Archive for March, 2009

Anonymous Banker: Why are Working Capital Lines Disappearing?

Friday, March 13th, 2009

President Obama has put together the Financial Stability Plan, which states: “This effort will include measures to improve the disclosure of the exposures on bank balance sheets. In conducting these exercises, supervisors recognize the need not to adopt an overly conservative posture or take steps that could inappropriately constrain lending.”


President Obama, Congressional Leaders, Regulators: 

The business community of America needs your help.  You must change your focus and consider implementing lending policies and procedures that will allow businesses to remain open, allow them to continue paying their rent, paying their employees, and  paying their loans.


Put aside the liar loans that were granted over the last ten years to business owners that overstated their revenue and income. Those are NOT the loans I am speaking about here.  Our regulators allowed banks to violate every prudent test for safety and soundness in bank lending over the last decade.  And now that you let the proverbial horse run out of the barn, you are empowering the banks to slam the door on all the businesses that are, or may still be, credit worthy.  Your actions will directly contribute to the severity of the depression that is coming upon us so quickly. 


It has been stated to me, by senior credit officers in one of the largest US banks, that  40% of RENEWAL REQUESTS for business working capital lines of credit are being declined, termed out and/or called by the bank.   The loans I’m addressing in this article  are to the smaller to mid-market companies that have not missed any payments, have met all commitments as agreed and still have a chance of surviving.  These are the businesses that support the economic future of the communities across our nation.


These working capital lines are the lifeblood of any business.  They provide the companies with capital that they need to purchase inventory, finance production of goods, carry receivables, and during these cycles, to pay their employees and their rent or mortgages.  It is NOT term financing.  And this is a very important point.  So I will repeat it:  IT IS NOT TERM FINANCING.


Working capital lines are repaid by the conversion of one asset into cash in a short period of time.  It is revolving credit.  A company uses the funds to manufacture goods.  They then sell the goods and convert inventory into receivables.  Then they wait and they convert the receivables back into cash.   The difference between their cost and what they sell it for, is the profit.  From that profit, they pay salaries, rent, etc.    They do not repay working capital lines from PROFIT.  Businesses  repay working capital lines from CONVERSION of assets into cash.  Then they begin the cycle all over again.


A term loan, conversely, IS repaid from profits.  If a company buys a piece of equipment, they should not use their working capital to buy it outright.  They should finance it over a period of time that is typically determined by the useful life of the equipment they are buying.  A computer for example would be financed for two years, a die press machine for seven or ten years, and a building for twenty years.  These loans are paid for by profit over a specified period of time.


There are a number of things that go into the evaluation of a request for a working capital line to a small business owner.  We look for diversification of receivables and timely collection of receivables by our borrower.  We look at turnover of inventory as related to the type of inventory they carry. We evaluate repayment history and the company’s capital position.  Banks want  companies to retain capital and not distribute all their profits to the owners.  We look to see if they can pay the revolving line down during the course of a year.  We look at secondary sources of repayment through personal financial statements:  cash, investments and equity in the business owners’ homes.  (Thanks to the banking industries bad behavior, all business owners have less to offer the bank by way of secondary sources of repayment!)  We also look at the personal credit scores of the owners.  Gross sales and revenue trends also carry significant weight.


I’m not here to give our leaders a lesson on bank lending.  But perhaps it would be wise if you at least understood the principals that should be applied to lending.  You need to understand this in order to understand what is happening that is going to kill this country.


Regulators are now requiring the banks to evaluate existing and new working capital line requests in the following way:    First pass, we look at all the typical things we looked at before as defined above.  But now, Regulators are adding another pass by requiring banks to determine what would happen if the customer could not pay back their working capital line through normal asset conversion.  Regulators are requiring the banks to evaluate if these same customers can repay the debt, at the time the line is made or renewed, from profits over a three to five year period. 


This is determined through a ratio called ‘debt service coverage’.  A business that can and does repay working capital lines from the conversion of assets, oftentimes cannot pass the debt service coverage evaluation criteria.  A $250,000 working capital loan cannot always be repaid if it is converted to a five year term loan, particularly in a declining revenue and profit environment.  Using this as a standard for evaluation means that most companies no longer qualify for their working capital lines and our Regulators are giving the banks a perfect excuse to cancel the lines of credit and demand payment.


Each and every day, in my work as a business banker, I am addressing this issue.  These are not customers that are late on their payments, delinquent in any way, or not meeting their obligation.  These are customers who, without a credit line will be OUT OF BUSINESS.  Their workers will be unemployed and their commercial real estate left vacant.   


Is this your vision of Economic Recovery?    I don’t think it is.  I just think that you are so focused on the big picture that you are not seeing what is actually happening in the real world today. 



This must not be allowed to happen.  Right now there are only two categories of loans on the books of the banks. The good loans and the bad loans.  There are test standards that determine where each  loans fits.  Today, there must be a third category for loans that are being paid and that support those companies that have exhibited every ability to pay.  These companies still have a fighting chance.  Directly addressing the small business owners’ needs will bring a much needed level of confidence to the people of this country.


Give the bank lenders the ability to do our job.  Let us document a file and explain why, in spite of a company not passing the “debt service ratio” the banker still believes that the working capital request represents a viable deal.  And make our regulators live with that decision until we are proven wrong and the loan starts to actually show real signs of default in the form of slow or late payments.  The bank can always classify the loan at a later time and it will be in no worse position than it is now.  I recently challenged one such decision, and I was told by a Senior Lender in my bank that they perceived a deterioration in the credit based on the “debt service coverage” and it would be better to grab any money we can now while the getting is good!  This is the philosophy that the banks are using while they spew their deceitful claims that “they are still making loans”. 


In the rare cases where the lines are being renewed,  the banks are increasing  the interest rates across the board.  Banks are enjoying a historically low cost of funds.  They borrow  through the Fed at zero to ¼% and they pay their depositors between zero and 1%.  Yet businesses  that were previously being charged Prime + 1% or Prime + 2% are now having their rates increased to Prime + 6% to Prime + 11%.  The banks are clobbering the business owner with higher rates at the very time that these businesses need to be cut a break.  I propose that they are doing this to offset all their losses on the liar business loans they made over the last ten years that have no chance of being repaid.  And you, our leaders, are doing nothing to stop them.


I beg our leaders to see the truth in what I am saying.  I know that I am only one person, but perhaps Congress should call various bank lenders into a closed session and have them testify about what is REALLY happening in the industry.  And I don’t mean the CEO’s of the banks and the Senior Risk officers.  I mean the seasoned,  mid-level lenders.  We certainly could tell you a lot, if you would just give us an opportunity to communicate with you.  You will not believe how bad it is out here. 


I urge you all to focus on the details and on implementing effective lending policies and programs that will keep our businesses open and our citizens employed.  Irving Fisher, one of America’s reputed economists, outlined the factors that contributed to the length and severity of the Great Depression.  Fisher saw it as a chain of events that started with debt liquidation and distress selling, the contraction of the money supply as bank loans were paid off and a deterioration of confidence.  Will you allow the banks to create the scenario where history will repeat itself?   Or will you ensure that when history unfolds and our future generations look back at this period of time, that they can say that YOU had the strength of character to make the tough decisions that brought us quickly out of this crisis?  We are all depending on it.


Readers:  Please, take a moment to send YOUR story to President Obama, the Senate and House Banking Committees and your Congressional Leaders.


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