Commercial Loan Considerations

SOME CONSIDERATIONS FOR THIS CONSERVATIVE LENDING ENVIRONMENT

As a business owner, your primary efforts are likely focused on just keeping your business operating in this environment.  As a result, you may not have given much thought to what you’ll do when your current bank financing matures. The older, more competitive banking market is gone for all but the best customers; a new era of more conservative lending is upon us.

This article will discuss some lending issues we are seeing now and which you will likely see become more prevalent in the next couple of years.

Avoid Covenant Defaults if at All Possible.

While every borrower makes an effort to keep within their loan covenants, that responsibility takes on a vastly more significant role in a conservative lending environment.  When loans are hard to come by, you are more likely to need to stay with your current lender. 

While in the past, loan covenant violations might have resulted in little more than a slap on the wrist.  We are now seeing banks charging significant covenant waiver and default fees, bumping up interest rates across the board and in some cases even imposing new, much stricter, covenants.  While it may sometimes be difficult to remain within your loan covenants, particularly financial covenants, you should seriously consider the impact of a covenant default and know that there is a fairly high likelihood that any violation will now cost your business some serious money.

What to Do – Pay strict attention to the financial and other covenants in your loan documents.  Watch for inadvertent defaults (such as failure to provide timely financial statements).  If you have questions on interpretation of your covenants, we can review your loan documents and discuss options.

Interest Rate Floors, Restricted Rate Options and Other Charges.

We are seeing more and more lenders imposing interest rate floors on their loans along with elimination of the “prime” rate as a borrowing option in favor of a rate based upon overnight LIBOR .  Overnight LIBOR, you may recall, went sky-high last fall when many banks didn’t even trust their counterparts.   While overnight LIBOR is currently quite low, when coupled with an interest rate floor, many borrowers are seeing significant rate increases.

We are also seeing more unused line charges for revolving credit facilities, shorter renewals and overall increases in margins.

What to Do – While you won’t likely be able to avoid these changes when your loans are due, you should start planning now for how these changes might impact your financial results.  Also, sometimes asking for other modifications to loan terms will trigger an opportunity for a bank to modify other terms.  Consider whether you really need any modifications right now.  If your company is doing great right now but may have some concerns down the road, consider asking for an early loan renewal.

Revised Property Values and Advance Rates – Consider the Future.

While revolving credit lines typically come due every one or two years, other loans, such as real estate financings, usually have 3 to 7 year maturities with amortization schedules that result in large balloon payments coming due at maturity.

Many businesses own the real estate they operate in, either directly or through related entities.  If that loan was taken out or last renewed over a year ago, chances are you received an advance rate up to 80% of the fair market value of the real estate .  When that loan may next come due, however, we are expecting significant reductions in valuations and are now seeing advance rates on completed and occupied buildings closer to 60 to 70% of the new appraised value.

What this means is there is likely to be a significant disconnect between the amount which will come due on your real property loan and the amount the bank may advance on that property.  A sample calculation shows this potential result:

In a recent conversation with a commercial banker, we discussed the above scenario.  While the banker said he would try to work with his customer on this disconnect, he essentially stated that for the loan to be renewed, the borrower would need to come up with additional security in order to maintain the current loan balance.  In plain English, the banker will likely want other assets for the bank to attach or ask the company owners to put more cash into the business to pay down the loan (or, left unsaid, the borrower would be in default and claims made on the guarantor).

The above scenario is particularly distressing since these loans are typically cross-collateralized and cross-defaulted with a company’s business assets and loans.   Inability to refinance the property could impact lending to the business itself.

Raising this scenario is not meant to sound the trumpet of impending doom.  However, we want to alert you to potential realities you might face and offer some suggestions as to how to anticipate and potentially diffuse this potential bombshell.

What to Do - Some Options and Advance Planning

Just realizing the above scenario can exist in this new lending environment is a first step. 
If your commercial real property loan is coming due anytime soon and you do not have sufficient equity in the property to weather a reduced advance rate, you need to start planning on how you will address any potential shortfall.    Some options for you to consider are:

Build a Reserve.  Start now if you can but speak with your tax advisor regarding the implications of this option.

Consider an Outright Sale. Is an outright sale an option?  If there is a significant anticipated refinancing shortfall, can the property be sold in advance?  While a new advance rate on your loan might not be enough to pay off the loan, there might still be sufficient value in the property to pay off the current mortgage without having to expose personal assets to liens.   If you are considering consolidation of your operations, this can be an attractive option.

What about a Sale/Leaseback?  If your company is doing well, rather than sell and move, a sale and leaseback of the property can be an alternative. You may be able to sell the property and enter into a long term lease.  Often these transactions are run through private equity firms specializing in real estate acquisitions.

Alternative Lending Options.  There are resources available but they are not always easy to find.  In the current environment, sometimes you might need to speak with multiple lenders to find one that understands your situation and is ready to lend.  How do you find them? Often, an intermediary can be used that has significant experience in locating commercial and alternative lenders. 

Bring in Investors/Partners into the Real Estate.  There are individuals looking for investments even in this market.  If your company is an attractive tenant, sharing the equity with someone can help you reap at least some of the potential upside of the property in years to come.

Plan for Available Capital.  If the company owners have assets which they might want or need to liquidate to inject additional capital or loans into the business or property, you may want to consider appropriate timing to liquidate those assets to take advantage of periodic price spikes and the like.

While not every business will be faced with the same issues and impacts, we can work with you and your financial advisors to help you better understand and prepare for some of these risks and suggest resources for you to consider.  Please call us if you have further questions and we will be happy to help you consider ways to minimize your risks.