President of Fintrepid Solutions, an award-winning firm delivering customized solutions to support business growth and sustainability.
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As I interact with business owners on a daily basis, I’ve noticed there seems to be no consensus on just how severe of a recession we will see or what the impact will be. Thus far, the effects of a slowdown have varied greatly by industry. What these same business leaders are starting to see, however, is some changes in behavior by their lenders.
One customer was asked by their bank to provide guidance on the company’s strategy during the Great Recession. Multiple others have been asked in detail about their inventory strategy going forward. The increase in interest rates is an obvious impact on the business owner. What is not as clear is what is happening in the broader financial system, its impact on banks and what it could mean for your business.
While the recession debate grabs the headlines on Main Street USA, I’ve noticed the impact of Federal Reserve activity, along with inflation, is not understood well enough. Never in history has so much money been pumped into the economy as we saw during the Covid-19 pandemic. In the same vein, the Federal Reserve is now seeking to remove liquidity from the financial markets at the fastest rate in history as well. The exact effect of this quantitative tightening is not known as we are in uncharted territory, but it could result in upward pressure on interest rates and siphon liquidity out of the financial markets, meaning commercial banks may have less capital to lend.
There could be a bit of a storm brewing for businesses and their access to bank lending. Without going too deep into the economics, a bank’s ability to lend money is based on capital requirements set by federal regulators. Business and asset sales have slowed as values have declined, meaning fewer loans are turning over. Fewer loans turning over means less capital potentially available for new loans. Rising labor costs, high interest rates, higher carrying costs and economic headwinds dampening sales could cause bank portfolios to begin to deteriorate in quality, which also limits how much capital banks can lend. At the same time, banks have been tightening their credit standards on commercial loans. In a recent conversation I had with one bank president, he feared regional and small banks might end up having to turn down 20% or more new financings that would have been done a year ago. A flight to quality could well be upon us.
So, we have established that it could be challenging to get new capital, and even if you do, it will likely come at a higher cost relative to the past few years. But there are steps business leaders can take to minimize disruption and get a leg up on the competition.
Stand above the crowd.
With a flight to quality, how can you do everything in your power to stand out? Are your margins above industry averages? Do you have sufficient cash reserves that can mitigate risk? Maybe you have made small pivots wisely to take advantage of market conditions. Make sure your lender understands the story and key management actions—and that you have facts to back it up. Really sell your story, perhaps like you never have before.
Create a downside plan.
Banks are not in the business of being your unlimited partner; they are in the business of making money and managing risk. I’ve found having a downside plan you can present that still shows viability can go a long way to alleviating concerns the bank may have. Clarify your detailed assumptions on why the numbers are what they are in that version of the plan. Again, the story must make sense.
Understand your collateral.
Banks are heavily focused on collateral, so a deterioration in its perceived quality can be a red flag. If you have higher inventory levels, what is your strategy to lower them? What are you doing to ensure your customers are paying on time so your accounts receivable is solid? Asset values have fallen in many classes, so perhaps you have a longer hold strategy. How can you demonstrate to the bank that you have adequate dry powder to do so?
Know that recent results matter.
Banks are scrutinizing recent trends—the last three months, six months, 12 months—to understand the impact of a Covid-19 bubble, recessionary pressures and how businesses have responded. Proactively analyze your own business. What do those trends say? And how can you use the data to provide insights to the bank that your performance is positive or, at a minimum, not a major concern if there has been a falloff?
Do your homework on your bank.
Ask anecdotal questions about the bank’s portfolio. If they are public, you can obtain information about their loan quality, their reserves and overall performance. Pay attention to what you are hearing from other customers. Each bank will be affected differently, so knowing if yours is very healthy and will grow its loan portfolio versus one that will stand still or shrink can help drive your strategy and whether you might need to seek a new bank partner.
Be thorough—this will take effort—so give yourself plenty of lead time. I have seen diligent, proactive efforts in presenting to banks consistently drive higher success rates and better terms. It may be harder to sell growth, so you may be better off selling safety. By taking action proactively, you can help ensure you can obtain the financing that your competitor may not, and that could position you to seize opportunities that could take your company to the next level.
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