Dealing with Lenders When Credit Is Tight

Cynics often joke that banks lend money only to those who can show they don’t really need it. Nowadays, though, that sarcastic comment might actually seem like an understatement to some contractors. In today’s tight credit market, even well-managed and well-capitalized contractors can find themselves struggling to maintain adequate credit lines.

What can a contractor do when credit is needed but lenders are reluctant? There’s no single solution, of course, but here are some positive steps you can take to deal with a credit crisis – or even better, to prevent one from developing:

1. Cultivate – even cherish – a healthy relationship with your lender. Even long-time customers are finding lenders less accommodating these days, but there’s still no substitute for building and maintaining a solid track record with your bank or other lending source. On the other hand, don’t allow loyalty to cloud your judgement. While now is not a good time to be shopping for a new lender in hopes of achieving a small saving on interest, if your bank is no longer meeting your needs you may have no choice about switching.
2. Be prepared to inject additional capital into the business. One of the most common effects of the current credit crunch is a tightening of loan covenants, particularly a step-up in the required debt-to-worth ratio and other key metrics. In many cases this may require the owner to make an additional investment in the company.
3. Present a complete set of current financial statements including balance sheet, income statement, accounts receivable and aging, job status reports, and cash flow projections backed up by valid contracts. With few exceptions, lenders will ask for CPA/CA-prepared financial statements rather than company-prepared statements or tax returns. Of course, for any project that involves bonding, the surety will also require audited statements.
4. Be prepared to meet additional collateral and documentation requirements. Bankers often ask contractors to pledge personal assets – typically their primary residence – in support of a loan, and it is not unheard of for lenders to require audited financial statements of an owner’s unrelated business interests as well.

If all else fails, you may need to consider alternative lending sources – a credit line with a key materials or equipment supplier, for example. Bear in mind, however, that a new credit line could cause concern at your primary lender and adversely affect key financial ratios your bank is watching.

Adjusting to Today's Credit Reality

Recent months have seen numerous examples of established contracting businesses being turned down for routine renewals of their expiring credit lines, even though they have years of satisfactory history with their banks. In some cases, the new requirements are imposed when the personal connection between lender and contractor is severed due to a merger or acquisition.

Case in point: a well-established landscape contractor was recently informed that his soon-to-expire credit line could not be renewed without a sizable infusion of additional cash in order to comply with the recently acquired bank’s new standards. Although he recognized the importance of maintaining longstanding banking relationships whenever possible, the owner was reluctant to tie up virtually all of his personal net worth in the business, which is what the new standards would have required.

Feeling he had no alternative, the contractor began searching for a new lender, and found a local, community bank where the lending philosophy seemed very similar to the approach his existing bank had pursued prior to acquisition.

The smaller bank, eager to gain market share, recognized an opportunity to establish a new relationship. What’s more, since it had not been as severely affected by the national economy, it was able to be more flexible, allowing the company to establish a new line of credit with only a minimal increase in the owner’s investment.

Q: I managed to obtain a business loan to establish my small contracting business and I’ve never missed a scheduled payment. But the bank recently notified me I am not in compliance with certain loan covenants. What other covenants do banks usually require, and why aren’t timely payments enough to keep my loan in good standing?

A: To reduce their risk of loss, most banks generally require a borrower to maintain certain minimum financial benchmarks for the loan to be considered in good standing. Typical financial covenants include:

• Minimum current ratio
• Maximum debt-to-worth ratio
• Minimum net working capital
• Minimum tangible net worth