Economy impact on business and lending

Really? Can you do that?

Check your Guidelines

Well, first, consider that a lender/underwriter can do whatever the financial institution's (FI) guidelines allow assuming they are consistently applied in a legal manner. So if your FI allows you to use asset conversion, you can.

What is the difference?

Asset Conversion

You are counting on the borrower to liquidate assets to service the debt.


You are counting on the borrower to generate income from earnings (or operations if a business) to service the debt.

Is there a preference?

Most lenders prefer to lend on income from earnings (or operations if a business) rather than counting on the prospective borrower to liquidate assets (asset conversion) to make their debt payments on a timely basis.

Wait just a minute!

There are groups of borrowers who absolutely count on asset conversion to service debt, with the blessings of their lenders. This includes retired people for whom, if they did it right, their asset conversion is now their primary source of income. Drawing from IRAs and Pensions is asset conversion. Selling off an accumulated stock portfolio or real estate is asset conversion.

Borrowers who are real estate investors, especially if they have done okay during the recession, are buying (and sometimes rehabbing) and then selling real estate. I know we are all leery of the 'flippers' but some of them did just fine.

My advice:

Consider whether the income from asset conversion is sustainable given the borrowers networth and access to readily converted assets. Your guidelines may allow you to use this in borrower projected cashflow. If not, it may at least be a significant compensating factor.

Do you use asset conversion as cashflow? If so, when and how?

I live at sea level but only two hours from Mt. Rainier. We had a very late summer this year, some would say we missed it altogether in the Northwest.

But Friday was a summer day. Warm but breezy. Lots of sun. And late August is a great time to visit Mt. Rainier as the wildflowers pop in profusion.

Right? Not quite.

A late summer at sea level, it turns out, means a late summer on the mountain. The wild flowers are not out yet. And on the Skyline Trail, you cannot even get past Myrtle Falls without traversing some snow.

Don't assume...

If you were to go to the Rainier National Park website to check on trail conditions before heading up to the mountain with athletic shoes instead of climbing boots, and without your climbing poles -- I can't imagine who would do that -- here is what you'd find:

August 17, 2011: Mt. Rainier received a heavy amount of spring snow this year creating hazardous conditions in the backcountry. Subsequently we expect a very late melt-out this summer. Issues to consider are route-finding, creek and river crossings and trail damage. Good navigation skills are needed in these conditions. It is easy to get disoriented and/or lost. There are also steep, icy slopes in numerous locations around the park. Always check with Park Rangers for trail conditions before heading out into the backcountry.

Rather than the anticipated 3 hour hike, with a 1,700 foot elevation gain, we headed up one way, turned back due to snow, tried another, turned back. It was still breathtaking but not what we expected.

And if we plan to see the wildflowers, we need to head back up in a few weeks. I'll check online to see if they have popped before I drive the two hours each way to see them!

Lenders: What assumptions are you making about your borrowers?

About how their business is doing because:

  • it is 'Back-to-School' season
  • the recession is over
  • your other borrower's business is improving

Directors: What assumptions are you making about your financial institution?

About how you are doing because:

  • management is upbeat
  • the recession is over
  • the other directors don't seem as concerned

Check your assumptions by checking in...

For lenders and business bankers, not only is it a great time to visit business borrowers to be sure you have a good sense of how business is going, but it is essential because other business bankers looking to increase market share or re-balance their loan portfolio might just get there first.

And if you are a director? Never stop asking those substantive questions to continue monitoring the health of your financial institution.

What is good enough?

One last thought. Just because conditions are less than what you expect doesn't mean they are not good enough. We had a fantastic day. Be open to what you'll find when you ask the questions you should ask. And then make a fresh assessment of the situation.

This article,The Allowance for Loan and Lease Loss Becomes a Heavier Burden for Credit Unions, includes my thoughts on one of the up-and-coming challenges for credit unions and banks in keeping up with the time necessary to review loans for impairment to calculate ALLL accurately at the same time that loan volume is (finally) ticking up.

Read the article...

The issues this article touch on are the very same for community banks.

BTW...I have a strategic partnership with the software company, Sageworks, mentioned in the article. They have a new software solution for ALLL and my clients, readers and subscribers get a significant discount. Let me know if you are interested in a demo and I'll get you the discount!
Every year I teach Junior Achievement classes in elementary schools. It does not matter how busy I am with 'teaching' business owners and lending professionals. I take time out because it is the right thing to do and I hope you will, too.

It is encouraging!

These kids get it. Sometime between the common sense of a ten year old and the adult years, something gets lost.

Example: The JA book defined a Resource as something people need. One of the students, Max, suggested it should define a Resource as something people need or want. I had to agree!

Planning a business...

The students were given about five minutes to come up with a business they might start:
  • Business name
  • Type of business
  • Good or service
  • Natural resources they might need
  • Human resources they might need
  • Capital resources they might need
They struggled with this assignment, particularly in the short time frame. When time was up I asked if it was hard. Their discouraged faces told the story. Yes, it was hard.

I told them it should be. That starting a business is hard. That there are a lot of questions to ask before they start. But that every business started just the way they started a few minutes ago, with an idea and a start on the questions.

Time for business owners to (re)ask questions...

Perhaps business owners (and maybe their lenders) should ask questions again. The disruption of the recession calls for it.
  • What business are they in?
  • What has changed for their customers and what has remained the same?
  • What resources do they need?
  • Who can help them answer the questions?
Some business owners never asked the questions in the first place. And most of us need to ask them again.

What questions would you add to the list?

In his newsletter, The Tea Leaf, Jeff Thredgold covers where the jobs are, where they still are not, and what is next.

Here you go! Jeff Thredgold's Tea Leaf

The short version...
Overall construction is finally trending up in employment.
State and Local government is in big trouble.
As people who had given up come back into job search mode, it may continue to wobble.

What is happening in your geographic footprint?

Sageworks, Inc used it's data gathering to answer this question. Sageworks' data is aggregated in real time at a rate of approximately 1,000 financial statements per day in a shared data model with thousands of financial professionals.I recommend their credit analysis software for both my bank/CU and my CPA clients.

Their data was used to answer the question: Which industries have actually seen the light of recovery? While individual businesses and even geographic areas will be different, it might help you to know the top five recoveries:

  1. Manufacturing
  2. Wholesale Trade
  3. Retail Trade
  4. Agriculture, Forestry, Fishing, and Hunting  (private)
  5. Arts, Entertainment, and Recreation  (private)
In some ways that seems to cover a lot of ground. Follow this link to see the sales growth percentage change for 2008, 2009 and 2009 .

In today's Wall Street Journal, an article on Banks Reach Out to Small Firms caught my eye.

groceries.pngIt starts with a branch manager in a grocery store following a customer around who also owns a business and enticing him back to apply for a small business loan, which she was able to make.

The recent economic struggles have left lenders with a challenge if you are relying on historical cashflow figures. The Tax Return Analysis training I present to business lenders focuses on calculating historical/recurring/projected cashflow and we are certainly talking about other indicators these days. So here are three indicators other than cashflow mentioned in the article:

  1. BB&T and J.P. Morgan Chase & Co. say they are looking more closely at quarter-to-quarter comparisons when they evaluate small-business loan applicants to see if there are signs of a turnaround.
  2. Bank of America now gives more weight to orders and anticipated revenues when weighing a company's prospects.
  3. Loan officers at Webster Bank have been told to put more emphasis on character. "We want to recognize those people who have made the necessary changes in their business," says John Guy, head of small-business banking.
I have three questions for you:
  1. What are you weighing more heavily to determine if the small business you are interested in has turned around?
  2. Are you finding the regulators focused too much on recent historical cashflow, not enough or about right? Are they on board with alternative ways of looking at credit-worthiness?
  3. If 10 is loose and 1 is the tightest it has ever been, where are your underwriting standards related to small business loans? Never mind. Don't answer that just in case the regulators are reading. '-)

I have started asking lenders in my Tax Return Analysis training for banks and credit unions where they are on a 1-10 scale.

10 is the best year they had in the last ten years.
1 is the worst year of the recession.

In Southern California, the answer is averaging out to 5. Another way to think of this is 'halfway back'.

Where are you and your financial institution on a 1-10 scale? Use the comments below, give us your rating and your geographic region.
This blog-post is for business lenders and for business owners. While the lender and the owner may take different action related to risk, the list remains the same.

This TOP TEN list comes from a CFO Magazine analysis of SEC comment letters on U.S. Companies in 2009 and the first half of 2010. In many cases, this 'risk' list for publicly-traded companies mirrors the challenges of small- to mid-size companies as well.

The List

  1. Inadequate disclosure issues
  2. Market for products and services
  3. Reliance on suppliers, customers, governments
  4. Going concern
  5. Effects of regulatory changes
  6. Legal exposures and reliance on legal positions
  7. Ineffective internal or disclosure controls
  8. Reliance on certain employees
  9. Conflicts of interest/related party issues
  10. History of operating losses

Order of importance?

I am guessing not since the recent history of operating losses might be the first concern of a business lender. And if a business owner needs to borrow money, this may also be the first concern.

Pick your top three

Business Owners:
This may be one way to identify potential, immediate setbacks and challenges to go to work on. Pick the top three concerns and develop a plan to improve them.

Unless your company is large enough to have management in charge of different departments, there are only so many things you can focus on at once. Prioritize so you can focus.

Business Lenders:
Consider your current borrowers as well as your top prospects. Pick the top three risks that might apply to that borrower so that when you have the conversations, review the financials, 'google' the key players and check out their website you are actively seeking information to decide whether the risk is well handled.

Then include that in your write-up so that you (next time you look at that file), loan committee and the regulators know that you considered and addressed the risks.
I am tempted to say this is the second post on this idea of moving from cash-starved to cash-rich, and it is. But that is not to say it is second in importance.

The first focused on Balance Sheet strategies. Back track if you missed it and then come on back.

Following are Income Statement areas of focus for a lender or business owner/manager wanting to improve liquidity. As is often the case, the hunt for improved cash flow dovetails nicely with the goal of improving profitability.

*Income Statement* Cash Improvement Opportunities:

  • Identify your most profitable revenue sources (profits now and potential).
  • Compare costs (out of pocket, energy, staff time) of your various revenue sources to decide if you are focused on the most profitable.
  • Consider growth opportunities.
  • While we are at it, if your company is a small business, consider what you really want to do more of. What resonates? What is fun? Really, life is too short to be stuck with what you do not want to do.
  • If it has been over six months since you took a hard look at your expenses, look again.
  • Consider assets you could sell and then lease back or rent as needed.
  • Consider contract labor rather than carrying employees, but remember that one reason to keep employees is access as things ramp up and retention of skills and company knowledge.
  • Postpone expenditures and purchases that will not be obvious to your customers. Be careful not to come across as a company in trouble, though.
  • If your employees will be negatively impacted by cost-cutting, communicate. How long will the cost-cutting be needed? Is it needed in order to avoid or reduce lay-offs? What needs to happen (revenue level or number of months cash flow) for the expenses to be possible?

Resources on Financial Statements

As I shared in the post on Balance Sheets, lenders and business owner/managers often need a brush-up on business financial statements to make the most of these ideas. Here is a short list of the relevant eCourses I have created just for lenders and they are just as valuable to business owner/managers:
  • Balance Sheet Basics (25:39 minutes)
  • Income Statement Basics (16:05 minutes)
  • Statement of Cash Flows Basics (22:39 minutes)
  • Terminology: A Foreign Language (25:53 minutes)
  • Types of Business Entities (22:58 minutes)
  • Cash versus Accrual Basis (16:20 minutes)
  • Debt, Debt Ratios and Debt Shortcuts (15:47 minutes)
  • Depreciation in Financial Statements and Tax Returns (17:10 minutes)
  • Introduction to Analysis (18:35 minutes)
  • Liquidity Ratios and Analysis (19:18 minutes)
  • Operating Cycle and Turnovers (23:11 minutes)
  • Leverage (20:57 minutes)
  • The Write-up (21:37 minutes)
Check them out at