Marsh Business Advisors, LLC
"CAPITAL"
It Pays To Establish A Great Banking Relationship
By: Stuart Wm. Marsh
President, Genesee Capital, Inc.
January 22, 1993
Banker bashing is a popular pastime in the business world today. Given that, I will make a surprising proposal: As a businessperson one of your New Year's resolutions should be: Be kind to bankers.
Although I can virtually guarantee that his resolution is not already on your list, I'll give you three very self-serving reasons why it should be.
Reason #1: Banks are the primary source of short and medium term credit for privately held companies with annual revenues of less than $50million. Banks also are a major source of short-term credit for private firms with sales exceeding $50million, and for many publicly held companies. Unless you can find a cheaper, more flexible source of capital, you will need a bank.
Reason #2: The United States has been in a recession for two years and 1992's "recovery" was the most anemic since the Depression. When economic growth stops or reverses, the demand for capital drops, and many businesses simply maintain or reduce their bank borrowings; their attitude may be one of “not needing" their bankers.
Many economic indicators now are signaling the onset of a real recovery. The average length of a peacetime expansion is 55 months, and if one materializes, businesses everywhere will need capital to finance increased inventories, receivables, and new plant and equipment. These firms most definitely will need their bankers as they ask for additional credit.
Reason #3: The supply of lendable funds has shrunk. In the 1980s Congress gave the savings and loan industry the right to enter the commercial loan business. Many S&Ls then went out and borrowed huge sums of money by issuing Certificates of Deposits guaranteed by good ol' Uncle Sam (whose real name is "U. S. Taxpayer") and lent these funds to many worthwhile projects that now are unfinished, in default or bankrupt. Now U. S. Taxpayer is discreetly being handed the bill ("off-budget," of course).
With S&Ls virtually out of commercial lending, and banks putting much of their cash in risk-free Treasury securities instead of riskier commercial loans, the supply of lendable funds has contracted.
In sum, demand for capital will begin to rise at a time when supply is shrinking. Unless you can violate the laws of economics, it may be prudent to conclude that now is the time to be nice to bankers. I'm not suggesting that a round of golf and a couple of cocktails is the method to use. Rather, I'm suggesting that you learn how to establish and maintain a great banking relationship. The best way to do that is to find out what a banker wants.
Rather than approach a banker wondering what he or she can do for you, think about how the banker is wondering what you can do for him or her. Keep the following "Banker Wants" in mind:
Want #1: Bankers want to make loans. For most banks, commercial and industrial loans are the primary source of income. They simply take depositors' money and lend it to creditworthy borrowers. Banks are earning somewhere between zero and two percentage points above the prime commercial lending rate (currently 6 percent) and paying between zero and 3 percent for deposits. Not a bad gross profit margin. Although a bank could play it safe by not making any loans and simply buying Treasury securities, it probably wouldn't make enough money doings o. Today, if a bank doesn't make enough money, it gets shutdown or taken over. Bankers are just like everyone else; they want to keep their jobs and their job is to make loans.
When working with your existing or prospective banker, have the attitude that the banker wants to make the loan and is looking for some way to structure a deal that serves both your needs and his needs. Banks make money only when they say "yes" to a loan request.
Want #2: Bankers want to match assets and liabilities. If you want to borrow to finance the growth of your short-term assets (primarily inventories and receivables), borrow short term. If you want to borrow to finance the growth of your long-term assets (property, plant and equipment), borrow long term. Borrowing short to finance long, or vice versa, may create cash flow problems that will jeopardize loan repayment. Don't ask your banker to mismatch assets and liabilities.
Want #3: Bankers want their loans repaid. Although this statement seems obvious, it's surprising the number of businesspeople who aren't familiar with the standard definition of a loan: money lent at interest for the borrower's temporary use. Banks are in the business of providing short-term and medium term credit; they are not in the business of providing permanent capital. Always be able to show your banker how you can repay your existing loans, and if requesting a new loan, how you will be able to repay it.
Want #4: Bankers want two sources of loan repayment. Although you may be asking for one loan, a banker wants two repayment sources in case one fails. The two sources are cash flow and collateral. Remember applying for your first home mortgage? The banker required a certain minimum level of income (cash flow) and required a certain minimum appraised value of the property (collateral). Bankers want historical, demonstrated cash flow, not prospective cash flows. Show your banker that historically the profits generated by your firm are at least sufficient to pay all your debts, and also will be sufficient to pay back the new loan.
Banks avoid making loans where the cash flow needed to repay the loan will be generated only if the project the bank finances is successful. If you're asking for a short-term (i. e. less than one year) working capital loan, show the banker how you can convert your current assets into cash by selling your inventory in the normalcourse of business and collecting the resulting receivable (cash flow), and then be able to retire your current liabilities, which include the bank's short-term loan.
In case this primary source of repayment fails, show the banker the secondary source of repayment (the collateral) and that the liquidation value of the receivables and inventories will be sufficient to repay the loan. Be prepared to show this with an appraisal. If you're looking for a long-term loan (i.e. more than one year), show the banker how the incremental profits generated by the long term asset will be sufficient to repay the loan.
If the primary source of repayment (cash flow) were to fail, show the banker how the secondary source of repayment (collateral) would be sufficient to repay the loan upon liquidation. Again, be prepared to defend your position with an appraisal.
Want #5: Bankers want minimal risk. Banks lend someone else's (their depositors') money to creditworthy customers, and they can't afford to forgo their fiduciary duty by losing that money. If a bank charges off more than one quarter of one percent of its total loans it gets a very nasty letter from bank regulators who question the soundness of the bank's management.
The average business suffers higher credit losses than a bank can post. A bank's maximum return also is its minimum return: all of its principal lent plus accrued interest, no more, no less. A bank can't share in the upside of a deal, so you can't ask it to share in the downside.
Want #6: Bankers want information. Be willing to submit to your banker on a monthly basis a balance sheet, an income statement, a cash flow statement, a listing and aging of both accounts receivable and accounts payable, and a summary sheet showing orders, shipments, and backlog. This monthly operating data is critical to you; share it with your banker so he or she can understand your business better, and therefore respond better and faster to your loan request.
In addition, make a point of meeting personally with your banker over breakfast or lunch once a quarter. Even if there is nothing specific on the agenda, these frequent meetings open up the lines of communication and create a stronger relationship.
And never delay delivering bad news. The best approach is to provide your banker with notice of the impending problem as far in advance as possible. This shows the bank that you are aware of the problem and are taking appropriate action to resolve it. Delivering the bad news after the fact may look like you were ill-prepared and caught off-guard.
Want #7: Bankers want long term relationships: Most companies these days conduct business on the basis of a long-term relationship, not just on a transactional basis. Introduce yourself and your firm to a bank well in advance of needing its services, and take the time to learn as much as possible about each other. Give your banker plenty of time to consider your loan request. When confronted with an unrealistic time constraint ("We need this loan yesterday because we have to pay this past-due invoice"), the banker may choose to error on the side of conservatism and decline the loan request.
In summary, you can build a long-term, mutually beneficial relationship with your banker. Take the approach that bankers want to make loans, and that they want them repaid. Match assets and liabilities, and provide two sources of repayment for each loan. Provide your banker with a wealth of timely, accurate information, and meet regularly so your banker can truly learn your business. Understand that bankers are not in the business of providing risk capital because they're lending someone else's money, and they can't take all the risk while the borrower takes all the reward.
There is one more reason to be nice to bankers. Unlike the old days when banking was highly regulated and profits were virtually guaranteed, banking today is a difficult, competitive industry undergoing wrenching changes. All the bankers I've met in this town are just like the rest of us – working hard to satisfy shareholders and customers. The difference is, they've got regulators bashing them, too.