Banks are tightening credit standards for business loans, according to the Federal Reserve’s quarterly survey of senior loan officers. This applies to both large and medium-sized banks (shown in the graph above) and small banks. Interest rates on business loans are rising relative to the cost of bank funds. Bankers also report a reduced demand for loans.
Small business owners, as well as corporate CEOs, should talk to bankers regularly, even if they are not currently borrowing money. The conversation needs to go beyond the banker pitching the institution as a great partner. Instead, business owners need to understand where their company stands against the bank’s credit standards. Regardless of whether the company currently has a loan with the bank or not, knowing whether they will qualify for a loan now or in the future will help the company plan.
Questions a credit business should ask its banker
1. Has the bank changed its credit standards in a way that would affect the creditworthiness of our business?
2. If we don’t meet the new credit standards, what options do we have? Would additional information or collateral help?
3. Do you know of other funding opportunities that would be suitable for us?
4. If the recession hurts our sales and profit, at what point will the bank cut off our credit?
5. Do you have any ideas on how we could improve our creditworthiness now so that we are better prepared for a recession?
The last question is the most important, but don’t expect an exact answer. Banks consider various factors and cannot give a one-size-fits-all answer to the question. But a good banker can give the client an idea of how bad things have to get before the bank gets worried. Some companies already have a significant cushion, but others are already skating on thin ice. And unfortunately, many business owners don’t know how thin their ice is.
Some business owners are hesitant to bring up the possibility of problems, but that’s unwise. Every banker knows that recessions hurt companies. Any banker will appreciate a client considering the possibility of a recession and what steps will ensure resilience.
Questions Businesses Without Loans Should Ask Their Banker
Businesses that are not currently borrowing will benefit from an idea of whether they will be bankable if a good deal comes along. For example, suppose a competitor has health problems and needs to sell the business. Or suppose a new opportunity has arisen that will require a large capital investment. Or imagine that a flood imposes short-term hardship on an otherwise healthy business. These situations arise and a wise owner is prepared for them. Here are good questions for companies that are not currently borrowing money from their bank:
1. If we ask for a loan today, is the bank likely to finance it? (The question will likely ask for a purpose for the hypothetical loan, such as purchasing equipment, financing accounts receivable, or acquiring another company.)
2. What loan objectives would the bank prefer?
3. How far is the company now from the bank’s credit standard? If he is creditworthy today, how low could his finances drop before the bank closes the line of credit? If it is not creditworthy today, what would need to improve to become creditworthy?
4. What changes can the company make to improve the bank’s view of its creditworthiness?
The banker will likely want to see the company’s cash flow versus current debt service. The recent trend of sales and profit growth is also important. Liquidity—how much of a company’s assets can quickly be turned into cash—is also a factor. Collateral is important, usually in the form of receivables, inventory or real estate. Credit history is also important.
Most of the time, the banker won’t be able to give a definitive answer, but a good loan officer will be able to help the client understand how close the company is to the dividing line. Some banks have automated the loan approval process to the point that the person talking to the customer does not know what the bank’s standards are. Fortunately, many banks have people who can help business owners understand the basic standards the bank maintains.
Business loans during a recession
The recession provides good opportunities to buy companies that have good financial performance. Some other businesses will be available for purchase, and others will offer land and used equipment for sale. Some brand new equipment may appear if the buyer has canceled an order. Having good credit will help a company take advantage of these opportunities. And early conversations with bankers will speed up the process.
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