This article are provided for information purposes only, and are not intended as legal advice.


Business strategies in tough times – Part I

March 9th, 2009

The economy is shrinking, your clients are in financial difficulty because their bank will not extend them credit and all their customers are slowing down payments therefore your customers are slowing down payment to you. This in turn is creating cash flow issues for your firm.  What do you do?

 

Do you have a solid business which needs additional working capital?  If so, do you qualify for a bank loan?  Some of the banks have had major financial difficulties and are required to reduce the amount that they lend to their customers.  To understand the significance of a bank loss, think of the following:  your banker writes off $1 billion of mortgages and generates a $1 billion loss in their financial statements.  The banking authorities allow the bank to leverage their equity 10 to 1 in Canada which means that the bank must reduce their maximum lending limit by 10x this loss or $10 billion.  Each bank allocates a certain amount to industry sections.  If the bank allocates loans to different industry sectors for example 40% relates to real estate, 20% to retail, 20% to wholesale and 20% to manufacturing sectors that means that the bank must reduce their loans to the real estate industry by $4 billion in my example and by $2 billion to the retail, wholesale and manufacturing sectors. 

 

If the bank had loaned the maximum amount allocated to their customers in  each of industry sector, the bank must call some of their customer loans even though the customers may be in compliant with their banking covenants.  The bank may reduce the line of credit to many customers to get under the lending limit or call the loan for others to comply with their legislation.  In Canada, the banks lend 10 to 1 of their equity, I believe the US is 17 to 1 so the implications of a large loss is magnified in the US compared to Canada.  The banks have not reduced their dividends which increase their retained earnings and allow them to lend more money.  This would help them solve the lending problem but the bankers are more worried about their share price then they are about freeing up capital to lend money to their customers.

 

I recently saw a term sheet given by a Canadian bank which said, here are the terms and conditions of your loan agreement and even if you are in compliance with all aspects of your loan agreement, we have the right to call the loan.  I have never seen this wording before.  I am assuming that the bank is near their top of the amount allocated to each industry sector and wants to have the right to reallocate their book of loans at their discretion.

 

 What does this mean to you?  If you are banking with a bank who is at the top of their lending limits and must juggle their allocation between industry sectors, you may be squeezed by your bank because of poor business decisions made by your bank.  You may want to look for another bank who is not in the same financial condition as your bank to get a line of credit that is based on your business operations rather than on the banks problems.


Filed under: Business strategies — Gary Landa @ 8:31 am


1 Comment »


  1. As a former commercial and international credit manager, I have often read the fine print to everything. All credit card companies and some lenders have always reserved the right to call a loan for ‘a myriad of/or for any reason’ (outside of real property or other perfected contractual stipulations re: fixed assets (UCC-US). In pre-reg telecomm we capitalized many baby Bells outright prior to setting up sufficient vendor trade agreements with major banks. If your business is in need of capital — you may also wish to review what types of hard assets you require re: equipment, etc… some publically traded manufacturing sources may be willing to write their own paper again, at a higher rate, without regard for back-end backing in order to boost quarterly results and instill investor confidence. There are many opportunities during a down econ-trend… smart manufacturers and developers will seize the opportunity to boost sales through greater risk (that’s the way it’s always worked:) – MJM

    Comment by MJ McMenamin — March 11, 2009 @ 6:28 pm


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