Crunching the credit Featured

7:00pm EDT January 26, 2009

These days, there is a misconception regarding the credit crunch. If you take a look at the data published by the Federal Reserve, commercial and industrial lending was actually up through November 2008. This means for traditional operating businesses, there is plenty of credit available.

The same data shows the real difference in credit today — lending standards have generally tightened. So, businesses on the margin (high leverage, weak cash flow coverage) that may have received loans several years ago may now have trouble getting those same loans. Further, the data shows that loan spreads have widened for businesses.

“Even though LIBOR and federal funds are at historically low levels, a borrower’s all-in rate, even with a higher spread, is extremely cheap right now,” says Doug Houser, CPA, senior vice president with FirstMerit Bank.

Smart Business spoke with Houser about how businesses can plan to operate successfully with new lending standards.

How can businesses survive if they are dependent on credit?

Communicate with your bank. This cannot be emphasized enough. Banks are being extremely diligent about reviewing their credit portfolios. A business owner should meet at least quarterly with his or her bank and review current financial information, including the budget/backlog and receivables aging. The business owner and the bank should be on top of any trends or changing industry conditions.

Business owners should also scrutinize the bank. That means owners should perform their own due diligence. Business owners should know the bank’s financial condition (profitability, loan/deposit ratio, charge-offs and capital level) and its ability to provide additional credit in the current market. Through this turmoil, an extreme divergence has developed in what certain banks can and cannot do. It is important that the business owner understand the bank’s capabilities.

How do you recommend business owners adjust their business plans to prepare for tighter lending standards in 2009?

The primary concern of a business owner should be his or her own operation. The credit is available to the well-managed business. A motto for a business owner should always be this: Plan for the worst and hope for the best. That means a business should have a definite action plan should market or industry conditions deteriorate. The business should have flexibility to withstand changing conditions. The most important measure of this flexibility is the business’s working capital position and access to liquidity, including a line of credit. An owner should be examining all assets and business options in order to maximize liquidity.

What are successful businesses doing today to stay on top during turbulent times?

Most have communicated with their banks and negotiated extensions to their lines of credit to ensure access to liquidity. Too often, businesses focus on what they paid for the credit. Smart business owners realize that the access to credit and ability of the bank to respond appropriately is vastly more important. The ability to access credit is crucial for most companies, thus, being a well-run business has never been more important. Most capital market alternatives are not available for accessing credit. Bank credit remains the best source of capital for closely held businesses. A business’s credit needs should contract as its volume contracts. Again, the credit is available and inexpensive right now, but the business owner should be prepared to meet higher standards from the bank in order to gain access.

What qualifications are banks looking for today when they provide credit?

Today, banks are looking at a business’s cash flow, liquidity (working capital), net worth, collateral and industry risk. Certainly, specific industries are having a tougher time accessing credit. Industries such as automotive, investment real estate owners/developers and retailers are a few such industries. That said, a superior management team can still produce outstanding results in a difficult industry, and a good bank will provide credit to the right owners/managers.

Again, communication comes into play here. Banks want to know what you are doing and what you plan to do in the future. Keep them involved in your business plan.

What risks should business owners be aware of during turbulent times?

Today business owners don’t only have to worry about their own actions. Businesses also need to know what their business partners, suppliers and customers are doing in their businesses. Receivables risk is greater than ever. A business should re-examine its customers. What is their financial condition and ability/history of payment? Don’t assume that a ‘legacy’ customer will pay just as it always has. Communication is also important with those with whom you do business.

Are these tighter credit standards something businesses will be able to survive?

Most businesses have an uncanny ability to do what they need to in order to survive some hardship. The real difficulty for those businesses on the margin is to find the ability to fund the growth when demand ramps back up. It is at that point that the flexibility afforded by a strong balance sheet becomes imperative.

DOUG HOUSER, CPA, is a senior vice president with FirstMerit Bank. Reach him at doug.houser@firstmerit.com or (614) 314-5937.