What You Need to Know If You're Trying to Get a Bank Loan

In the fourth quarter of 2010 the FDIC's list of "problem institutions" grew to 884 banks -- the highest number since the savings and loan crisis in the early 1990s. It's no wonder so many banks remain reluctant lenders to small businesses as they continue the scramble to shore up their portfolios.

The story isn't much different with many of the smaller regional banks. Institutions that were aggressively writing loans only 18 months ago now want only companies "willing to wait a year or two to prove themselves in order to get financing." (That is a direct quote from a loan officer at a well-known regional bank.) In other words, they want your deposits now and will lend you money later -- maybe.

Plus, many lenders are applying more "aggressive pricing" with their small business customers. A recent American Banker newsletter (sorry, no link) encouraged member community banks to raise loan fees and interest rates for small firms. The reasoning? Most companies only change banks when they experience poor customer service, so they will absorb the increased fees without much resistance. (Check your statements to see if your bank followed the advice.)

In short, it's rough out there. If you're going after a bank loan, you better know how to position your business for this lending environment.

We have three suggestions for you. They're best practices under any circumstances, but absolutely critical right now.

1. Investigate the health of the bank.
You won't find the FDIC's list of problem institutions. It's kept secret; otherwise it would be a self-fulfilling prophecy. But you can get a pretty good idea by asking these questions:

• Have they posted a profit or loss in the last four quarters?
• Are their earnings decreasing or increasing?
• Does the bank have adequate liquidity?
• Are they in the middle of a merger or have they recently been acquired?

2. Don't be blindsided.
Don't take your current banking relationship for granted. Banks are far less forgiving than they were in the previous decade and more and more are exercising their "fine print" policies. A good payment history alone may not be enough to protect you.

We worked with two clients, a software company in the Midwest and a large ($100 million plus) service firm, that learned that lesson the hard way. They had perfect payment histories, but their loan covenants required them to maintain certain levels of receivables and inventory. When the recession hit, sales slipped at both companies and their inventories and receivables fell below the necessary level. This had happened from time to time in the past, but their bankers overlooked it then. Not anymore. Due to the increasing number of business failures and the greater scrutiny of their own portfolios, the bankers did what they had to do.

For the software company, it meant an interest rate hike from prime plus one to 10%. The service firm wasn't as lucky: The business lost its line of credit. Both businesses were forced to seek other banking relationships at a time when they were in a weak bargaining position.

The lesson: Read your covenants carefully! If you are out of covenant, beware and be aware. Make a business plan to get back into covenant as quickly as possible. If you do get that ominous phone call or letter, presenting that plan and showing your progress can help buy additional time.

3. Follow the money.
Consider establishing a relationship with a back-up bank. Smaller, more aggressive, local banks tend to stay current on state, local, and particularly the federal programs that are or will be offered to stimulate the small business market. This is likely to be the winning combination for the near future.

Jim Chessen, the chief economist at the American Banker's Association, said recently that the improving economic outlook is convincing banks to lend at terms that are more favorable to businesses: "Bankers are optimistic that loan quality to businesses will improve in 2011. Eighty percent of the banks expect loan quality to large and mid-sized firms to improve, and 70 percent expect an improvement in small business loan quality. No banks expect business loan quality to decline in 2011."

We can interpret this in one of two ways. The first is that if bankers believe that they will be making better loans, they'll likely make more loans. The second is that they'll be more discriminating in order to make only high-quality loans. With either interpretation, the fundamentals for approaching banks remain the same.

Do the work to find out who is aggressively courting the business market you are in. The following is a list of potential sources that can help you compile an initial target list. While you may not need all of them, you can't go wrong if you tap a healthy handful of them:

• Major customers
• Suppliers, vendors, and professional service providers
• Business peers (this may be your best source)
• Trade associations
• Online resources such as ibank, sba.gov, LinkedIn, or just a plain old Google search

Have a small business finance question for The Money Dept.? Hit the comments or email Rich and Mary using the contact form under their photo.
Flickr photo courtesy of m.prinke, CC 2.0