Brett Bowen Commercial Finance

 

 

Many of my clients bought into the real estate boom 4 or 5 years ago with traditional bank lending, only to be faced with their notes ballooning at a time where declining property values are meeting head to head with the banks’ declining advance rates. Their notes are not being renewed. These are folks with great credit, great liquidity, and long term relationships. Sterling risks, with the exception of the now higher LTV on the commercial real estate.

The banks are taking care of themselves. Frustrating as that may be to some, I’d hate to see the alternative. After all, their shareholders, clients, and government demand it.

Banks have a capital crunch. It is costly for banks to get and maintain capital to invest with their clients in the form of loans.

When the credit rating changes, due to a higher LTV per a drop in market values or any other reason, it doesn't matter how strong the clients are. The risk rating changes.

Banks keep a portion of their capital held in reserve in the form of loss reserves, just in case. This is based on a formula derived from the loan’s risk rating. The higher the risk, the higher the loss reserves required.

The funds in loan loss reserves are just sitting there, just in case. They aren't earning. Consider it "dead inventory". If the bank had to "buy its capital", those reserves are costing the bank money, especially with the ability to access new capital so impaired. This will explain why banks are so quick to purge even excellent credits from their commercial portfolios.

With the banks’ lack of desire for "dead inventory", consider operating lines of credit, the life blood of main stream business. Let's suppose you have a line of credit. You hold it for seasonal reasons, or hardly even use it at all. It lets you sleep at night, jump on an opportunity, take trade discounts, or finance the manufacturing cycle, etc.. The bank sees that line of credit not being used, and for which it is holding back funds on top of that for loan loss reserves. It sees “non-earning assets coupled with loan loss reserves, or “dead inventory”. It sees that it is short on capital and the costs involved in getting more. The bank needs to get that money earning. That's logical. What do they do? They look to reduce or even close down these lines of credit and redeploy those dollars where they are earning.

What would you do if your line was reduced? And if it were gone? And you had a balloon pending on your commercial real estate?

Is this in your future? Is it in your clients' future? Or your suppliers future?

In the case of securing real estate debt, the clients that can, will need to reduce debt to make the balloon refinance work. If not, then they may need to refinance outside of banking. This will raise their cost of capital. This will strain cash flows.

How does one act on, or manage, this situation?

Dig deeper into your risk management profiling to study suppliers and clients with terms.

Are your suppliers stable or are you over concentrated and facing a supply time bomb?

Do you pass your new lower credit capacity issue to your clients and begin to reduce or eliminate terms? Will your client base erode?

If you sold your business and are holding a note personally, have "earn outs", or goodwill due to you, talk with a CPA familiar with "Impaired Goodwill" sooner rather than later.

Ultimately, banks are not funding at the same level they were a few years ago. That's probably a very good thing.

Credit is out there, but buyer beware. Moving out of the banking arena and into other tiers of funding can feel like a different planet. However, this may be how one needs to source money until the stars realign at the bank. (My representation can help navigate these waters, searching for the best funding opportunity for your situation.)

Pay attention to your FDIC limits. Look into www.fdic.gov and verify how your accounts are specifically titled.

 

Make an informed decision.