How to work with a lender in times of trouble

With the unforeseen pandemic we find ourselves in today, Peter and Doug discuss what agencies should know about working with a lender. Peter explains the criteria that lenders use in considering whether to make a loan, and how the criteria change in an economic downturn. He also shares information about how agency owners can best prepare their businesses for borrowing, in case they need funding during the coming months. 

Transcript

spk_0:   0:13
Welcome to Insurance Agency Insights, where we're committed to helping small and medium-sized agencies achieve their business goals. We're your hosts, Doug Burke, Investment Banker and adviser to the insurance agency industry. And I'm with...

spk_1:   0:27
Peter Friedman, CEO and President of AgileCap, a specialty lender focused exclusively on the insurance agency industry. Over the last 20 years, through the ups and downs of the U. S. Economy, AgileCap has advised agencies on growth and investing in the future. Every other week we'll bring you insights on how finance and investing in capital will impact your agency and allow you to grow into the future.

spk_0:   0:53
My first question relates to our economic situation. With the unforeseen pandemic we find ourselves in today, will a lender look to blame or shame a borrower for the situation they find their business in, or do banks understand the broader context of the economic situation?

spk_1:   1:09
Generally speaking, good banks or lenders understand what's going on in the current environment. It's critically important - even though we're in a global pandemic - to be upfront and communicate your particular situation. You have to show good judgment in this environment - and also in any environment, to be honest - about how you can grow your business, and how you can survive in your business. So they're looking to build on that relationship, as you should be too, during this environment. They're not generally looking to start new relationships - and we can talk a little bit about that in the future- but it's critically important that you're communicating with them and that you're offering some hope that you're making the right choices so that your business will survive and potentially thrive, going forward.

spk_0:   1:56
You see many bank commercials say that a bank is here to be your partner. But I think of a song from the singer, Cheryl Wheeler, called "We're the Bank"...the opening line is, "We're the bank, we're not your friend". How do you think of your relationship with your customers?

spk_1:   2:11
To be honest, I think that's a fair assessment. At the end of the day, banks are for-profit enterprises. They're looking to grow as well as you are. They're looking to make a profit. So I don't think a bank is your friend. What I think a good bank can be -  and a good lender can be - is a partner. They can work with you in all situations, so you - as a borrower - can focus on your business and partner with them. They want you to focus on your customers, your employees, and your operations. Then lenders will work with you.  

spk_1:   2:43
We've seen some examples of things going quite poorly where a borrower may decide to throw their hands up and walk away from a business. Or they're not focusing on the basics: the good housekeeping of making sure that their business is stable, their records are up to date. Or they're not communicating. So yes, they're not friends, but banks and lenders can be good partners. And I would say the opportunity to build on that relationship - and build on that partnership - is always there, and it's something you should continue to do. But...probably not a friendship.

spk_0:   3:20
Can we dive into how a lender looks at their customers, aside from being partners? Are there specific criteria or characteristics of a borrower that they're looking for?

spk_1:   3:30
All banks and lenders have different specific criteria. But I would say they fall into three general buckets, and we call those the "3C's":  Collateral, Cash flow, and Character. The first, Collateral, is: "What your is business worth?". The same way you look at what your house is worth, or your car is worth, and how does that compare to the loan that you have. In housing crunch that we experienced in 2008-2009, many of us have houses that were effectively underwater, where the asset was worth less than the loan. Banks will look at that collateral value and see what your business is worth. That will vary with the market - and vary with lots of other factors - but that's one of the key things that they look at. However, the most important one is the second one: Cash flow, Which is: "Can you pay the loan?". A common metric that banks use is called the Debt Service Coverage Ratio or DSCR. That is: with your revenue, in every month, can you pay all your bills, pay your employees, pay your loan, and is there a little something extra left there, including paying yourself? It's a critical criteria that all banks use, and probably one that you should focus on when you're getting a loan so that you understand how you're being assessed. The last one is Character. This is a softer one. It involves your credit score, your personal financial statement, maybe how much you saved, and your history. Have you declared bankruptcy in the past? What sort of personal activities have happened? This is a much softer one, but just as important as the others. So banks look at it slightly differently, and each lender looks at it slightly differently, but the three basic characters are: Collateral, Cash flow, and Character.

spk_0:   5:14
Peter, what happens if there are issues with the three C's after a lender has extended capital to a borrower?

spk_1:   5:20
So we'll take them one at a time. But broadly speaking, lenders have flexibility to work with borrowers. Once you're a client, the relationship changes a little bit and the partnership strengthens because the bank or lender has capital at risk. Generally speaking, banks that are federally chartered, have much harder guidelines. A non-bank lender may have some more flexibility. But we'll look at each one and think about it. Your collateral...it can go up and down with the market...what's your business worth? I would offer, several months ago your business might have been worth more than it might be today. It just kind of depends on what's been going on. Unless you're looking to sell your business, or need to sell your business, the collateral value is somewhat flexible and lenders have a lot more flexibility around that as well. On the cash flow side of things, lenders can work with you. They can do periods of interest-only, or they can do something called "forbearance", where there's a non-payment for a period of time, but it's legally agreed upon, and you're not technically in default. So there's some flexibility when it comes to cash flow that your partner - your lender - may be able to work with you. The character one...that's a little harder. Lenders understand that there are bumps in the road along the way. We all have personal ups and downs that may happen, or in your business may happen - dings in credit scores, a speeding ticket - things of that nature. Your bank's going to want to look for a pattern. If there's no pattern then - ultimately - bumps in the road happen, and that's understood. But if there's a series of patterns - repeated speeding tickets, for example - there's going to be some sort of concerns...and your bank should communicate, and you should communicate with them. There is flexibility. The ultimate goal of the lender is to get paid back and so they can tweak things in order to make sure they get paid back, but there are limits to flexibility. And you should be open with your lender as to what their limits are, and what they can and can't do, because that's critically important.

spk_0:   7:19
So those are the rules, but what about the soft stuff? How should a borrower work with a lender on the soft stuff?

spk_1:   7:24
So, generally speaking, it's coming back to that partnership/relationship. They're not your friends. They're not your family. You might have - at some point in growing your business - borrowed money from friends and family, and that's a different sort of relationship from a lender. But it is critically important that you invest in that relationship, and that you are talking to your lender - and earlier is much better than later - that you're communicating about what's going on with your business - goods and bads  - and that they are aware of the situation, because they have money at risk.  

spk_1:   8:02
Another soft thing, I would say, is that your lender wants to make sure that you are keeping your records and your information up to date, and that you can be responsive to them. If they say, "Hey, I understand you're having a hard time...can you give us this piece of information?" and that you're able to get it back to them in a reasonable amount of time. They understand you're busy, and that you're trying to run your business, but at the same time, they see your ability to control your business - and work with all the key aspects of your business - as an important reflection of their ability to get paid back. Ultimately, lenders air fairly flexible. It is expensive and complicated and difficult to pursue legal action and take foreclosure and all those types of activities. And so lenders are much more willing to bend, if there's open communication and that relationship - and that partnership - is there. Not a friendship...but that relationship is there. And that's one of the key things that I think lenders will look for...the soft stuff.

spk_0:   9:01
So is there anything else that a borrower should think about?

spk_1:   9:05
Ultimately, a lender wants to see that you are running your business, that you are focused on what we consider the three critical pieces of your business, or "The Triangle". Are you, as an owner, focused on your customers? Are you engaging with them? Are you aware of what they have going on in their business? The same way we - as a lender - want to make sure we understand what's going on in your business. Are you focused on your people? Are you making sure in this time, in particular, are they set up and working effectively from home? Are they comfortable with their current environment? That your systems...that you've invested in the right agency management system and its operational and it's going well? And finally, they want to make sure that you're focused on your bank - the lender - as well as potentially other investors...people who've put money in your business. We think of it as a triangle: the customers, the people, and the capital. And we want, as a lender, to make sure you are successful in this partnership that we're developing.

spk_0:   10:03
Thank you, Peter. That triangle is very helpful. And this has been a very helpful conversation. I look forward to our next topic.

spk_1:   10:10
Thanks, Doug, I think next we'll kind of talk about, as we move out of this urgent phase - and each community is slightly different - into more of a stabilization and recovery, what you, as an agency owner, can do to position your company for growth. We'll look at acquisitions and what's happened in the market; what will go forward and how you can say, "What is next, and what is that growth opportunity?"  

spk_1:   10:34
So thank you everyone for listening. We'd appreciate it if you'd follow us on Twitter @AgileCapFunds, on Facebook @AgileCap, or www.AgileCap.com, where you can sign up for newsletters and other information. At this point in time, stay safe and stay sane, and thank you very much for listening.