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.
The state’s open energy market continues to provide businesses significant savings.
Retail choice has been a tremendous benefit to Pennsylvania businesses, and new products and services continuously provide greater benefit. However, businesses — with assistance from their energy supplier — need to monitor legislative and regulatory policies to ensure they maintain the benefits of energy savings and the promising developments in today’s energy markets.
“This is another critical time in our industry and for Pennsylvania businesses,” says Bob Barkanic, senior director of energy policy at PPL EnergyPlus. “Executives need to be monitoring pending policies and develop energy supply strategies to lock in these low energy prices.”
Smart Business spoke with Barkanic about new federal and state regulations and new energy policy opportunities.
What will happen to electricity prices as a result of new federal and state environmental regulations?
Protecting the environment is important to all of us. The challenge is balancing this objective with today’s current economic climate.
Our goal is to educate policymakers and customers to ensure the best decision possible is being made. For our customers, our objective is to explain the potential impacts and risks so they can procure their energy correctly. The proposed environmental regulations are expected to boost energy generation (production) costs, and these higher costs will eventually be passed along to businesses and households.
Environmental policies that potentially will have an impact on electricity prices are:
- The Cross-State Air Pollution Rule. This EPA regulation takes effect Jan. 1, 2012, and requires 27 states, including Pennsylvania, to improve air quality by reducing power-plant emissions that contribute to ozone and particle pollution in other states.
- Section 316(b) of the Clean Water Act. The EPA is developing regulations that require that the location, design, construction and capacity of cooling water intake structures at power plants reflect the best technology available for minimizing adverse environmental impact.
- The regulation of coal combustion residuals. The EPA has proposed federal regulations to govern the disposal of coal ash and other wastes generated by electric utilities and independent power producers, which would potentially make handling more expensive.
These environmental policies are important to Pennsylvania and to our nation. The goal is to implement them correctly — with transparency and with an effective market structure — and to inform businesses of how to prepare for the changes that will result from the policies.
What effect will renewable energy requirements have on electricity prices?
Renewable energy, like environmental policy, is an important component of an effective long-term energy policy. PPL Corp. believes a balanced approach toward energy policy is vital to the economic health of our state and country. A balanced approach would be a prudent mix of nuclear, clean coal, natural gas and renewable energy resources. In addition to these physical assets, demand response, energy efficiency and energy conservation should be included in the mix.
However, a balanced approach is needed for renewable resources, as currently these resources may cost up to four to five times the cost of conventional generation. Most states, including Pennsylvania, have a Renewable Portfolio Standard (RPS) which requires that a certain portion of electricity production come from renewable resources.
As government has provided grants and tax incentives for these resources, more resources have been added than needed by RPS. Therefore, states are looking to increase renewable energy requirements, thus potentially increasing the costs of electricity for businesses.
What effect will the development of natural gas from Marcellus Shale have on Pennsylvania businesses?
The abundance of natural gas in the Marcellus Shale has the ability to keep Pennsylvania’s energy prices low for a very long time. These low energy prices will benefit everyone, by either lowering costs or by offsetting other cost increases in electricity and natural gas bills. In addition, drilling is boosting the local economy by attracting new companies, creating direct and indirect jobs, and generating lease and royalty checks for property owners.
The benefit of Marcellus Shale is meaningful. To ensure these benefits, policymakers, industry and the people of Pennsylvania must develop a well-defined and a properly regulated market structure. We all benefit from Marcellus Shale if done correctly — safely, continuously improving technologies and regulations, and with open communications.
What can policymakers in Harrisburg do to provide greater benefits from retail markets?
Pennsylvania’s open energy market has created a competitive business advantage, but more can be done. Executives and consumers still need to be educated on why they should shop for energy and how to navigate the retail energy markets. The Public Utility Commission is currently holding hearings on improving retail markets. There are many opportunities to improve the current market — modifying utility default service plans to better align with current market conditions, enhancing technologies to improve and increase product and service offerings, improving utilization of smart meters and continuing the education process. Fortunately, business leaders don’t have to wait; they can shop the market and enjoy lower rates today.
PPL EnergyPlus, LLC is an unregulated subsidiary of PPL Corporation. PPL EnergyPlus is not the same company as PPL Electric Utilities. The prices of PPL EnergyPlus are not regulated by the Pennsylvania Public Utility Commission. You do not have to buy PPL EnergyPlus electricity or other products in order to receive the same quality regulated services from PPL Electric Utilities.
Bob Barkanic is senior director of energy policy at PPL EnergyPlus. Reach him at (610) 774-6722 or RJBarkanic@pplweb.com.
Historically, commercial real estate afforded investors predictable and favorable returns. In fact, many of the richest Americans on Forbes infamous annual list attribute all or a portion of their hard-earned fortunes to a bevy of sound real estate investments.
But commercial real estate prices plunged nationwide by 73 percent at the start of the recession and, though values have started to rebound in some cities and sub-markets, generous returns are no longer guaranteed. Going forward, investors need to anticipate every possible scenario and run numerous pro-forma models in order to forecast a realistic return.
“You can’t make sound investment decisions in commercial real estate by relying on gut instinct,” says Dr. Tammie Simmons Mosley, associate professor of Finance, California State University, East Bay. “You have to factor-in market uncertainly, review data and employ rigorous decision-making to validate your assumptions.”
Smart Business spoke with Simmons Mosley about the due diligence that leads to sound investments in commercial real estate.
How should investors approach decision-making?
Engage a team of professionals from the outset, including a realtor and an investment analyst, so you can tap their expertise through the various stages in the process.
1) Set goals. You won’t be successful if you try to hit a moving target. Establish how much money you’re willing to risk in addition to your desired rate of return and investment timeline before creating an investment profile and searching for a suitable property. This includes knowing the specific property capitalization rate for that locality.
2) Acquire financing. Whether you plan to use equity, debt or a combination of both to consummate a purchase, line up your financing in advance so you know the parameters and can negotiate with confidence.
3) Understand local laws and taxes. Local taxes, fees and even zoning and signage regulations can impact the success of a commercial building, so be sure to research and understand the local laws and regulations before you make a purchase.
4) Evaluate the tenant base. Assess the ability of current and prospective tenants to garner customers, because the efficacy of the local trade area will determine whether tenants can meet current or future rent obligations. Then use that information to create various scenarios and estimate a realistic return during the financial modeling process.
What constitutes a viable investment strategy?
Start by examining the area’s macro trends and assessing the impact on existing commercial properties to determine the best way to spend your time and money. For example, if local incomes are dropping and unemployment is high, it may not be wise to invest in a boutique retail center until the economy improves. While an influx of new office buildings may lure tenants away from mature projects and force landlords to grant temporary rent concessions, especially if available space exceeds demand. Include a demographic analysis of the average household size, age and income, and then look at how the property has fared over the last five years and the pipeline of future projects to realistically estimate the investment’s performance over the entire holding period. Finally, link your strategy to your goals in order to create a profile of your ideal investment so your realtor can suggest properties that match your appetite for risk and desired return.
What should investors review and consider as part of their market analysis?
Consider the purchasing power of the local market area as part of your analysis. How many demographically desirable customers reside within a two-minute or three-minute drive and can they use public transportation to reach the location? Next, consider the specific site and environmental factors. Will you incur heavy environmental clean-up costs or zoning roadblocks if you want to remodel an industrial property for another use? Will property setbacks keep you from expanding a shopping center or parking lot? Review data and human intelligence to conduct a thorough market analysis.
Which pro-forma statement models help investors estimate an accurate return?
First, run a broad pro-forma statement model or financial statement that estimates the property’s annual return over the entire holding period. Then, run a monthly model for the first and second year, because equity and debt investors will want to see a more precise cash-flow estimate during the risky start-up period. Then, repeat the process using a variety of assumptions to see how the investment performs under a variety of scenarios. Run the absolute worst case scenario, the most optimistic scenario and the expected scenario to see how uncertainty impacts your rate of return. Finally, calculate your expected internal rate of return by assigning a probability weight to each model while making sure that the total weight adds up to one.
Do you have any other tips or best practices for prospective investors?
Prevent bad investments by having an in-depth understanding of the commercial real estate market, because you won’t succeed in today’s environment with superficial knowledge. Use realistic assumptions and data from reliable sources to create multiple scenarios and pro-forma statement models, otherwise, its garbage in, garbage out. Be sure to check the math in your software program or financial model, because a bad formula can misconstrue an investment’s risk and estimated return. Finally, understand the current capital tax gains treatment so you can retain every possible dollar after exercising extreme due diligence and rigorous decision-making during the investment process.
Dr. Tammie Simmons Mosley is an associate professor of finance at California State University, East Bay. Reach her at (510) 885-3316 or firstname.lastname@example.org.
There’s been no shortage of threats to business continuity over the past decade; terror attacks, hurricanes and tornadoes are constant reminders of the need for a well-honed disaster recovery plan. But the era has also featured two devastating recessions and a rash of corporate downsizings, leaving executives with fewer resources to guarantee the timely restoration of critical business operations and databases.
“The events of the past decade have taught us that businesses must deal with disaster recovery in a pragmatic way,” says Kerwin Myers, senior director of product management at SunGard Availability Services. “Otherwise, companies may make critical mistakes and may never recover from a disaster. Conversely, overspending on disaster recovery can also pose a threat to your company.”
Smart Business spoke with Myers about how to ensure business continuity by taking a realistic approach to disaster recovery.
How have the events of the last decade impacted disaster recovery?
Executives seldom thought about disaster recovery before Sept. 11. Now, they recognize the need for planning, but restoring a network and recovering data require professionals with specialized skills, and the rigorous process often takes a back seat to day-to-day operations. Additionally, companies must now adhere to governmental regulations and industry mandates designed to ensure organizations develop business continuity plans.
What are the typical pain points that organizations face when recovering from a disaster?
Recovering from a disaster hinges on accurate and current disaster recovery procedures. Many organizations fail to recover or take longer to recover because these procedures are not accurate or not current. Production Information Technology environments are constantly changing. This means that an effective change management practice that includes a process for updating recovery procedures and recovery configurations is a crucial component to successful restoration. Changes in the production environment happen daily, impacting recovery. As a result, the recovery plan must be kept up to date with day-to-day production changes.
In many cases, organizations depend on the same staff for production and disaster recovery. This requires production to be redeployed to restore critical applications and data during a disaster. But the event may prevent workers from reaching the facility or inflict personal hardships or injuries that keep them from working.
Last, IT professionals spend most of the time maintaining and updating applications, so restoration efforts may be hampered by a lack of knowledge of restoration practices.
What are the key planning elements to help ensure a seamless recovery?
Recovery plans should be customized to individual businesses but should include these critical steps to ensure effective recovery.
* Create specific and sequential recovery processes and procedures. Employees need clear procedures to restore critical IT services.
*Establish priorities. Some mission-critical applications and technical functions must be restored immediately to minimize financial loss. Consider cost/performance trade-offs, estimated recovery times and business needs when establishing post-event priorities.
* Close skill gaps. Staff members must take on specific roles and duties during recovery, but there’s no time for training once disaster strikes. Inventory the required skills to execute the plan and close gaps through training or by contracting with external providers.
* IT organizations must ensure production changes are being replicated in recovery configurations and procedures.
What mistakes may impede or prevent a complete recovery?
An outdated recovery plan can stymie recovery. Companies need to reconcile the plan with the changing technical configuration and update procedures and priorities to align with the business requirements on a quarterly or semi-annual basis, as recovery may fail if the plan elements aren’t tested and refined.
Should all data be recovered in the same way?
Most data centers are a collection of new and legacy systems and applications from multiple vendors, which means all data can’t be recovered in the same way. For example, data from critical tier-one applications may be replicated on servers in other locations, which is expensive, but the investment practically eliminates down time after a disaster.
Applications that run in the cloud can be accessed from any location and the provider assumes responsibility for disaster planning and recovery. Tier-two apps could run on separate servers and are restored from tape backups or a virtualized environment.
How are virtualization and cloud-based solutions impacting backup and recovery processes?
The emergence of the cloud and virtualization has created new rapid recovery options at a better price point. Applications that run on Web-based platforms can be supported by third-party providers with hundreds of servers, so recovery can be as simple as switching to another site. The best providers take a holistic approach by considering the interdependency between legacy and Web-based applications and offer a comprehensive solution.
What should an IT manager look for in an outsourced disaster recovery service provider?
Beyond price and equipment, an IT manager should evaluate the following criteria.
* Experience and expertise in processes and procedures.
* Commitment and conviction backed by guarantees and SLAs.
* Track record. Has the firm been tested by a real disaster? Was the recovery successful?
* Testing and audits. A provider should conduct hundreds of tests and audits each year, so ask to review its documentation before committing.
Kerwin Myers is a senior director of product management for SunGard Availability Services. Reach him at email@example.com.
Competitive energy markets give business leaders an opportunity to choose a supplier, negotiate rates for electricity and natural gas, and customize a suite of innovative products and services to meet their needs. But nearly 38 percent of industrial and 67 percent of commercial companies still haven’t cashed in on the state’s open energy market because they’re still relying on old buying habits, says Robert D. Gabbard, president of PPL EnergyPlus.
“I firmly believe that an open marketplace creates efficiencies and is superior to a vertically integrated monopoly, because prices have been trending lower since 2008 and the early adopters have been able to reduce their company’s overall energy costs by 5 percent to 10 percent and, in some cases, even more,” says Gabbard.
Smart Business spoke with Gabbard about how businesses can capitalize on Pennsylvania’s open energy market by forming new buying habits.
What major changes have taken place in the Pennsylvania energy market in the last five years?
The creation of an open, competitive energy market in Pennsylvania has spawned industry consolidation and several mergers in recent years. On the one hand, consolidation is advantageous because only the most efficient and financially sound suppliers survive and savvy executives have seized the opportunity to garner additional savings by leveraging their purchasing power.
On the other hand, executives must use due diligence to select a financially sound supplier and choose products and services that support their business model. For example, if your company has implemented a green initiative, select a supplier that offers energy from renewable sources.
Or, if your goal is to drive revenue by signing new customers to long-term agreements, it makes sense to reduce price volatility by negotiating a long-term energy contract.
The bottom line is that there’s no need to settle, as business leaders have the opportunity to select a supplier and a suite of products and services that fit their company’s needs.
What is the most important thing businesses in Pennsylvania should know about the competitive energy market?
Pennsylvania is no longer operating under a monopolistic structure, but you don’t have to take a lot of risk or sign a long-term contract to garner lower rates and better service. Start by making small changes that create new buying habits, such as researching suppliers, requesting quotes and then signing a simple, short-term contract. Once you’re comfortable with your supplier and the bidding process, you’re ready to source additional savings by utilizing demand-side management programs or shifting daily production schedules to capitalize on lower energy rates throughout the day.
You don’t have to predict your future energy needs to receive a low rate, because there are programs for businesses that can’t forecast or that expect a change from their historical usage, and there is even a program that offers price certainty while allowing customers to take advantage of a reduction in wholesale energy prices. Your supplier should offer to conduct an analysis and help you identify ways to lower your total energy costs that exceed a reduction in your basic energy rates.
What trends should businesses be paying attention to in the energy sector?
Unlike the old days, executives need to monitor the underlying commodity prices monthly or quarterly so they can spot opportunities to extend and renew their energy rates and contract terms. If you don’t have time to monitor the wholesale market, select a supplier that will do it for you and contact you when an opportunity arises.
Energy companies competing for business in a competitive, open marketplace foster innovation and technology developments, so be on the lookout for products and services that will help you monitor and control your daily usage and forecast your future needs. Don’t hesitate to suggest a new product from your supplier.
The key is selecting a trusted supplier that is compatible with your company’s culture and business objectives, because Pennsylvania business executives no longer have to settle for the status quo.
What makes PPL EnergyPlus different from other energy suppliers?
We’ve been in Pennsylvania for more 90 years so we understand our customers’ needs and the nuances of each city. At the same time, we offer the security of a multinational Fortune 500 company with a strong balance sheet. Our in-state network of power generation plants creates operating efficiencies by allowing us to deliver energy across very short distances.
But our greatest differentiator is our business model and our commitment to customized service instead of taking a one-size-fits-all approach. We consult with business managers and recommend specific ways to use power more efficiently before suggesting a customized slate of products and services
PPL EnergyPlus, LLC is an unregulated subsidiary of PPL Corporation. PPL EnergyPlus is not the same company as PPL Electric Utilities. The prices of PPL EnergyPlus are not regulated by the Pennsylvania Public Utility Commission. You do not have to buy PPL EnergyPlus electricity or other products in order to receive the same quality regulated services from PPL Electric Utilities.
Robert D. Gabbard is the president of PPL EnergyPlus. Reach him at RDGabbard@pplweb.com or (610) 774-4168.
Although pricing plays a pivotal role in generating profits, most firms end up leaving money on the table, because they rely on ad-hoc or undisciplined practices instead of a well-honed strategy. Worse yet, they don’t establish a price based on the product’s value, or forgo profitability by hastily initiating discounts to grab market share.
“Executives don’t run enough ‘what if’ scenarios before establishing a price for a product or service and then hope that something good will happen,” says Dr. Jagdish Agrawal, associate dean and professor of marketing for the College of Business and Economics at California State University, East Bay.
Smart Business spoke with Agrawal about the dos and don’ts of pricing management.
Why do companies overlook the need for disciplined pricing management?
For starters, academia hasn’t paid enough attention to pricing so MBAs aren’t familiar with the tools or the need for a rigorous methodology. In fact, there isn’t a single academic journal on the benefits of good pricing. Executives also tend to think that the market establishes the price for goods and services, when it’s up to the seller to educate buyers on their product’s value.
What are the components of an effective pricing strategy?
These best practices are integral to an effective strategy.
- Start with a profit objective. Market share and profits aren’t necessarily related; conceptually, you can reduce your price to zero, lose money and capture the entire market. Start with a profit objective before establishing a price for the product and then research the market to see if it’s on target.
- Practice value-based pricing. Pricing should be determined by the value of a product or service, not production costs. Research the competition and then adjust your price up or down based upon the inferiority or superiority of your product.
- Understand market segmentation. Airlines are experts at market segmentation based pricing. They understand that business travelers don’t pay for their tickets so they don’t care about price, but families always shop for the best deal when booking a vacation.
- Price proactively. Avoid knee-jerk reactions to competitive price changes by continuously monitoring buyer preferences as well as social and economic changes so you can adjust prices proactively.
- Develop prices collaboratively. Solicit input across the entire enterprise, because each group offers unique expertise and perspective that leads to better pricing.
- Invest in marketing. It’s not that buyers won’t pay more, but they need education and data to appreciate your product’s value.
How can companies utilize tools to attack pricing both tactically and strategically?
Savvy companies understand price elasticity and customer preferences and use niche software programs to conduct incremental break-even analyses. For example, what will happen if you drop the price of a product by 5 percent? How much will sales go up and will you still make a profit? Conversely, what will happen if you don’t reduce the price? Start with a conjoint marketing analysis to uncover the nexus between price and value by forecasting the impact of various price changes and then conduct trials or tests to validate the results before initiating wholesale price changes. Some product managers are turning to a new field called behavioral economics, which helps them understand buyer motives and strategically offer rebates or other discounts to communicate a product’s price and value to customers.
How can companies avoid typical mistakes?
Marketing has four variables, or ‘Ps’: price, product, promotion and place. Because price is the most flexible, people tend to use it for instant gratification. But it’s a mistake to temporarily lower prices for competitive purposes, because it compresses margins across the entire industry. Another error is incorporating irrelevant or non-incremental expenses into the cost assumptions because it results in an inflated price that isn’t based on the product’s value. Fixed costs like managerial salaries aren’t necessarily impacted by the number of products a company produces, so you stand a better chance of developing value-based pricing and realistic forecasts by excluding them from the estimated costs. Isolated pricing decisions made by a single department like marketing or accounting are usually off the mark. Instead, develop the brand’s positioning and profit objectives before creating a coordinated promotion and advertising campaign. Next, develop various pricing scenarios through a collaborative effort and run ‘what if’ models to validate your sales and profit goals. If necessary, adjust your product’s positioning or marketing strategies until they align with the desired outcomes, because everything should flow from the brand’s positioning.
How can companies boost profitability through pricing improvements?
Start with the actual product or service to uncover untapped market segments and incremental profit opportunities. Does your product solve a problem? Are there prospective customers who would be willing to pay more for a solution? For example, retailers usually charge less when customers buy online, but some people are willing to pay more for the experience of shopping in a pleasant environment. Train everyone in the company on pricing fundamentals and methodology so they make better pricing decisions and spot additional opportunities to sell goods and services for a higher price. Remember, price is the only marketing variable not associated with the product’s cost, and price allows you to realize the value of all your investments and boost profits.
Dr. Jagdish Agrawal is associate dean and professor of marketing for the College of Business and Economics at California State University, East Bay. Reach him at (510) 885-3290 or firstname.lastname@example.org.
It’s not unusual for borrowers to sign a loan agreement without understanding all of its provisions. Now, those hasty decisions are coming back to roost as business owners struggle to turn a profit in a tepid economy and comply with a host of pre-existing debt covenants. To make matters worse, business owners often commit another faux pas by failing to notify their banker before a violation occurs and end up facing rising interest rates, increased collateral requirements or limited cash advances.
“In better times, bankers were often willing to overlook minor covenant violations,” says Jonathan Sigal, first vice president of loan review and senior portfolio officer for Wilshire State Bank. “Now, bankers are worried about a borrower’s financial ability to make their loan payments, so a covenant violation is serious stuff.”
Smart Business spoke with Sigal about common loan covenants and how executives can take steps to avoid a violation.
What do debt covenants typically cover or require?
Bankers use covenants to set parameters that business owners need to take into consideration when making decisions that could jeopardize their ability to fulfill their loan obligations and to ensure that the loan’s provisions are consistent with the borrower’s risk profile. They tailor the covenants to mitigate each loan’s specific risks by imposing a series of financial and reporting requirements. For example, the covenants may mandate a certain cash flow or asset-to-loan ratio, so a company doesn’t become overleveraged and borrowers can liquidate assets to make their loan payments in a pinch. Bankers may require landlords to submit a quarterly rent roll or notify their loan officer if certain situations occur. Business owners need to understand the covenants and how to comply, because violations are no longer considered a minor inconvenience, and regulators insist that bankers strictly adhere to the loan’s provisions.
What’s the best way to avoid a covenant violation?
Business owners should read the loan document and understand the covenants before signing on the dotted line, because education and awareness are paramount to avoiding a violation. Next, assess the feasibility and long-term impact of the covenants by authoring a business plan and financial forecast. It’s better to know up front if you need to boost margins or postpone additional investments in order to meet the covenants over the life of the loan. Finally, create a spreadsheet and proactively compare your monthly results against the covenant requirements so you can change course or make adjustments before a violation occurs. Since reporting usually takes place on a quarterly or semiannual basis, continuously monitoring the company’s position gives executives the opportunity to head off violations at the pass.
What should executives do if a violation is imminent or unavoidable?
Don’t wait until a violation occurs to schedule a meeting or pick up the phone. Alert your banker right away and be ready to outline what you’re doing to change the situation. Bankers have to protect their interests, so once a violation occurs, they become enforcers and often have to initiate disciplinary action. But if you lay out the problem in a letter or e-mail, and offer a viable resolution and a timeline, your banker may become your supporter and even propose ideas or possible solutions. Remember, your banker must have confidence in your managerial abilities and know that you’re on top of the situation. Finally, always document your discussions in writing and create a paper trail, since there’s no such thing as a verbal agreement in the banking world.
Is it possible to get a waiver or reduction in covenant requirements?
If a covenant is redundant or the reporting requirements prove to be too burdensome, it’s possible to have it eliminated or modified as long as both parties agree. It’s also possible to get a waiver if you can show that an adverse situation is temporary. For example, perhaps a large customer has impacted your cash flow, but they’ve recently agreed to pay invoices every two weeks, or your company has incurred nonrecurring expenses or one-time losses that are reflected in your financials. If your request to modify a covenant increases the bank’s risk, be prepared to offer something in return like transferring accounts from another financial institution or providing additional collateral, such as a deed to a second property. Bear in mind that the bank may charge a fee for modifying covenants, but in general, bankers will acquiesce without changing any terms if a covenant waiver makes sense and doesn’t impose a lot of additional work or extra risk.
Do you have any other advice for executives?
Chief financial officers and accountants are usually familiar with debt covenants, but business owners also need to understand the commitments and responsibilities, because a violation can lead to severe restrictions or even foreclosure. Ask questions during the loan documentation and drafting phase, so you can create a realistic forecast using a variety of assumptions and contemplate the business impact of fulfilling the requirements. How does the covenant define cash flow when calculating ratios and is it possible to exclude certain expenses from the calculations? Remember, a bank can re-price your debt if your company undergoes significant changes to its financial position or operating results, and how you handle a violation may factor into their decision.
Jonathan Sigal is first vice president of loan review and senior portfolio officer for Wilshire State Bank. Reach him at (213) 427-7921 or email@example.com.
HR professionals haven’t seen a need to revise their company’s health care strategy. After all, they’ve been busy with staff reductions and taking steps to offset rising health care costs, while waiting for a government committee to clarify the murky details of health care reform.
But it’s time to stop procrastinating and get back to the drawing board, because employer health care costs are projected to rise by 7 percent in 2012 and insurance carriers are reporting an increase in employee claims for illnesses related to post-recession stress.
“It’s easy to avoid change in times of uncertainty, but at some point it only puts you further behind,” says Bruce Davis, principal and national practice leader for Health & Group Benefits at Findley Davies. “Employers should continue introducing purposeful changes to their health care plan within the context of a clearly conceived strategy.”
Smart Business spoke with Davis about the latest health care trends and how employers are using the information to make plan changes and update their current strategy.
Is cost shifting the new reality?
Surveys show that companies will continue shifting costs onto employees, who are already stressed because they’re working longer hours and haven’t received a substantial raise since the start of the recession. So this is the perfect time to revisit your basic contribution philosophy. For example, it might make sense to shift costs for dependents and part-time workers instead of reducing the health care subsidy for full-time employees. If you communicate a new pricing structure and reinforce the eligibility requirements before open enrollment begins, employees may voluntarily lower costs by removing ineligible dependents or transitioning to a less expensive plan. If your plan costs are still too high, consider conducting a dependent audit or changing the spousal requirements, because you may be able to avoid additional cost shifting.
Is wellness really the solution to rising costs?
Employees receiving short-term disability benefits may be responsible for more than 50 percent of an employer’s health claims. Furthermore, new studies indicate obese workers have greater incidence of workers compensation claims and a longer/more expensive duration of treatment.
Also, working long hours while caring for an aging relative creates so much stress that employees often use the Federal Medical Leave Act to take time off and are less productive when they finally return to work. Savvy employers are starting to understand the connection between work-related absences, family issues, depression and disability claims, so they’re taking a holistic approach to wellness by bundling health incentives with workplace safety programs. They’re also offering stress-reducing benefits like EAP and elder care resources in an attempt to control the entire spectrum of health-related costs.
Will employers continue migrating toward high deductible health plans and HSAs?
High deductible plans and HSAs are not a magic bullet for rising health care costs. In fact, data show that education and market-driven plan changes may yield similar results. One company with a zero deductible plan substantially lowered its costs by educating employees and helping them become smarter health care consumers. Generic drugs already accounted for 40 percent to 50 percent of this company’s filled prescriptions, but teaching employees to request less costly alternatives from physicians and pharmacists increased generics to 70 percent. Employees have a vested interest in maintaining their coverage, so don’t underestimate their desire or ability to help the company save money.
How are employers handling health care reform?
While some employers have been reluctant to change their current plans and forgo grandfathered status, because they would have to comply with additional requirements, other HR professionals have been concerned about the excise tax on ‘Cadillac plans,’ so they have been tweaking their plans to stay below that tax threshold. They’re initiating changes to control costs, like adjusting co-pays on prescription drugs, changing contribution levels and encouraging employees to proactively manage their health by offering incentives to complete a risk assessment.
How should employers approach this year’s open enrollment period?
Many are using this year’s open enrollment period to educate employees, scrub ineligible members from the program and introduce outcome-based incentives. Several of our clients are using inducements to increase participation in programs that help employees manage chronic conditions, as the majority of health care claims emanate from illnesses like diabetes and hypertension. The use of onsite medical clinics is also increasing, especially for employee assessments and health care screenings. These clinics have been successful because fewer families have a regular physician and employees are more inclined to proactively manage their health when they have convenient access to a doctor.
What else can employers do to manage health care costs in this era of uncertainty?
Employers are leveraging their purchasing power to lower costs by joining prescription drug collaboratives and purchasing groups. They’re also excluding certain pharmacies to improve overall ingredient cost discounts and eliminating coverage for expensive brands that have generic or over-the-counter alternatives. In addition, employers are re-considering the use of more narrow networks of hospitals and physicians to optimize discounts while preserving quality and access. Also, the competitive market for life and disability coverage has let companies request bids and apply the savings to health care. Overall, it’s not a time for rash decisions, but there’s never been a better time to institute small changes and revisit your health care strategy.
Bruce Davis is a principal and national practice leader for Health & Group Benefits at Findley Davies. Reach him at (419) 327-4133 or firstname.lastname@example.org.
After battling a lackluster economy for years, most executives are out of ideas for increasing revenue and lowering operating costs. But the smart execs are reviewing history to predict which customers will buy more or splurge on high-end products and enticing them with strategic advertisements. And some are analyzing data to hone inventory purchases or decide how to optimally deploy resources.
The savvy executives don’t have a crystal ball, but they have invested in software and staff to conduct data mining and predictive analytics. Research from Accenture confirms that high-performance businesses are five times more likely to use analytics strategically when compared with low performers.
“Business leaders can avoid mistakes and predict future demand for products and services by utilizing data mining and predictive analytics,” says Dr. Zinovy Radovilsky, professor of management for the College of Business and Economics at California State University, East Bay. “Unfortunately, most don’t know where to start, so they continue to make decisions based on managerial opinion instead of facts.”
Smart Business spoke with Radovilsky about the opportunities to control costs and increase revenue through mining and predictive analytics.
What are analytics and data mining?
Analytics is a diverse field of statistical, qualitative methods and models used for predicting future business trends and customer behavior, and savvy executives are using the practice to make opportunistic business decisions. The process starts when professionals extract or mine data so it can be analyzed and used to identify relationships between the predicted parameters and other factors. The analysis phase is called descriptive analytics, which helps organizations discover what happened in the past, why it happened and how these events impacted the business. Predictive analytics uses the results of both data mining and descriptive analytics to make predictions and optimize business decisions.
How can mining and analysis turn data into dollars?
Analytics may highlight ways to increase customer retention or cross-sell certain additional products and services. At the same time, predictive analytics can reduce operating costs by predicting demand so companies can better forecast inventory or reduce wasted resources. The need for predictive analytics is spreading across various industries and business functions, like marketing, finance, operations, supply chain and human resources.
Predictive analytics and data mining help executives forecast future demand by analyzing customer behavior and profitability by market segments, so they can boost revenue and profit margins by selling additional high-value products and services to certain customers. For example, 1-800-FLOWERS.com attracted 20 million new customers and increased repeat business 10 percent by employing a real-time decision manager that uses predictive analytics applications, business logic and historical purchasing data to motivate customers by offering flower arrangements that appeal to their personal preferences.
How can predictive analytics and data mining reduce operating costs?
These examples illustrate how data mining and analytics can reduce operating costs.
- Predicting future demand helps operations and supply chain managers develop accurate inventory forecasts, purchase the right amount of supplies and eliminate unnecessary waste.
- Predictive analytics can substantially improve allocation of critical resources including equipment, labor and material. For example, after developing and implementing an optimization model to allocate small boat resources, the U.S. Coast Guard reduced its small boat fleet by some 20 percent and overall fleet operating cost by around 5 percent.
- Response modeling allows companies to identify repeat customers from the outset of the relationship and reduce the cost of mailing or calling by targeting only those who are likely to respond. The bottom line is that companies can cut marketing costs by targeting fewer customers while getting the same response.
How does a lack of data analysis or an inability to forecast future events restrict a company’s success?
Companies have accumulated a substantial amount of quantitative business data about their products and services, customers and suppliers. But, their ability to create a competitive advantage by utilizing the data and employing appropriate quantitative models varies significantly. In fact, two-thirds of U.S. companies surveyed by Accenture acknowledged that they need to improve their analytical capabilities. Some organizations still rely on executive opinion instead of using data and analysis to predict the future and make prudent business decisions.
What should executives consider before embarking on a data-mining mission or investing in software or experienced personnel?
Implementation of data mining and predictive analytics can be very time consuming and requires changing the existing decision-making processes and culture, hiring analytical staff and making investments in computer technology. Executives should consider several important things before implementing and managing predictive analytics projects.
First, clearly formulate strategic goals of using predictive analytics and data mining, and identify where the tools will likely make a difference. Then, prioritize the goals by their business impact and ease of implementation and utilization. Finally, identify prospective return on investments before purchasing software, hiring staff and training current managers to use analytics.
Dr. Zinovy Radovilsky is a professor of management for the College of Business and Economics at California State University, East Bay. Reach him at (510) 885-3302 or email@example.com.
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.