Why “Big Banks” Are Turning Down Working Capital Lines of Credit at a Record Pace (Part 3 – Dodd Frank Does It Again)

20:20 11 December in Blog
120
Community Banks are closing their doors because of the cost of compliance.  Small Business pays with less access to credit.  Unintended consequence of one size fits all regulation schemes.
WSJ Headline “Tally of US Banks Sinks to Record Low” on December 3, 2013.  There were many banks that failed as a result of the financial crisis, but-the real impact of the reduction of banks in the US is on small businesses that rely on credit from Community Banks.  This means less credit for small businesses who rely on the Community Banking network for working capital and lines of credit
Community Banks are bearing the brunt of Dodd Frank because of the costs of compliance with the new regulations and are closing as a result.  The new regulations are being enforced through out the banking system even though throughout the financial crisis Community Banks were not the cause of the crisis or nor even a significant portion of the crisis could be attributed to Community Banks.
Community Banks are smaller banks with several hundred million dollars in assets that are typically formed by successful local businessmen and women.  Their typical business plan is to stimulate the local economy by lending to other small businesses that large banks tend to avoid.  These smaller businesses require more support than a typical money center or regional bank is able to provide.  However, their presence in small markets and even in major metropolitan areas such as New York City is vital to the strength of small business and their ability to grow.  They provide accounts receivable lines of credit, equipment loans, real estate loans and in some cases even accounts receivable factoring.
Community bankers work on the principal of the Three C’s: Credit, Collateral and Character.  Large banks work off of computer models that determine whether or not you will be granted a credit line.  In most cases cyclical business, which many small businesses are characterized as, do not stand a chance against the money center or regional bank’s computer models as they are regularly rejected.  The beauty of a Community Bank pre Dodd Frank was that the small business owner could sit down with their local community banker to review the collateral, demonstrate they have good credit and character and establish a credit facility to help grow their business.  In the alternative, if there was not a chance that the bank could lend to a small business they would let them know immediately.  There is a benefit to a fast “No”.
We see this time and time again in our business at Capstone Capital Group, LLC.  Clients tell us they our factoring services as a backup to the line of credit they are applying for.  We can see immediately that there is no chance they will be approved by the money center or regional bank’s computer model.  However they go to the bank and apply through a business officer who is not trained to prequalify the applicant.  Several weeks are wasted in preparing and presenting all sorts of information that is required as part of the application process.  Once the loan request is denied, the business owner cannot make up for the lost time consumed by the lengthy application process that resulted in a denial of credit. 
Most non-bank financial institutions that support small business act like the pre Dodd-Frank community banker in many ways.  The Three C’s are employed because they take the time to understand the customer’s business and attempt to craft a program that will help the customer grow. 
Speaking from experience, we were in need of a $10,000,000 letter of credit facility to support our trade finance business.  We went to one of the large banks that you see on every corner in New York City where Capstone Capital Group, LLC has its operating accounts.  We advised the bank that we did not want to borrow from them, but instead we wanted to give them money so our letters of credit were cash collateralized.  You would think this is a pretty safe credit facility; after all we are giving them cash as collateral.  Although we were using our own cash to collateralize the “credit facility” we still had to provide a significant amount of both business and personal information.  This was understood since they are regulated by the federal government. 
What we were not prepared for was the approval process.  The bank actually wanted us to put up $20,000,000 for a $10,000,000 credit facility.  The process would work in the following manner:
  • A $10,000,000 deposit would be used to establish the letter of credit facility 
  • When letters of credit documents were presented we were not able to use the $10,000,000 that had already posted as collateral to pay for the goods purchased under the letter of credit. 
  • New funds would constantly be needed to provided the bank to cover the drawings under the various letters of credit issued so the $10,000,000 in collateral would always be on deposit. 
We inquired as to the logic of this approach and we were advised that their system is completely automated and in fact there was no human intervention whatsoever. To ensure that they did not extend us credit without cash collateral we were required to have twice the value of the letter of credit facility available to the bank.  Needless to say we took our business elsewhere where the credit terms made more sense. 

The federal government wants small business to thrive and grow and hire new employees to reduce the unemployment rate.  However, the federal government’s policies have unintended consequences that actually stymie progress for small businesses.  Could you imagine the growth rates of small business in the U.S. if the regulations that restrict their growth and ability to borrow were relaxed?  There would be one hell of an economic recovery underway!!Visit our website or connect with us on LinkedIn or respond below should you wish to discuss this further.

Why “Big Banks” Are Turning Down Working Capital Lines of Credit at a Record Pace (Part 2)

20:57 03 December in Blog
100
The Wall Street Journal reported on November 22 that “New Loan Rules Are on Tap.”  Small businesses who use Deposit Advance loans to even out their working capital shortfalls will now face restrictions as the Office of the Comptroller of the Currency will increase scrutiny on banks that make these types of loans.  The WSJ further reported that the implementation of these guidelines will push borrowers to payday lenders, pawn shops and others outside the banking system.  This regulation is a negative development for small business because most small businesses avail themselves of consumer debt programs that can be garnered by the owner for working capital.  This development will unfortunately increase the cost of capital and further limit small businesses access to capital.  With a bit of planning we can work around this legislation.
Going to a payday lender or pawnshop for financing should not be your first choice.  There are many secondary lenders and factors in the market that are reputable and in most cases are more flexible than banks.  These institutions are well capitalized, highly professional and would be very pleased to work with small businesses that have working capital needs and are growing.
An example is Capstone Capital Group, LLC (of which I am a Principal) provides Working Capital by purchasing your Accounts Receivables and unlike other companies in the same line of business, there are no long terms contracts.  Capstone provides working capital at your request, only when you need it.  Our clients grow rapidly once they learn how to effectively deploy the capital we provide.
One of our clients is an electrical contractor.  Prior to working with us the company struggled to achieve sales of $5,000,000 per year.  The company was notified last year that its $1,500,000 revolving line of credit would be termed out to a 60 month term loan.  Just like we discussed in last week’s post, the bank was facing the option of classifying the loan or converting it to a term loan.  Following the conversion of the credit facility into a term loan we established a factoring facility for our client. 
For those who don’t know, factoring is a financial arrangement where a company (in this case, Capstone) purchases accounts receivable from another company.  The purchaser advances funds and assumes the credit risk.  Once the invoice is paid, the purchaser sends the balance collected less their fee to the company that sold the accounts receivable in the first place.
We negotiated a Limited Subordination Agreement with the client’s bank and began factoring their accounts receivable.  During the first few months of the relationship, the client factored selected invoices and began to bid on projects they could not bid on before due to their line of credit limitations (which prevented the client from taking on new jobs prior to previous jobs being paid).  Part of the bidding process requires disclosures regarding how companies will fund contracts if awarded.  Normally, a contractor indicates his available credit on his bank line.  However, by using Capstone, our clients can write “unlimited” because our credit approval process is based on the credit of the general contractor or the owner of the project, not solely our client. 
What seems like a minor change in the way our clients conduct their business have significant positive results.  From our prior example, Capstone knew the outcome would be positive but our client had no idea.  In summary:
  • Our client’s business changed from job to job (due to cash flow limitations) to a significant backlog of work.
  • Multiple contracts were awarded at good margins and suppliers were paid in advance of terms creating payment discount opportunities and increasing profit margins on already profitable jobs. 
  • Sales went through the roof.  Typically, Capstone’s clients grow on average by 15% to 20% per year.  This client went from $5,000,000 in sales per year to $13,000,000 in sales per year. 
  • Remember that pesky term loan for $1,500,000?  The loan balance as of the end of the 3rd quarter was below of $750,000.  The bank was (and still is) happy to have us involved and began referring other clients to us who had similar problems.  
  • Fortunately for us, this is the norm for our clients rather than the exception. 
What is your back up plan if your bank decides to term out your credit line or you are denied a working capital line of credit?  Lay off some of your valuable staff?  Turn away good and profitable business?  You can turn a negative event into an opportunity to grow your company with Capstone Capital Group, LLC.
Visit our website or connect with us on LinkedIn or respond below should you wish to discuss this further.

Why “Big Banks” Are Turning Down Working Capital Lines of Credit at a Record Pace

17:42 19 November in Blog
110
Has your request for a Working Capital loan ever been declined or converted to a term loan restricting your ability to grow?  Many construction subcontractors who have expanded bidding opportunities are running into problems finding working capital due to significant restrictions put in place by the Dodd-Frank law.
Below is a  response Capstone Capital Group, LLC received from a global financial institution on behalf of a client for whom Capstone Capital Group, LLC was seeking a Limited Subordination Agreement (LSA) so that we could Factor their Construction Accounts Receivable and accelerate their working capital to pay essential expenses like rent and payroll in a timely manner.  All references to names or places have been deleted  to protect the privacy of the client and the “big bank”.

 

“The request has been declined based on the reasons provided below:
The subordination of the receivables mentioned in the attachment will diminish the overall value of our UCC filing as it requires us to take junior position to the Factoring company.  This relationship is already considered high risk as the line is currently in process of being termed out due to EW concerns (High Utilization, Insufficient Liquidity, and # of recent inquiries).  In addition further concern was noted due to recent review of financials indicating a decline in revenues between 2011 and 2012 with negative taxable income for 2012.”

 

This “big bank” response is typical in today’s banking climate.  Dodd-Frank, which created the “too big to fail” banking syndicate, has resulted in small businesses being frozen out of the working capital loan markets because they are deemed to risky.  Cyclical businesses are no longer welcome at America’s “big banks”.  Dodd-Frank requires banks who continue with these loans to put as much as 30% of the loan value up as cash collateral due to the loan’s risk rating.  Revolving credit facilities are being termed out, locking up the flexibility that many business owners need to grow their business and hire more employees.  Business owners in need of working capital seem to have limited options for obtaining working capital.
To help small businesses (or business owners) secure working capital in a manner that is compliant with federal law, Capstone Capital Group, LLC provides a LSA which only requires the “big bank” to subordinate only on an individual invoice-by-invoice basis.  Unlike the quote and typical subordination agreements, Capstone Capital Group, LLC does not seek subordination on all of the small business’ assets, only on a single invoice factoring, thereby maintaining the senior lien position for the “big bank” on all of assets of the small business.
Capstone Capital Group, LLC has observed that through the use of the LSA, our clients grow rapidly and are able to reduce the term debt owed to their bank ahead of schedule and in many cases in half the time. For more on this topic – check out our article from The Secured Lender Magazine – Debt Hangover Relief
Visit our website or connect with us on LinkedIn or respond below should you wish to discuss this further.

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