Obtaining credit: Proven best practices
The recession left a significant and destructive mark on the lending environment—commercial and industrial loan volume in the United States fell a stark 23 percent in the course of only two years (October 2008 – October 2010), largely due to GDP decreases and the ensuing write offs.(1) During this two year period, loans coming to maturity and write offs counteracted any new loans that were issued throughout the recession. Banks were struggling to maintain profitability since net cash flows were negatively impacted by the loss of interest payments, and regulators stepped in. As a result, the process of obtaining credit now is, according to some borrowers, a much more painstaking and lengthy process than in the past, sometimes taking up to twice as long to secure even a low-risk loan.
When seeking credit, understanding the current pressures in the lending sphere will enable a borrower to prepare accordingly. First and foremost, understand why lenders are being more cautious with lines of credit. Average net interest margin (the spread between percent interest collected by the bank and the percent interest paid out by the bank) has been steadily decreasing from 3.84 percent at the end of March 2010 to 3.57 percent at the end of March 2011.(2) With this smaller margin and the additional regulations, lenders’ prolonged and lengthy analysis for each credit application is justified and something that borrowers will have to accept.
What will banks look at during the analysis? Banks evaluate prospective clients in terms of the risk-return tradeoff. A client must be able to demonstrate, with a high degree of certainty, that their business can withstand an economic downturn.
According to Rodrigo Ciparrone, Chief Financial Officer of GVT, a telecommunications provider, there are several, proven best practices that will make you demonstrate creditworthiness. “Investment banks follow their due diligence; when requesting a loan, a best practice is to report your company’s cash flow projections and balance sheet projections for the next five to ten years. Banks will want to understand you company’s current debt structure and the seniority of the debt you already have in place,” said Ciparrone. When applying for a loan, there is no such thing as being over-prepared. Accurate and detailed forecasting, with substantiating documents, will provide borrowers with an advantage over their less-organized peers.
Likewise, being transparent is another best practice for successfully obtaining a loan. It is crucial for a borrower to mention, sooner rather than later, anything in their financials that might be less than perfect. Ciparrone states, “It is imperative to be realistic regarding your company’s plans. Your company will have to perform, and you do not want to sub-perform on these commitments, as you will encounter problems with your company’s ratings if you fail to reach your forecasted goals.”
“It is vital that all relevant items are disclosed, and you may even want to discuss items or commitments that are not on the balance sheet,” Ciparrone suggests. By helping the lender to understand your business and the obstacles it faces, you build a relationship based on trust. A borrower that has a strong relationship with their lender is more apt to continue receiving services through financial difficulties that may arise.
Although the lending environment has not yet returned to pre-recessionary levels, we are seeing some improvement. During the eight months directly following the October 2008 – October 2010 decline in loan volume, overall commercial and industrial loan volume from all U.S. banks has since increased by five percent. The growth is a result of new loans exceeding maturities and write-offs, which is a promising sign that banks are, though slowly, placing trust in U.S. businesses again.
1 Loan volume data provided by the Federal Reserve Bank of St. Louis’ Economic Research Division. It can be accessed at http://research.stlouisfed.org/fred2.
2 Net Interest Margin for all U.S. Banks,” Federal Financial Institutions Examination Council (July 2011). Accessible at http://research.stlouisfed.org/fred2/series/USNIM.