A Bank That Looks At More Than Numbers
In 1976 after three years as a manufacturer of ultraviolet fire detectors for industrial applications, Detector Electronics Corp., of Minneapolis, ran into a cash crunch that threatened its ability to maintain its rapid growth. Through its commercial bank, the young company had a credit line secured by its assets, permitting it to borrow as needed according to a fairly typical formula: 80% against its accounts receivable and 25% of the value of inventory (see INC., November 1982, page 150). But the formula didn't make cash available quickly enough to enable Detector to fill a stream of new orders from the petrochemical industry.
On the strength of either Dettector's assets or its heavily leveraged balance sheet, no traditional commercial banker would have been eager to approve a larger credit line. The company's president and chief executive officer, Ted Larsen, one of three ex-Honeywell Inc. executives who founded the company, was already bracing himself for harsh instructions from the bankers to bite the bullet and scale back growth and current operations. "That would have been the normal bank response," he says. But much to his surprise, the message from the bank was anything but grim. Turning aside conventional lending criteria, Northwestern National Bank of St. Paul agreed to provide more financing for working capital by advancing cash based on receivables and a share of confirmed orders as well as inventory. The impending crisis was averted.
As unusual as it is for a bank to lend on anything so speculative as unbuilt product orders, "it made more sense to us than advancing a higher percentage against the inventory," says the bank's senior vice-president, Dennis McChesney, 39, who came to the bank nine years ago from New York's Chemical Bank. At Detector, he explains, inventory consisted of raw materials and work in progress, which would have been extremely difficult to liquidate at a profit. "But if they could continue to turn the orders into sales," says McChesney, "we had every reason to think the sales would generate profits." Strictly speaking, he concedes, "it was asset-based lending without the asset."
In contrast to venture capitalists, commercial bankers don't thrive on taking chances. Yet Northwestern/St. Paul has been building a reputation lately among financial professionals in its region as a maverick lender to smaller and younger companies, willing to tolerate risks that most other banks would find untenable.
Most of the lending arrangements for the bank, which has $400 million in assets, differ very little from those of the other 86 commercial banks owned by its parent, $16 billion Northwest Bancorporation, or even its competitors. But since the mid-1970s, Northwestern/St. Paul has made dozens of loans whose terms, admits McChesney, "are just a tad out of the ordinary." The bank, of course, isn't alone in its eagerness to sign up new commercial customers with lots of potential. But unlike a lot of banks, says Alan K. Ruvelson, president of First Midwest Capital Corp., a Minneapolis venture capital firm, "Northwestern Bank of St. Paul doesn't expect to find them on a silver platter. They'll work hard to justify a loan."
The bank's willingness to look beyond Detector's inventory to its strong confirmed-order book may have been one of the earliest examples of its flexibility. With its two-year record in building and shipping its products, Detector emerged as a better credit risk than the numbers suggested. But since then, McChesney says, the bank has also agreed to make other business loans that many bankers would find imprudent. Indeed, even where a conventional credit analysis of a business argues against making a loan, the bank might still go ahead if the company or its owners exhibit such other compensating strengths as management talent and solid production performance.
To help the bank identify and analyze unusual lending opportunities, a special lending division of three lending officers was established in mid-1981 to concentrate on companies involved in high technology and other specialized areas, such as chemicals and plastics. But a readiness to override traditional financial criteria with "good judgment," says McChesney, was encouraged long before in the bank's lending division.
The bank, for example, has made several loans to companies in which it waived the customary requirement that the owners furnish personal financial guarantees, which lenders typically require of young or undercapitalized companies. Instead, "we ask for more owner equity or better financial controls," says McChesney. In another instance, the bank boosted the advance rate for an electrical wholesaler -- from 80% of its receivables to 95% -- to deal with a temporary cash bind. McChesney says the bank is currently exploring the use of warrants on equity as a way to boost its return on selected loans.
Perhaps the most extraordinary loan application the bank ever approved, though, was for a company that had yet to generate its first dollar of revenue and whose highly sophisticated product -- a supercomputer -- was still in development. Financed by its founders and several venture capitalists, the company sought a substantial credit line to draw on when it ran into a projected working capital squeeze. Not surprisingly, notes McChesney, "we came up short when we looked at the numbers. So we looked at the product and the people."
The most tangible criteria indicated rejecting the request. But conversations with the company's competitors and some potential customers convinced the bank that a major loan wasn't as daring as it seemed. Despite the fact that a much larger Minneapolis bank refused to make the loan, "we committed a $1 million credit line," says McChesney. As it turned out, the company, Cray Research Inc. of Mendota Heights, Minn., founded by ex -- Control Data Corp. engineer Seymour Cray, never used the credit line (a condition of which was a key-man life insurance policy on Cray). Shortly after the loan approval early in 1976, Cray Research seized an opportunity to go public, and today it is a proven performer with sales of more than $100 million.
It isn't uncommon for Northwestern/St. Paul, like any other bank, to charge several percentage points above the prime rate for its riskier loans. But its penchant for going beyond traditional lending standards can hardly be justified by rate alone. Rather, explains McChesney, it is tlne opportunity to establish ground-level relationships with newer businesses that will stay with the bank as they grow. "We think the best payoff is a loyal customer," he says.
For example, notes McChesney, Detector Electronics is now a public company with sales of $12.4 million, a strong balance sheet, and a $2.5 million unsecured credit line with the bank. And Cray Research uses Northwestern/St. Paul as its lead bank for a $50 million multicurrency revolving credit. "Once a company becomes profitable and all the financial ratios are in place, then every bank in the country wants to bank them," he says. "We try to differentiate ourselves by being aggressive and getting them early."
Despite a perception of heightened risk exposure, however, McChesney maintains that in practice the bank has run into very little difficulty with its more aggressive loans. In a recent case, the bank discovered that a customer's booked orders, against a loan that had been advanced, wasn't as solid as it thought; delivery dates for the orders had been delayed. "But nothing has gotten to the point of a writeoff," he says. This record has been accomplished without a requirement that unusual loans pass through multiple approval levels within the bank. A senior lending committee reviews loan applications only when they exceed $250,000. Otherwise, division managers authorize loans.
"We certainly don't lend to just anyone who walks in the door," says McChesney. But when a company's financial statements don't tell the whole story, Northwestern/St. Paul isn't afraid to look further. "If you want to differentiate yourself from other lenders, you really can't be a by-the-numbers banker anymore," McChesney says. "We like to consider a company's promise and potential."