Most banks, especially community banks, in the US are well run businesses and fulfill many of the varied financing needs of the consumer and local commercial communities. They provide a clearing house for commerce by virtue of the checking accounts. They offer a lending environment that is usually tied to the characteristics of the local economy. They provide a safe haven (in most cases) for our savings. They provide a vehicle for many of us to reach out and grab the American dream….home ownership. They sell money orders and they provide access to a vast network of personal finance products including auto loans, education loans, home equity loans and credit cards. But bankers are just like any other business person and as such they want their banks to earn a profit and generate a strong return for their investors. One way to accomplish that is to make sure they have great flexibility and security when lending money. Unfortunately many of the things that give them flexibility and security are not favorable for us…the borrowers, and your friendly banker is probably not going to alert you.
BROAD AND BLANKET LIENS
When a bank makes a commercial loan the loan documents almost always give them a ‘position’ in all of the assets the borrower currently has and may acquire in the future. To perfect this position the bank will file a UCC1 Financing Statement recording an interest in all assets of the business and this becomes part of the public record. This is called a broad based blanket filing. One of the most challenging aspects of this practice is that any future creditor may require you, the borrower, get a specific release from your bank. In addition since the bank has an interest in your assets you must get their permission to sell or borrow against any of those assets and most commercial lenders are reluctant to cooperate by releasing their interest.
ANNUAL FINANCIAL REPORTING
Most bank loans and almost all bank lines require that the borrower and any guarantor provide periodic financial statements and tax returns. In the event that the financial condition of any party to the loan has deteriorated the bank may have an option to call the loan and declare it 100% due and payable regardless of the original terms and regardless if all payments have been made on time. Additionally there are time requirements for providing the information and if the statements are not prepared according to GAAP the bank may have the right to make you hire an independent accounts to produce the statements or declare your loan to be in default.
CROSS DEFAULT CLAUSE
Most bank lending agreements contain a cross default clause which empowers the bank to declare all of a borrower’s loans in default if any one of their loans goes into default and allows them to declare all loans immediately due and payable in the event of a default.
So, if your college age son’s car payment is missed it’s possible, although not likely, that your friendly bank will demand that you pay off your business’s $2,000,000.00 Line Of Credit. This doesn’t happen very often but during the economic freefall of 2008 many business owners were forced to choose between making all of their loan payments on time and putting food on the table.
Many banks require a borrower to maintain minimum cash balances in their depository accounts at all times during the term of the loan. These compensating balances have a specific economic value and from the bank’s perspective, impact their overall yield and return on investment. In essence the bank is earning interest on 100% of the loaned amount but has only advanced the amount of the loan less the minimum cash on deposit. When the minimum compensating cash balance is 10% or 20% the effect on the loan economics is profound.
SENSE OF INSECURITY
Some bank lending agreements allow the bank to call the loan if they ‘feel insecure’ with the customer or any guarantors. During the period from 2008 to 2011 a number of banks refused to lend to any company related in any way to the real estate business and called many loans that were made to companies in that segment. Additionally most banks universally reduced the valuation of real estate they held as collateral for loans and not only refused to renew most Home Equity Lines but called many Home Equity Loans due and payable simply because the perceived value of the property was lowered. Businesses and consumers alike were caught between a very big rock and a very hard place and had nowhere to turn for help. During the real estate run up between 2000 and 2008 many small proprietary business owners routinely used the inflated value of their homes to take out loans for their businesses because that was cheap and available and when those loans were called or reduced and they couldn’t repay timely many homes were foreclosed and many businesses failed.
HIDDEN DEFAULT TRIGGERS
Default by a debtor or any guarantor of any loan even if it is unrelated to your business may trigger a default of all commercial loans. So if a minority shareholder has personally guaranteed a business loan and they default on a personal car loan or a home mortgage or a credit card payment some commercial lenders have the right to call your loan and demand payment in full.
Other surprise potential default triggers include the declaration of bankruptcy by you or any of your stockholders even if it has no impact on your business, your sale of any company stock to an ‘unapproved’ party, the movement of an asset without the bank’s prior permission or the unauthorized disposition of any corporate asset.
THE RIGHT TO AUDIT YOUR BUSINESS
Although this ‘right’ is rarely exercised many banks have the right to enter your business premises and conduct an on-sight audit of your books. With some lending documents this ‘right’ is reserved for a default, however, with many other bank agreements the bank simply has to give you reasonable notice of when they’ll be visiting and what documents and records they’d like to see. Refusal to allow them their audit can constitute a default.
LESS THAN 100% FINANCING
Many banks will not approve a loan unless the borrower has some ‘skin in the game’. They require a down payment or cap reduction or other type of investment that puts the borrower at risk beyond the repayment of a loan. Additionally many banks will not include or significantly limit the amount of “soft costs” in a commercial loan. Such items as shipping, installation, site preparation, training and sometimes sales tax may not be financed by a bank and the borrower has to come out of pocket to make up the difference.
HIGHLY TRANSIENT STAFF
One of the things I’ve noticed in my 40 plus years of working with commercial banks is the constant movement of their staff. We have worked with a bank in Minnesota for almost fifteen years and are currently dealing with our ninth manager. Just about the time their manager gets to know us, who we are, what we do it seems they leave for another bank or get a promotion or they do something else entirely. When I asked our latest manager, he admitted that this ‘corporate shifting’ was a matter of policy at the bank. Apparently upper management, none of whom I’d ever met, believed it was important to make sure none of the line people got too close to the customers. When I pressed him to explain why he told me there was concern that if an individual got too close to their clients they might take that client with them when they moved to another bank and the possibility of fraud between the banker and the customer increased. They decided the best way to deal with the problem was to keep their staff and customer relationships very short termed.
All banks are audited by at least one governmental regulatory agency and many are audited by more than one. It seems like banks are constantly being audited. The findings of these audits can significantly impact the bank’s ability to conduct business and banks have become extremely sensitized to how they are viewed in audit reports. In fact ‘the auditors’ have become the principal focus of many bankers and many run their day to day businesses based upon how an auditor will view what they have done regardless if it makes good business sense or not. Consequently if you’re in the printing business, have a very successful business and apply for a loan to a bank that just received a poor audit review based on five completely unrelated defaults to printing companies, you might be declined outright or approved but at a higher rate than you really deserve.
We offer this informational document as our opinion based on over 40 years of experience in the commercial finance industry and suggest that you to use it as a part of your decision making process. As with all important decisions, especially financial decisions, we also suggest that you consider all aspects carefully and consult with your attorney or accountant or other party who is knowledgeable about financial matters when considering entering into a legally binding agreement.