Banks Failing, Capital Drying Up?
Adequate capital to invest in the growth of a business is crucial. Navigating financing for SMBs can be challenging even in the best of times. As announcements come out about banks being in trouble, whatever you do, don’t panic. The three troubled banks in the news had many issues causing their problems. Get the facts about what’s going on.
Remind yourself every day that, in general, the economy is doing well. The federal banking system is strong and well-prepared to monitor conditions and manage individual banks through the challenges they’re facing. 3% unemployment means businesses are busy doing what they do to supply demand. Stuff happens when market conditions change; there will always be losers and gainers.
What’s in the news:
Stock banks and SMB lenders, Signature Bank, First Republic Bank, and Silicon Bank Corp., require additional funding due to liquidity issues. And if they didn’t get it in time, they are being taken over by a quick-reacting federal system. But not all SMB lenders are in trouble.
The good news is that Market Watch recently reported that “. . . 102 of 108 banks listed showed expanding margins for the fourth quarter from a year earlier.” Top performers expanded by at least 1% in a year, while banks with liquidity issues had less than 10% expansion or contraction. More on this in a bit.
First, what’s the background?
What we care about most – is the health of SMBs, Small to Mid Sized Businesses. We also know that SMB financing is very important. SMBs have depleted cash reserves due to COVID shutdowns, supply chain issues, inflation, and payroll hikes. Delays increasing prices for fear of losing market share aren’t helping recovery. Large balance loan payments for EIDL and Main Street loans are difficult to manage, especially during tough times.
Eroded profit margins make it harder to maintain an adequate balance sheet that supports additional lending. Playing the tax minimization game jeopardizes many small businesses access to bank funds in the best of times. Rising interest rates make loans more costly, further digging into profit margins that may already be stressed. And now a bank failure – how serious are things becoming, and what should SMB owners be looking out for?
At the same time, the sources of most lending, banks, face their challenges. Years of lending in a low-interest rate market are now over – it sounds like it could be good news for banks on their income side, and it likely will be once banks get through the transition. But first, they have to deal with rising interest rates on the expense side along with stricter lending standards.
An existing low-interest loan portfolio means limited income from term loans and mortgage lending. That limited income portfolio now runs smack into higher borrowing costs to access capital and maintain adequate reserves.
As any small business owner will tell you, going into a cycle with a low-profit margin that then collides with higher costs and fixed revenue can cause sleepless nights. The need for profit runs smacks into obligations that can’t be quickly unwound, and which can quickly turn into losses. And that means serious problems for any business. Any savvy small business owner will tell you that under declining profit conditions, they have to turn things around fast – something that is hard for banks to do on their own.
Further adding to the problems is a slowdown in lending demand over the past several years. Five million small business owners turned to non-bank lending via EIDL. Some SMBs have stopped pursuing additional borrowing. And other SMBs with balance sheets that are underwater don’t qualify, no matter how badly they need or want to access capital. Pressures in the housing market cool demand for real estate loans. All this makes it harder for banks to transfer into enough new, higher-interest-rate loans to support their balance sheets.
What to do next?
- Look for banks are better prepared for rising interest rates and slowing loan growth. Look at a bank’s net interest margin. Keep your eye on the FDIC insurance limits of $250,000 compared to the balance your company keeps in each bank. Remember that many loan covenants require minimum deposits to support lending already in place – which may mean you have no option but to stick with deposits beyond what the FDIC will insure at your current bank. And stay tuned for further FDIC announcements on what will happen to uninsured depositors.
- If you decide to shop for an additional bank partner, look for banks with improvements year over year on the net interest income / average assets (NII/AA) ratio. It’s not necessarily which bank has the highest net interest income / average assets (NII/AA) ratio, as some banks in trouble still had last quarter ratios of 3% or higher. Instead, look for banks with the one-year expansion of the NII/AA and watch out for those with declining ratios.
- If you carry high account balances with any one bank, consider spreading your risk. Managing cash in multiple locations takes a bit more effort, but it may give you peace of mind to know that the FDIC fully insures you. But before you decide to do that, read on. You have to keep your bank covenants in mind.
- Please take a deep breath, and contact your bank manager for their input. In general, we advise you to stick with the local and regional banks. They are closer to to being “on the ground” in your local market, aware of your business’s role in the success of their client portfolio, and more able to make localized decisions, within reason, to support your business and get you SMB financing.
- Be prepared to educate your bank management on the status of your business and your industry. The bank may be watching your sector from a high level but may not understand the nuances of your niche or where you stand competitively. Do what you can to boost the bank’s confidence that you are a good risk for SMB financing and that they are a good partner for your business and vice versa. If they have a critique, don’t get your backup. Listen carefully and ask for their suggestions. On the other hand, if you can’t get access to management or you feel the bank isn’t listening, consider shopping around to see what you get as a reaction from other banks. Remember that right now, banks are looking for good-quality customers.
- At the same time, don’t expect any bank to bail you out if your balance sheet is under water. If you’re not sure what that means, talk to your banker to get their view on how you’re looking. Contact a financial strategist to advise you on how to make or keep your business “lendable.” Give us a call; we’re committed to helping business owners succeed under all conditions.
- Figure out what your obligations are to your current bank partner. How much do you have borrowed? What do your loan covenants require for deposits to back up those obligations? For example, if you have a credit line with a balance outstanding, you probably must have cash and accounts receivable under 60 days past due that are more than that outstanding balance. Pull out too much money, and the bank can call in the balance due on your credit line. Don’t go there!
- If you’re worried about the cost of existing credit lines and other loans with adjustable rates, make an appointment to meet with your banker to discuss terming out these lines and loans into fixed-rate instruments. If you have an EIDL loan, keep your loan payments current. That’s going to be some of the best low-interest lendings you’ll get, don’t jeopardize the loans by getting into past due status. And If you have an EIDL loan, consider getting a life insurance policy – that loan is for 30 years and may outlast you. Don’t make your SMB financing a problem for your successors to deal with. If you have Main Street Loans, meet with your banker to discuss options. Those are pricey loans, and you may have options depending on the quality of your assets.
The Bottom Line
- Take a hard look at your profit picture. If your business is not making enough profit, raise prices, do it now! Look for high-quality customers who will pay a premium for what you can provide them. If you’re selling B2B, invest in expanding your sales force to increase the flow of new, good-quality business into the pipeline. Need help figuring out how to boost sales? Reach out to us – that’s what we excel at – the strategy and tactics of doubling revenue and tripling profit in both up and down markets.
- If you’re selling B2C or B2B, take a hard look at how well your marketing efforts are doing to produce leads. And look for additional input from marketing strategists who can point out ways to improve your results. Give us a call, we’ve been studying what to do about marketing strategy for years, and we’d be happy to share our thoughts with you.
- Do your best to line up with good quality business partners. Take a good look in the mirror to know the facts about where you stand, so you can build a good action plan to get where you want to be. It will take some time to change banks or spread out risk across multiple banks if you think that is needed.
- Get good advisors in place to help you work through any challenges your business might face. It would help if you had an outside perspective to make good decisions when it comes to SMB financing. And making good decisions is what your job as owner and CEO, is all about.