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University of Massachusetts Amherst

Family Business Center

Wait and Hope, or Speak Up Now?
When and How to Communicate with Your Bank When Business Is Down

by Joseph P. Shaw, First Vice President-Regional Team Leader Northern CT/ Western MA, First Niagara Financial Group

James, the owner of a light manufacturing company, is worried. The economic downturn has led to 20% drop in his sales, and he isn’t quite sure when he can expect a turnaround. In the short term, he has come up with a plan to cut expenses, reduce his staff, and lower his overhead. But his receivables are going down fast, and he’s worried he won’t be able to keep up. He’s using his available cash to pay his vendors, but as he submits his borrowing base certificate each month to his bank, he’s growing concerned that he soon won’t have enough collateral to back up his line of credit, and it may lead to repercussions. He comes to a crossroads — should he wait to see if his expense-reduction plan works and his company returns to profitability, or should he notify his bank now that there are some troubling warning signs on the horizon?

If This Sounds Familiar, You’re Not Alone

There is hardly an industry today that isn’t experiencing some degree of pain. Yet no one knows exactly how far their company is going to slip, or when to expect a broad recovery. So the question facing many business owners today — perhaps you too — is: “how much should I share with my bank, and when?” Raising a red flag early scares many business owners. They believe it could lead to an immediate rate change, or, worse, could prompt their bank to shut down the company’s line of credit altogether. Facing mounting pressure already, business owners suspect putting their bankers on alert will only add to the heat. And quite simply, many see no upside in sharing worries before they turn into real problems. They only see the downside: that it could expose vulnerabilities that ultimately lead to a change in their risk profiles. Those fears, while human, are largely unfounded, and could be dangerous to your company.

Communication Helps; Surprises Hurt

When considering the risk of each borrower, your bank looks at more than just your financial statements. They also consider the quality and credibility of your company’s management. As a result, communicating with your bank — early and often, whether it is good news or bad — helps to secure the trust of your bankers, regardless of the market cycle. Conversely, surprising your bankers with news that could have been shared earlier cuts into your credibility, and is likely to make your bank more cautious — no matter what the numbers say. This is especially relevant when business is down. Clearly, your bank has to make loan decisions that are commensurate with the level of risk it calculates for each borrower. So of course it is possible that a serious and sustained downturn in your business could ultimately impact the rates, fees, or terms of your loan. But the business loss would be what prompts that, not the communication about it. In fact, the earlier you communicate, the greater chance you have of avoiding changes. From the bank’s perspective, finding out early provides important planning time. It gives the bank’s loan committee a chance to fully understand your situation and get comfortable with what may be an uptick in risk. It also opens up options to explore mutually beneficial solutions. Working together, you may find ways to restructure the loan — for example, by using existing value in the company’s assets that the bank hadn’t recognized previously (such as equipment that can be appraised and then collateralized). In the end, speaking up early gives you, and your bankers, breathing room. Instead of turning up the heat, your bank may be just the partner you need to reduce the pressure.

How to Tell Your Bank

Once you’ve decided to notify your bank, it’s important you do it in the right way. Take the time to get ready, and present your case. Don’t just say you’re drowning and expect a lifeboat. Explain what your problem is, how you got into it, and how you can foresee getting out. The object is to get the bank to buy in to your plan. So you have to come to the table ready to drive the discussion, and with an organized set of materials. Be ready to provide:

• Interim financial statements, including year-over-year comparisons;
• Projections by quarter. If you expect to violate a debt covenant, say so; but also include a reasonable expectation for when you may be back in compliance;
• Details about any extraordinary items. If you’ve had a lawsuit, a fine, or have had to write off a significant receivable due to a single large customer filing bankruptcy, note those as one-time, extraordinary events; and
• An honest and practical recovery plan. It is better to show a well-thought-out recovery plan that takes 18 months to implement rather than an unrealistic plan showing a quick recovery. Include a downside scenario and response plan. And remember that, in the eyes of the bank, an expense-based recovery plan has far less execution risk than something like adding a new product line.

Keep in Touch

As a rule of thumb, if you’re wondering if the scenario you’re facing is worth discussing with your bank — it is. Just like any other strong relationship, the one you build with your bank should be based on a steady, open dialogue. By establishing credibility and securing trust, you form a bond that can be especially beneficial when your company is facing challenges. And by keeping in touch throughout market cycles, that bond will only increase in strength.

Now pick up that phone…

 

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