How Commercial Loan Brokers Should Guide Clients When Banks Tighten Credit
A renewed trend toward tightening credit began in late 2022 as lenders and investors reacted to projections of a pending economic downturn. Following recent news stories of several significant bank failures, further bank regulations and credit tightening are expected. Brokers must be prepared to help their clients navigate the rough lending landscape as banks tighten credit standards in 2023.
This article begins with an overview of why a bank may restrict or recall credit to a business, then outlines steps for brokers to help transition those businesses to an alternate business financing structure. Learn how commercial loan brokers can become credit heroes by guiding clients to reliable funding when banks tighten credit.
Why is credit restricted or recalled on business financing?
There are three main reasons why a bank may restrict or recall credit on business financing:
- With pandemic assistance programs at an end as interest rate hikes, inflation, and speculation of a pending recession grow, loan defaults are beginning to rise. Data shows how delinquency rates increase when the economy is stressed.
A business that can’t meet its repayment schedule on time is in default of its business financing agreement and will become a definite target for credit restrictions or a credit recall.
- Breach of Covenants. Regular financial performance reporting to the lender is typically required as part of a conventional financing agreement. These reports usually focus on the financial covenants that must be maintained to uphold credit qualification. These covenants are terms and conditions normally expressed as specific ratios and performance levels that must be maintained throughout the loan. Suppose a business fails to preserve specific financial performance levels, such as debt-to-equity ratios or a certain level of cash flow. In this case, the lender may consider restricting or recalling credit.
- Change in Conditions. The economic outlook for a particular industry or sector could take a turn for the worse. Sometimes a bank will begin to reassess its overall risk exposure and allow macroeconomic factors to influence portfolio management decisions. Having a low-risk tolerance, banks may doubt the ability of a business operating in a troubled industry to repay its loan even if the business itself is performing well. Banks may restrict or recall credit to minimize risk exposure in these circumstances.
Time is of the essence – a quick transition is needed
If a bank recalls a company’s financing, the business may be forced to repay the outstanding balance within a short period, for example, 10 to 90 days. For many companies, this sudden and unexpected financial burden launches the beginning of a financial crisis! If the business can’t satisfy the bank’s recall demand, the bank may take legal action to recover the debt, causing damage to the business’s credit score and reputation.
The clock starts ticking as soon as the bank gives notice – time is of the essence! Commercial loan brokers with connections to alternative tech-enabled lenders can help clients by guiding them through their options, arranging a repayment plan, and facilitating a quick transition to new funding.
Four steps to arrange a quick transition
Commercial loan brokers should be well prepared ahead of time to enable a quick response to business clients in financial distress. Be proactive and arrange working relationships with lenders and investors capable of managing fast, efficient, and flexible business financing. With these resources in your toolbox, follow these four steps to guide business clients to new and reliable business financing:
Step 1: Understand the reason(s) for credit loss. Understanding the nature of a problem is the first step in finding a solution. A broker’s client may be nothing more than a victim of circumstance. The bank may need to shore up its balance sheet and is looking for ways to increase short-term liquid assets and minimize long-term assets. As a result, it may decide to call a loan or line of credit despite the business fully complying with the loan’s terms and conditions. In such a case, a broker should be able to transition this type of client to a suitable alternative lender easily.
Or maybe a client is facing a recall because of default. First try to understand the circumstances surrounding the default. Was it caused by macroeconomics, or was the default caused by the business’s mismanagement? A broker can help plot the business’s next move after understanding the answers to these questions.
Step 2: Evaluate alternative funding options. Brokers should work with their network of lenders to evaluate alternative funding options. Two popular forms of alternative funding are asset-based lending and invoice factoring:
- Asset-based lending (ABL) allows a business to secure a loan based on the value of its business assets. For example, a company may be able to borrow up to 95% of its accounts receivable, 75% of the appraised value of fixed assets, and 60% of inventory. This type of financing is structured as a term loan.
- Invoice factoring is designed to accelerate cash flow by delivering payments to businesses within hours of issuing invoice receivables to their customers. Qualification is quick and easy, and this type of financing does not add debt to the company’s balance sheet.
Step 3: Develop a financial plan. Brokers can advise clients as they develop a plan to restructure business financing. Suppose the intention is to pursue another conventional funding solution. In that case, the plan should include an up-to-date balance sheet, income statement, and statement of cash flows, along with a cash flow forecast of at least 36 months. A much less detailed plan is required if the business seeks financing from an alternative lender.
Step 4: Assist with documentation and negotiation. Brokers should assist the client by identifying the necessary documentation for whatever financing is being applied for. The detail and amount of documentation required for business financing depend on the lender’s qualification requirements. Conventional lenders, like banks, typically require more extensive financial performance and credit history records, whereas alternative lenders usually require much less paperwork. Whether to act as an intermediary to facilitate negotiations depends on your relationships with the lender and your client.
Build your network of alternative lenders
Commercial loan brokers should be proactive and start building a network of alternative lenders in preparation for the anticipated fallout from bank credit restrictions. Cultivate a network of lenders experienced in the industries they serve and willing to pay dividends to referring brokers. Establish the relationship you want – whether to be involved and retain control of the accounts or act from arm’s length as a referring partner only.
It’s easy to think about short-term solutions when a client is in dire need of financing. But, to help ensure the client’s future success, brokers should also think long-term when recommending a new financing solution. Look for lenders having long-standing relationships with clients and brokers. These lenders have proven success stories and solid business relationships that endure. This approach will benefit the client and the broker, as it could lead to additional referrals in the future.
Become familiar with each lender’s products and services. With this knowledge, you can guide clients to the best lenders to rescue them from a bank recall. Doing the work upfront to create these relationships will position your brokerage as a go-to resource for businesses facing a sudden financial crisis.
According to a survey conducted by the Federal Reserve, 79% of the largest banks in the US began tightening credit underwriting standards for commercial and industrial loans in the second half of 2022. Several significant bank failures in Q1 of this year added more pressure to tighten credit standards further. 2023 will be a year of reckoning as business financing facilities are scrutinized.
Commercial loan brokers need to be ready with a plan of action. Do the leg work upfront and build a network of experienced alternative lenders willing to pay lucrative referral fees and recurring commissions. With the right lenders in place, your brokerage will reap financial rewards and brand recognition as a credit hero.
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