In today’s cloudy economic climate
business owners still need the opportunity to borrow money to either start their company, expand their current business or make those necessary
improvements. However, as the job
market continues to shrink and companies across the country continue to
tighten their belts, are banks still willing to lend money to business owners in
need?
“Houston is a bit of an anomaly compared to the rest of the country in terms
of having a stable economy,” says Cecil
Arnim, senior vice president and business banking market manager for Wells
Fargo in Houston. “Commercial banks
are certainly doing more in-depth analysis than before and more stress testing
of repayment scenarios.”
Smart Business talked to Arnim to
better understand commercial lending
from the bank’s perspective.
What does a bank look at when considering
whether to provide a commercial loan?
When we look at a commercial client
one of the overriding business factors is
the equity investment the client is making. That customer looks at a rate of
return anywhere from 15 to 20 percent
at a minimum in order to invest. In
order to achieve that return, the customer will have to be patient as it may
take from one to two years for the
investment to bear that kind of fruit.
In commercial lending, on my best
day, I may have a spread of 3 percent,
and that, by definition, makes me risk
averse. If the relationship requires extra
work or analysis, if you start looking at
allocating salary and man hours, a 3
percent spread may drop to 1 percent
very quickly. So I may not be making as
much on that deal over the long term.
What we are trying to get across to
our customers is that because our commercial lending spreads are so razor
thin, typically that’s why we require a
lot of financial information so that we can fully analyze that company and its
ability to repay the loan. By the same
token, because we are fully informed,
debt always tends to be cheaper than
equity. If I want equity investors I’ve got
to pay them over time between 15 and
20 percent or more. On the amount I
borrowed from my bank I may be paying prime plus one, which could be 6 or
7 percent. The debt costs less but I have
a very definitive repayment schedule
and I have to continue to deliver updated financial information to the lending
institution.
A second point every client needs to
understand is that banks can only provide service as well as the client allows it
to provide. If a client provides me with
updated financial information when it is
expected to do so by virtue of the loan
documents then we have a good idea of
where that company stands. So when it
has that emergency expense and comes
to us for help we can move that much
quicker because we have the updated
information.
With such a thin spread, what is the incentive for a bank to provide a commercial
loan?
A banking relationship is more than
just lending money. It’s the deposit side,
the treasury and cash management; it’s
all of the other products and services
we provide. Typically the client will
have the greatest need on the lending
side, whether it’s short-term working
capital needs or maybe a client that’s
been renting warehouse space and is
considering taking the plunge and buying a building. Individuals with a strong
capital structure and the ability to
repay benefit by being able to borrow
from a commercial bank at much
cheaper rates than those who have to
go out and find investors or pay the full
price themselves. Is a company better
off financing 70 to 80 percent of a building at 6 percent when for that same
investment it could have invested in an
alternative business that paid greater
than 6 percent?
What red flags do banks look for?
A client with a fair amount of debt on
the books that is greater than the
amount of equity is one red flag. Small-to medium-sized businesses are usually
leveraged from one to two times but
once you start getting more than three
times the equity we start having greater
concerns.
Another red flag is when a company
takes a long time to provide financial
information or keeps making excuses
for the delays. Finally, companies that
are always changing CPAs is a great
concern. Is it a matter of them firing the
CPAs or do the CPAs fire them? Either
way is not good.
CECIL ARNIM is senior vice president and business banking market manager for Wells Fargo in Houston. Reach him at (832) 251-5505 or [email protected].
