12 Steps to a Loan Renewal in 2010

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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“Temporary setback” in entrepreneur-speak rings of “loan default” in lender speak. Lenders hate bad news, even when they’re expecting it. They hate it even more when federal regulators are already giving their own financial statements the stink-eye. As a result, while you’re probably happy to have last year behind you, your banker may not be so willing to consider it history.

Don’t assume your bank loan — even a 15 year term loan — is yours to keep just because you have a written loan agreement. Buried in the fine print is an “insecurity clause” that allows your lender to demand repayment any time they get nervous. Let’s face it, bankers live by the golden rule...he who has the gold rules...so it’s your job to make sure your 2009 financial statements don’t send them running for the hills.

I was a commercial lender during the credit crunch and recession of the early ‘90s. I sat at ground zero and witnessed how worried bankers — shell-shocked by their own capitalization issues — scrambled to keep their commercial loan portfolios from driving them deeper in the hole.

While real estate borrowers were at the core of the implosion (sound familiar?), small business borrowers were caught in the fallout. Come time for their annual loan reviews, even a perfect payment history offered no protection from bankers who saw cataclysm in every financial tremor.

A new label, the “non-performing performing loan,” crept into credit committee conversations. For a borrower, the label was the kiss of death. Two years of losses, a weak balance sheet, or even a troubled competitor could earn a company that caustic label. Eager to protect their capital, banks invite their non-performing performers to either find a new lender or usher them off to what’s known as the work-out area of the bank v a.k.a. the knee breakers — the only thing they tried to work out was how to get their money back.

An owner of a company caught in this wave of irrationality had few options. The bank down the street had no interest in their competitor's rubble. Finance companies, known for their higher risk appetite, sifted out the best of the battered deals. Investors combed the wreckage for hidden treasures.

So how do you protect your company from being crushed in the crunch come time for this year’s loan renewal?

1. Figure out if you’re at risk. The biggest red flags include:

• net losses;
• lower revenue, gross profit margin, or profitability;
• overdrafts;
• decline in collateral value;
• violation of loan terms; slower accounts receivable turnover;
• lower personal credit score;
• multiple queries from other lenders on your credit report (which tells your banker you’re shopping for loans).

2. Reread your loan agreement and be sure to avoid anything that violates its covenants and conditions such as:

• failure to “clean up” or reduce your line of credit to zero;
• missing agreed-upon financial ratios;
• allowing your loan amount to exceed collateral ratios;
• incurring new debt;
• using your line of credit to purchase equipment or property.

3. Plan to personally deliver your financial statements when they’re due. Take that opportunity to discuss what you’ve done or are doing to increase income, reduce expenses, or speed up your cash flow. You might even prepare a revised financial statement showing how those changes would have improved your 2009 performance.

4. If 2010 is trending upward, prepare an interim financial statement or informal report to demonstrate that. If things are dire, prepare a worst-case scenario to show that you’ve thought ahead and know how you’re going to stop the bleeding.

5. Keep your lender in the loop for any good news about your company, customers, or industry.

6. Keep an eye on your suppliers, customers, competitors, and industry. In addition to the chance that their problems will roll downhill, publicity about any difficulties may put your lender on alert.

7. Check your personal credit report. Since the last recession, credit scoring has all but replaced the traditional “5 Cs of Credit” approach to small business loan decisions (character, capacity, collateral, conditions, and capital). As a result, it’s crucial that you review your credit report for any signs of trouble.

You can get a free copy at AnnualCreditReport.com. Order one from each of the three reporting agencies; you never know which one your lender will use and what’s reported on one, may not be on another. While you’re there, pay the extra money for a copy of your credit score from at least one agency. If you spot any errors in your report, dispute them immediately and in writing.

8. Try to keep your consumer lines of credit and credit card balances at less than half of your credit limit.

9. Talk to your accountant about how to make last year’s performance look as strong as possible. Avoid reassigning any expense that lowers your gross profit margin (e.g. assigning your sales staff expense to cost-of-goods-sold versus marketing expense).

10. Watch for trouble at your bank. Their financial problems could become yours.

11. If you’re not already personally guaranteeing your business loan, prepare yourself for that conversation as well as one about additional collateral (such as your home). Your reluctance to provide these tells your lender that you’re willing to risk their assets, but not your own. If you do have to take the hit, dampen the blow by pushing your lender for an agreement on financial targets that will trigger the release of the added security.

12. In an effort to help small businesses recover from the recession, the SBA has streamlined the approval process, increased the guaranteed portion of the loans (so lenders will be more inclined to lend), lowered their fees, extended their terms, and most importantly, revised the rules on their most popular loan programs (7a and CDC) to allow them to fund replacement debt. If it looks like you’ll be asked to find a new home for your loan, or if you want to lighten the load on your existing payments, an SBA lender may be a good choice.

When then public enemy #1, John Dillinger, was asked, “Why do you rob banks?” he replied, “Because that’s where the money is.” Sage advice for business owners, I’d say. Not the robbing part, of course. While a Tommy Gun assault may cross your mind from time to time, it has never proven to offer the basis for a long term relationship with a banker.

Have you had your annual chat with your lender yet? For better or for worse, we’d love to hear about it.