Following the last financial crisis, the focus on the safety and soundness of banks was good for the financial system.
New bank liquidity and capital policies, among other things, strengthened a weakened system. The banking system today is stronger, with more assets and better loan underwriting standards.
Despite good intentions, however, these rules, that were a compromise of regulation and politics, created a new and untested regulatory framework that may well have unintended consequences for financial markets, especially small and mid-sized businesses.
The Volker Rule, for example, bans propriety trading by banks. This prohibition, when combined with enhanced capital and liquidity requirements has led banks to avoid some activity in key equity and debt markets.
The Most Vulnerable Are …
Why should the small to mid-sized business care? Because they are the most vulnerable. New capital, liquidity and trading rules for banks are interrelated and falling security values and highly tightened markets force banks to reduce assets and hoard their liquidity in order to pass regulatory tests. If the banks and the companies they serve are not able to raise capital in a weak market, the resulting contractions in loans leads to reduction in spending, layoffs and pain for middle America.
Small Businesses are impacted especially hard by this. Studies by Harvard University and the Richmond Federal Reserve have concluded that the Dodd Frank financial law has impacted regional and community banks disproportionately. Between 2007 and 2013, the number of community banks declined by 41%. These are the very banks that make up a significant amount of lending in community real estate, agriculture and small to mid-sized businesses.
Forced To Retain More Capital …
Although many banks continued to lend in the 2008 crisis, this next time, the new capital and regulatory environment will cause banks to retain more capital with an eye toward satisfying the regulators; rather than meeting the needs of their customers. The larger banks need to preserve capital will intensify because of new rules requiring them to revalue assets as they become riskier as well as decreasing their capital reserves from unrealized securities losses.
If banks, both small and large, reduce their lending, customers will have a more difficult time finding lending in a declining market. While non-bank lenders and financial institutions are a potential source of credit, their overall lending capacity is not sufficient to cover the shortfall.
Banks Under Great Pressure To …
While the news reports tell consumers and businesses that the regulators are urging banks to lend money, the banks themselves feel regulatory field forces are exerting great pressure to eliminate questionable loans and increase capital reserves.
Banks themselves often do their customers no favor. As individual customer credits become more subject to regulator scrutiny, bankers are often torn between the corporate need to maintain the customer and the regulating effect on capital reserves. So the message to the customer remains mixed regarding the status of a loan that the regulators determine is risky.
How Should A Borrower Behave?
Revitalization Partners has recently worked with a number of companies in the $25 -$50 million revenue range. All had loans that were classified as “troubled” by bank regulators. Each of these lenders had issued multiple forbearance agreements to these borrowers, leading the borrowers to believe that as things improved, their normal banking relationships would be restored.
When actually asked directly about a potential return to a normal banking relationship, each of the banks indicated that such a move was highly unlikely. Yet, each borrower believed it would happen. Miscommunication or mixed message?
How should a borrower behave if they are in technical or actual default of a loan? The first thing to realize that it does happen and most banks are prepared to work with you when it does. Once! A single forbearance agreement need not be the end of your relationship with the bank. But, if at the end of that first forbearance agreement, your loan is not in compliance, it is time to take other action.
Make Sure Your Bank Knows That …
First, make certain that your bank is clear that you understand the seriousness of the situation. Let them know that you understand that you may need a new lender and that you want their assistance in the transition.
Just as you have a problem, your banker has a problem and demonstrating an understanding of that problem and desire to solve it goes a long way. Make certain that you not only talk with the banker handling your loan, but with the credit officer as well. He or She can play an important role in the management of your account.
If you’re a banker working with a Borrower with a troubled loan, the most important thing is to make certain that your borrower completely understands both the terms of the forbearance agreement and the position of the bank regarding the overall credit. Many borrowers do not understand the severity or urgency of the situation and the sooner you are clear regarding the view of the bank, the more time a borrower has to meet their borrowing needs.
We Were Able To Help Each Company …
As we have written in the past, there are lenders for almost every business and the important thing is to find the lender that fits your situation. We were able to help each of the companies we worked with find a new lender.
Demonstrating to your current bank that you understand the issues and keeping them apprised of both your current business situation and efforts to solve the problem can insure a smooth separation for both your business and the bank. And who knows: The day may come when you’re happily back together.
Al Davis and Bill Lawrence are our guest bloggers this week. Al and Bill are Principals with Seattle-based Revitalization Partners, one of the top U.S. restructuring firms, working with all sizes of businesses to help solve complex operational and financial problems.