent marketing expenditures, because abundant giveaways and free rent could be a sign of a troubled property.
How can investors partner with bankers to secure a loan?
In this age of cautious underwriting, investors need a creative financial partner who understands the need for liquidity and is willing to consider options that satisfy the needs of both parties. For example, bankers used to consider future cash flow when determining funding limits, because they assumed the owner could raise rents to cover the increased debt. Now, bankers may need to offer a smaller loan, such as an earn-out loan, where future time-sensitive benchmarks allow them to increase the loan as occupancy rates or rents rise. The lender usually agrees to fund future loan increases at today’s rates, which protects investors in a rising rate environment. Collaborative evaluations and creative financing protect both investors and lenders in this new world of commercial real estate, where not every deal is a guaranteed winner.
Rocco Pirrotta is senior vice president and manager of the Commercial Real Estate Group for Wilshire State Bank. Reach him at (213) 427-6592 or email@example.com.
Cash flow is the lifeblood of any successful business. So when credit markets tighten and the economy slows to a crawl, executives often spend valuable time monitoring payables and receivables instead of pursuing lucrative business deals. To solve the problem, leaders frequently turn to traditional, yet costly, remedies like upgrading accounting software or prodding customers to hasten the collection process.
Fortunately, it’s possible to improve cash flow by processing rudimentary financial transactions online or outsourcing them to banks. Modernizing the banking process offers executives myriad benefits such as reduced paperwork, improved efficiencies and a real-time opportunity to manage finances.
“Business leaders don’t have to invest in software or rely on the postal service to speed up collections,” says Elaine Jeon, senior vice president and chief operations administrator for Wilshire State Bank. “By leveraging the robust technology of banks, executives will enjoy better cash flow and reduced risk without making additional investments in technology or hiring additional staff.”
Smart Business spoke with Jeon about the advantages of using treasury management services to improve cash flow and manage company finances.
Which treasury management services improve cash flow?
These services enhance a company’s ability to control the flow of cash, and because employees access the system online, they don’t have to visit the branch to make deposits or initiate transactions.
• SpeeDeposit: Deposit checks as soon as they’re received by scanning the items and submitting them electronically. You’ll also get faster access to funds because deposits are accepted and credited until 7 p.m., and there’s no need to safeguard unprocessed deposits or fill out deposit slips.
• Automated Clearing House (ACH) Origination: The check’s never in the mail when you collect receivables and pay vendors electronically. ACH affords companies precise control over the timing of payments and reduces bad debt exposure, allows business owners to forecast cash flow, negotiate and enforce explicit payment terms and even compete for new deals or larger contracts.
• Lockbox Services: Businesses receiving a high volume of checks can leverage the bank’s staff and technology to process payments and, best of all, deposits are credited the same day they’re received.
• Wire Transfer: Initiate wire transfers to domestic and overseas locations without leaving your office. You’ll also enjoy lower fees and a later cut-off time by processing transfers online, and the added convenience may inspire you to enter new markets.
How does online processing lower risk and improve security?
Treasury management allows companies to leverage the bank’s technical infrastructure, IT expertise and network security without purchasing additional software or hardware, because employees access the program through a secure website. The system also accommodates an unlimited number of users, while reducing the risk of embezzlement or fraud, because administrators can establish access and permission levels and segment transactions by size. Creating different access levels allows the accounting staff to enter transactions so managers and executives can review and approve them online. Each user’s identity is verified when they log in and companies can instantly add or delete employees when the need arises. Finally, businesses that issue large numbers of checks, like real estate or escrow companies, often use positive pay services to prevent fraud. With positive pay, the bank verifies each check number and amount against a list supplied by the company to make sure checks haven’t been altered.
Why is the bank’s software superior to in-house programs?
Companies often collect data in several software programs, so executives have to transfer the information onto spreadsheets to obtain a holistic view of the company’s banking transactions and financial information. The bank’s treasury management system consolidates financial data and transactions from multiple accounts and business entities, giving executives and officers a single, real-time view of the entire organization’s finances along with the analytical capabilities of a Fortune 500 company. And because the program is Web-accessible, executives can monitor cash flow, analyze the company’s daily cash position, identify funds available for investment and improve yields by initiating transfers from anywhere in the world.
How can executives assess the costs and benefits of purchasing these services?
Certainly executives need to consider the cost of treasury management before deciding to purchase the services. But it’s important to note that online processing or outsourcing banking transactions allows companies to reduce or eliminate many direct and indirect costs along with these additional benefits.
• Online transactions are paperless so they increase efficiencies by reducing the need for faxes and e-mails.
• Multi-level security reduces risk without creating costly, redundant processes.
• Banks provide technical support and employee training at no additional charge.
• Transactions are processed by trained, specialized bank personnel who are more efficient than external employees.
• Fewer trips to the branch and streamlined processing lets employees focus on customers and revenue-generating activities.
Above all, treasury management allows executives to prioritize growth and innovation rather than administrative tasks, and that’s important in today’s environment.
Elaine Jeon is senior vice president and chief operations administrator for Wilshire State Bank. Reach her at (213) 427-6580 or firstname.lastname@example.org.
Executives who fail to maximize their banking relationships may miss out on opportunities to improve cash flow, garner attractive financing rates or off-load the processing of rudimentary accounting transactions.
On the surface, this seems like an avoidable problem. After all, executives need banking services to drive revenues and profits, and bankers have a bevy of programs at their disposal. But executives are often paired with novice bankers who lack the business acumen to embrace their vision, suggest appropriate solutions or advocate on their behalf.
“Executives shouldn’t settle for an order-taker or a lackadaisical banking partner, because they have a lot to lose,” says Simon Oh, first vice president and manager of the Irvine Branch for Wilshire State Bank. “Insist on regular account reviews, a customized service plan and advantageous rates, or go find another banker.”
Smart Business spoke with Oh about the techniques and strategies that maximize banking relationships.
What should executives look for in a banking partner?
Banking relationships are unusual, because bankers actually play a dual role. They not only represent the bank to the client, they represent the client to the bank and negotiate on their behalf. To execute this delicate yet strategic mission, your banker should ask questions, understand your business objectives and obstacles and offer a customized suite of services and rates that will help you meet your goals. Unfortunately, new bankers often take a transactional approach to client relationships and tout the product of the day instead of recommending services you really need. It’s better to surround yourself with expert advisers like a knowledgeable banker, lawyer and CPA, because each member of the team offers wisdom and solutions that can help you grow your business.
What’s the key to the selection process?
Ask the banker about his experience, whether he’s familiar with your industry and how he’s helped other companies facing similar challenges. You want to assess his listening skills and his ability to analyze your financials and develop solutions before making a commitment. Finally, evaluate his aggressiveness and his willingness to offer competitive terms. Some banks are more business-friendly than others and your ability to strike a good deal may hinge on your banker’s negotiation skills and tenacity.
What’s the best way to manage a banking relationship?
First, meet with your banker at least once a year, or more often if you’re contemplating a major change like buying a building or using a line of credit to finance an acquisition. Think of a visit with your banker like a visit to the dentist, because it’s better to diagnose and fix problems before you suffer a financial toothache. Share your concerns and expectations, your five-year business plan and your current financials and tax returns, so your banker can suggest services to help you meet your goals and proactively assess your borrowing ability. You’ll be poised to pounce on an emerging opportunity if you know your borrowing capacity and interest rates beforehand. Additionally, your banker should analyze your company’s turn on receivables and debt ratios and then suggest ways to meet or exceed the industry norm; his job is to make sure your financials support your vision. Finally, be ready to negotiate. While banking services are not free, you can garner better rates by consolidating all of your accounts and services with a single bank.
Which banking services incite growth in a stagnant economy?
In times like these improving cash flow is invaluable, and banks offer services that speed up the collections cycle and allow businesses to hold on to their cash for as long as possible.
- Remote deposit services. This service allows businesses to deposit checks immediately without leaving the office.
- Automated Clearing House (ACH) origination. Provides businesses with the ability to collect fees for products and services on a timely basis by directly debiting client accounts.
- Online bill payment. Businesses can schedule exact payment dates, instead of relying on the postal service and issuing checks days or even weeks in advance.
- Online domestic and international wire transfers. Negotiate exchange rates up front and capitalize on advantageous rates by paying invoices in foreign currencies.
- Outsourced receivables and payables. Outsourcing rudimentary accounting transactions to your bank often improves cash flow and security while allowing your staff to focus their time and energy on revenue-generating activities.
- Seasoned banker. You’ll miss out on important benefits unless you partner with a seasoned banker who can spot a need and recommend a solution.
How can executives leverage their banking relationship to strike a better deal?
Although most services have fixed pricing, many banks consider the entire customer relationship when negotiating fees. Research the market, so you know the going rate for services and products before you meet with your banker, then unleash your secret advocate and let him lobby on your behalf.
Simon Oh is the first vice president and manager of the Irvine Branch for Wilshire State Bank. Reach him at (714) 665-6801 or email@example.com.