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Your Banking Relationship Is Changing ... Are You Prepared?

The ongoing credit crisis, and now the economy in general, are continuing to take a major toll on the banking industry. Many now think the problems in the banking sector are becoming worse than previously predicted, and the list of troubled banks grows almost daily. All of this turmoil is having a major impact on the availability of credit to all but the most credit worthy borrowers. Some say that credit is being made available only to those who clearly do not need it.

Your bank contacts might be telling you that banks are lending, but it is important to understand that lending terms have changed dramatically and the pool of available lenders is much smaller. Borrowers are now faced with tougher underwriting requirements, likely higher interest rates and fees, and greater scrutiny before and after the loan is funded. Even companies who are performing relatively well will most likely feel the effects of the changing world of banking.

Expanded Risk Management Programs and Additional Oversight

Various regulators are paying increasingly closer attention to the controls banks have in place to monitor and evaluate the credit risk of the entire portfolio. These tougher standards will inevitably trickle down to borrowers. Banks' outside auditors are putting most of the banks' assets under a microscope and are focusing more closely on risk management, internal controls and valuation. This pressure from outside auditors and regulators is driving many banks to increase requirements for borrowers on the amount of and speed with which information is reported. This reporting might include monthly rather than quarterly reporting with a due date 15 days after month-end. Obtaining borrowing base certificates more frequently is also a possibility. Banks are also increasing the amount of oversight placed on each borrower.

We are seeing more banks taking a keener interest in management's forecasts. Expect banks to start looking at various levels of forecast from short-term (13 weeks) to six and 12 months with increasing levels of detail the shorter the forecast period. The sudden and dramatic decline in the real economy means that much of the historical trend analyses are of little value in determining future credit risk. As a result, bank underwriters are looking to current forecasts to gain a better assessment of a borrower's potential risk. Companies should expect to be asked for forecasts and budgets as well as to spend actual face-to-face time defending their business plans. Finally, many banks are requiring more frequent field exams. Annual field exams might now be done on a semiannual or even quarterly basis. Finally, audited financial statements could now be required where a review was acceptable in the past.

Possible Refusal to Forbear, Refinance or Renew

Diminished capital at many banks is driving these banks to reduce the total risk profile of their portfolios. One way to reduce risk is to force less-desired borrowers "out of the bank." It is important to understand that banks might be looking to reduce exposure to certain industries, credit risk profiles, loan types or borrowers who do not generate enough profitable fee income. So, a borrower who appears to be doing fine might still be pushed to find a new banking relationship.

During the term of the loan, a bank might force a borrower out of the bank—on very short notice—when a borrower breaches any loan covenant, no matter how small. Banks generally have the option to enter into a forbearance agreement in the event of a breach. However, a bank is not necessarily required to offer such a concession to the borrower. Companies should understand this risk in advance and avoid any breaches of loan covenants, no matter how minor they might seem (e.g., financial reporting due dates). Keep in mind that a bank is likely to charge a fee for any forbearance agreement. These fees vary, but may be in the range of 1% of the loan amount plus the bank's costs (i.e., legal fees).

Reductions in Loan Limits and Advance Rates

Another tactic many banks employ to reduce risk exposure is to reduce the total limit on a loan facility (e.g., a $2 million facility might be cut to $1 million). This tool is often used when a borrower has historically maintained significant excess availability on their line. Cutting the loan limit reduces the bank's technical exposure without directly forcing the borrower to find a new bank. This is commonly seen in situations where the borrower is performing relatively well, but the bank needs or wants to reallocate its use of capital. This reduction can have a serious impact on the company if the company planned to use excess availability for strategic purposes or as a financial safety net.

Lowering of advance rates on asset-based loans is a way for banks to reduce loss exposure by decreasing the loan to value ratio. In the current economic environment, many banks are reducing advance rates on many types of loans from the obvious (real estate) to the less obvious categories of machinery and equipment, inventory and accounts receivable. These reduced advance rates are intended to protect the bank from possible declines in collateral value after funding the loan. The collateral values are at risk for a variety of reasons including general declines in value (real estate, machinery and equipment, inventory) and customer bankruptcy (accounts receivable, inventory).

Lowered advance rates and increased ineligible items both have the effect of less available credit to the borrower and could have a very serious impact on working capital. There are steps companies can take to mitigate some of this risk to their assets, specifically accounts receivable and inventory. Banks like to see borrowers proactively taking such actions as this might work to protect the company's ability to borrow at historical advance rates. In addition, actions can be taken to better manage working capital and potentially reduce a company's borrowing requirements.

The Time to Act and Ask Questions is Now

While you might be concerned about opening a dialogue with your bank, it is almost certainly wiser to start asking questions now as opposed to being surprised later. It is recommended that you open up the discussion with your bank at least four months prior to lines come due.

Need some assistance?

Blackman Kallick's Lender Support Services team can help you work your way through these questions and issues.

For more information and guidance, please contact Mark Robertson directly at 312-980-3263 or mrobertson@BlackmanKallick.com.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.