July 2022 Bar Bulletin
By Bill Lawrence
There is no question that major economic indicators are pointing in the wrong direction and as a result, small to medium-size businesses are facing a number of challenges in maintaining profitability, let alone trying to initiate growth plans. Given that situation, one of the looming challenges that many companies will face is obtaining or renewing lines of credit with their lender. The outcome of those discussions will be of key interest to creditors as well as bankruptcy attorneys.
Since the start of COVID, federal and state governments have infused massive amounts of capital into the system through forgivable PPP loans and other related programs. This has helped thousands of companies survive and in fact, in many cases thrive, as they used this new capital to take advantage of increased demand. However, those programs have now ended, and companies must now deal with multiple economic challenges that could negatively impact their operating results, using conventional lines of credit and working capital to fund operations. As these pressures continue to mount, with seemingly no end in sight, it’s important for companies to assess their relationship with their lenders.
In order to understand the current mindset of the lending community, we offer an overview of the second quarter 2022 survey sponsored by Phoenix Management Services that outlines the current lending climate in America. This research was published recently and gives us some insight into what banks, asset-based lenders, and other capital providers in the financial eco-system are thinking.
One of the most significant findings reveals that when lenders were asked which risk presents the greatest potential to impact the U.S. economy, 56% believe supply chain distributions problems pose the greatest risk. The second biggest risk according to 22% of the respondents, relates to federal reserve policy. Another significant concern noted is rising inflation, as it impacts most if not all borrowers. Seventy-two percent of the lenders surveyed expect inflation to continue rising, which will cause further economic stress domestically by forcing consumers to decide which goods and services are no longer worth buying.
Notably, lenders’ optimism in the near-term economy decreased 10-
percentage points from Q1/22. In the current quarter, the majority (39%) believe the economy will perform at a “C” and “D” level during the next six months.
Lenders were also asked which industries they expected to experience the greatest volatility. Topping the list with 64% of those surveyed, was the belief that manufacturing industries will experience significant volatility, up from 57% the prior quarter. Forty-four percent believe real estate and rental/leasing will experience significant volatility, which increased from 14% last quarter. This represents a dramatic threefold hike in three months. Registering third on the list is the hotel and food service industry, where 39% of lenders believe operators will experience extreme volatility — up from 21% the prior quarter.
Further, it’s important to note that 71% of lenders expect that loan losses and bankruptcies will increase in the near term. This represents an increase from the first quarter 2022 as well.
The findings suggest that lenders will likely scrutinize financial reports more thoroughly from companies in their portfolio in an effort to head off potential loan losses. Given that most expect loan losses to increase in the near term, it’s clear that lenders will be doing everything possible to mitigate having to write off bad credits.
This is a strong signal to CEOs and CFOs of all companies to make sure they have open lines of communication with their lenders and proactively discuss the company’s plans, challenges, and action steps that address operating issues which can compromise cash flow — and most importantly, do it early enough to mitigate risk to the lender. This is especially important if a company operates in one of those aforementioned top three industries on the banker “watch list.”
Businesses will want to pay particular attention to how closely the lender reviews their financial information and the type of questions they ask along the way. This may provide valuable insights as to where the company stands with its lender. If management is unsure of how various data points are being interpreted, it’s important to have the banker give feedback regarding any issues or concerns they may have. What type of risks do they see? Those answers enable management proactively to communicate what the business is doing to mitigate these perceived threats. As we often remind clients, it’s not necessarily what you think about the business that’s important, it’s what your lender thinks.
While proactive communication is the first step, it’s also extremely important to have a plan B. Maintaining relationships with a number of commercial and asset-based lenders is vital. Understanding how other lenders view the business may provide a different perspective and creates options to fall back on should the lender decide not to renew the company’s line of credit.
Working proactively with financial partners and understanding how they feel about the performance of the company or its industry may be the difference between a business having the liquidity it needs to manage effectively its way through perilous financial periods, or scrambling at the last minute to find lending options that may not be the most cost-effective and further endanger its continued viability. Also, it’s important for management not to be afraid to ask for help along the way, as the future of the business may depend on it.
Bill Lawrence is a Principal at Seattle-based restructuring and corporate advisory firm Revitalization Partners. He and his partners write regularly about the operational and financial challenges companies face in successfully restructuring companies. Learn more in the firm’s blog as well as its e-book, “Insights to Grow, Build or Save Your Business!”