During home building's go-go years, banks loved us. We had cash flow (profits and liquidity) and we had collateral (assets to secure debt). Nothing will gain you more banker friends.
But in a cyclical industry like ours, relationships rooted in these two Cs can't last forever. As the housing correction has rolled on, cash flow and collateral have inevitably suffered. Despite our exhaustive efforts, many of us have tripped fixed-charge coverage ratios, busted tangible net worth covenants, defaulted on credit agreements and, in many cases, become "impaired assets" on banks' balance sheets. Nothing will lose you more banker friends than becoming an impaired asset.
When these things happen, longstanding banking relationships will usually succumb to core economic conflicts of interest. Our banker friends often start to tighten the screws–constricting liquidity, raising our cost of capital, and even encouraging us to find another lender. How should you respond?
Understand it's not personal This is not about you, it's about the market and the numbers. Banks supply the cheapest capital and therefore must be the most risk-averse of capital providers. Get past the emotion and rationally address the situation.
Listen Banks have idiosyncrasies–different boxes that different lenders need to check to feel secure. What does your bank want from you: Loan covenants met? Additional equity infused? Profitability achieved by a certain date?
Sweat the details You cannot successfully rectify or renegotiate what you do not understand. Re-read loan documents' language on your and your lender's rights and obligations under current, improved, and worsening circumstances.
Know the market Nearly everything in loan documents (including rates, fees, covenants, and cure periods) is negotiable ... and re-negotiable. Do research and get help to benchmark the key provisions in your loan versus market norms.
Take a conservative view Create 12-month financial projections, with liquidity and covenant calculations based on current and worsening annual sales run rates.
Understand your bank's best alternatives Analyze what your bank could get if it forecloses and liquidates your business. Banks' expected recovery is often less than you think.
A client recently bought out its $1.2 million loan with a large, national bank for $200,000 because it properly assessed the bank's best alternative: liquidation.
Pursue multiple paths concurrently You have more options than you currently realize. They may include renegotiating your covenants, refinancing your loans with new lenders, providing mezzanine and/or equity capital, or buying out your loan at a discount. Brainstorm your options, assess their relative merits and feasibility, and pursue multiple options concurrently.
Present your business in the best appropriate light Have updated, conservative (and therefore credible) financial projections, adjust actual historic results for non-recurring expenses, and prepare a thoughtful plan for the bank that realistically addresses its concerns/wants as best as possible. In order to show that you run a tight ship, clean up your books (reclassify "Old AR" and "Obsolete Inventory" as such) and get your facility neatly organized and squeaky clean. Banks want to know that you will protect their collateral.
Start early In dealing with bank problems, time is your enemy. As soon as you foresee issues or if a loan expiration looms less than 12 months ahead, prioritize this matter. On a loan refinancing deal, I've seen 30+ new lender contacts generate only two real term sheets. Lining up options takes time and sourcing new capital requires casting a wide net.
Matt Ogden is managing principal of Building Industry Partners LLC, a building products-focused private equity investment and M&A/debt advisory firm that is a co-founding equity sponsor of US LBM Holdings. E-mail: email@example.com. 214.550.0405