Walt A. Nelson
During the past several months, bankers and their commercial loan customers have been sniping at each other in the Springfield Business Journal and elsewhere.
Rather than assigning blame, perhaps a review of basic lending issues would be helpful. These tips are organized into two categories: ratios and relationships.
Ratio analysis
Although commercial loan applicants typically provide a complete ratio analysis of their company balance sheets and income statements, it also is important to emphasize the relationship between sales, profits, debt and total assets.
Sales growth depends on total assets.
If your firm anticipates a high level of sales growth, then the spreadsheets supporting your commercial loan application must show the source of capital needed to support sales growth.
Show calculations for external funds needed, termed EFN but also referred to as called RNF (required new funds) and AFN (alternative funds needed). Be sure to indicate that the firm's profitability is the source of some of the new funds needed, the balance provided by funds requested in the loan application.
Profits depend on total assets.
Your commercial loan application also should demonstrate that assets acquired with loan funds will improve the firm's degree of combined leverage.
DCL is the ratio of new sales to additional profitability. DCL takes into account operating leverage and financial leverage.
Once breakeven has been achieved, there is a production path or point at which the interaction of debts and assets multiply firm profitability. For example, if the DCL is 1.5, then for every 1 percent increase in sales, net income increases by 1.5 percent. This information is very useful to the firm's marketing department as well as to the prospective lender.
Relationships analysis
If you are my banker, you are not my friend and vice versa. The loan officer owes loyalty to bank profitability and not the commercial loan customer.
Bankers believe in diversification, too.
They make loans to firms in the same industry, not knowing which ones will survive. Suppose the bank has loans out to firms G and H, which compete in the same industry. The financials for Firm H begin to deteriorate.
The bank reacts by imposing stricter terms on Firm H, anticipating that Firm H will fail. When Firm H defaults, the bank calls officials at Firm G to request that G take over H with special financing provided. This example is related to the observation of frontier bankers two centuries ago that "it takes three bankruptcies to make a ranch."
Character captures credit.
The five Cs of credit are character, collateral, capacity (cash flow), capital (net worth) and conditions. Conditions are terrible.
Nobody believes the stated values of collateral, net worth or the dependability of cash flow. So the lender really is stuck with a belief in the character of the prospective borrower.
Here is the issue: Does the borrower have character or is the borrower a character?
Alan Greenspan once remarked, "Bad loans are made during good times." Unfortunately, the inverse also is often true: Good loans are not made during bad times.
If negotiations are at an impasse, remember the best rule: Never threaten, just leave.[[In-content Ad]]
Professor Walt A. Nelson teaches banking at Missouri State University. He can be reached at waltnelson@missouristate.edu.
