Where is Business Credit? – Part I

Part of the answer is the banking issue of “Too large to fail” changing to “Too many to fail.” Community banks are still struggling with the effects of the Great Recession. The large loan charge-offs and substantial additions to loan reserves are depleting their capital reserves. In most areas, community banks represent approximately 50% of bank deposits and loans. Therefore, their health has a direct impact on the ability of local businesses to obtain business credit.

The community bank problem is not going away anytime soon. These banks are searching far and wide to find new equity to bolster their Tier 1 equity ratios. The dearth of announcements is testament to the lack of success. And since the various regulators have not created a program to support private equity investments into the community banks, little relief is in sight. Continued losses in operations and bad loans are applying persistent pressure that reduces lending activities. The number of community banks in this situation is staggering.

In Florida, private estimates are close to fifty when compared to the fact that there are approximately 290 banks operating in the state. There are just too many problem banks for the regulators to resolve in a swift manner, similar to a bank with many problem loans. Therefore, the regulators are choosing to let banks languish in financial purgatory, the banks are neither able to attract capital or receive federal assistance. Eventually the regulators will close the banks. However, it is this lack of capacity (both people and money) of the regulators that will help insure this problem will stay with us for a while.

Tight credit is not completely the fault of weak community banks. Given the uncertainty of the economy all banks have tightened the underwriting guidelines used for making loans. These guidelines / policies reflect the more conservative mindset we all have towards our own funds. With uncertainty comes caution, and caution results in fewer loans.

Another reason for tighter credit is the poor operating performance of companies. These weak results have created greater credit risk for the banks. First, historical earnings probably do not realistically reflect the company’s ability to repay the debt. Second, forecasting earnings in today’s environment is difficult given the lack of “visibility” of future performance. Therefore, banks anticipate higher risk in these projections prompting them to discount the probability of occurrence. And, lastly, the poor performance of a company has probably weakened the balance sheet resulting in less liquidity and higher leverage ratios, not unlike the banks themselves.

There are actions and options for companies seeking money to fund operations or expand. Make sure you have eliminated all excess costs. Restate your historical results to show the effect of your cost-cutting. When forecasting provide as much evidence as possible regarding the “firmness” of your revenue projections – contracts or purchasing histories of customers, for example.

While bank credit might be limited in today’s environment, there are many sources of alternative funds. This includes subordinated loans and equity investments. And, while these two sources of money are more expensive than bank debt, these funds allow more patience for results then bank debt.

If you have comments or questions about this article, or would like more information on this subject matter, please contact us.

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