Banking On Lower Rates

 

Bankers and economists agree that once the economy finally turns upward, interest rates will follow suit. They also concur, however, that the upturn won't happen until well into the second half of 1983. In the meantime, short-term interest rates are likely to decline even further from the records of the last 18 months.

Such projections have prompted smaller businesses to review their bank financing. Is this a good time to renegotiate a loan? What are the chances of obtaining new financing, and what options are possible if your banker turns thumbs down?

"It's a buyer's market," says Thomas J. Skala, executive vice-president of Fleet National Bank, in Providence, R.I., responsible for commercial lending and retail banking in a three-state area. In a spot interview, INC. asked Skala why second-quarter '83 may be the best time to bargain with your banker.

INC.: Is now a good time for a small company to renegotiate a loan?

Skala: The first thing a business owner or manager should do is read the contract. Find out if there are any prepayment penalties in refinancing the loan. If there are no penalties, then absolutely yes, you should be looking for a refinancing. In reality, however, most business loans are offered at floating interest rates, so most businesses are already benefiting from the decline of rates. Some transactions have a fixed rate, such as an installment-type loan for inventory or equipment purchases. But the lion's share of small business loans are governed by the same rules that apply to large businesses -- a floating rate that goes up when the prime goes up and down when the prime goes down. To repeat, you would be wise to determine the basis of your loan. Is it floating? Is it fixed? Are there prepay -- ment penalties?

INC.: If a company has a fixed-rate loan at a higher level, should it renegotiate the loan immediately or hold off a little longer in hopes that rates might come down even further?

Skala: Rates may fall further, but there is an old adage that even the best of minds haven't been able to predict the top or bottom of markets, so it becomes a matter of personal choice. No one can predict with any accuracy when the low will come. In fact, there's a minor school of thought suggesting that rates could run back up at any time because everyone is concerned about the government's deficit. If the current rate for refinancing your loan is lower by at least 150 basis points, you should seriously consider rewriting the loan now. If there is only one- quarter or one-half [percentage point] difference, then you probably can wait.

INC.: Suppose the answer from the lending officer is negative. Are there any options, such as seeing a more senior officer of the bank or perhaps shopping around?

Skala: Right now it's a buyer's market. There is a greater supply of money than there is demand, so banks are anxious, not only to make new loans, but also not to lose the good business relationships they already have. A small company that has a good relationship with a bank and is a fairly solid business has tremendous leverage. Right now, borrowers should not accept an answer from the account officer that "it cannot be done." Banking is a very competitive business, and, if you hear an answer you don't think is acceptable, and you frankly don't think that it makes good business sense, then shop around.

INC.: What about borrowers seeking new financing? What types of businesses currently stand the best chance of obtainmg loans at favorable rates?

Skala: To obtain a new loan, a company has to be able to tell a reasonably good story about its business. Whether it is a manufacturing, wholesaling, retailing, or service business, banks are more cautious in considering new loans. Many businesses are suffering in terms of earnings and cash flow, so a bank is likely to make credit evaluations much more carefully. The economics have to make sense. If a small business is losing money, has a large inventory, and has sales that are still declining, it's going to have a tough time getting a loan even though the money supply is plentiful.

A few industries have more problems than others, such as the machine tool industry, which certainly has serious problems and will probably lag behind in any recovery. Still, banks are taking a long-term view. If you can demonstrate that you've got cash flow capabilities to service a loan, even if sales and earnings are down and other trends are going in the wrong direction -- if you have demonstrated that you are a successful business long-term and you want to expand or you need equipment, and you can show, even with declining sales and earnings, that you can support the loan -- then the bank is going to support you.

I don't want to say simply that banks are tightening up their credit requirements because the economy is poor. If you have the cash flow and a good reason to borrow, you're going to be able to get your deal.

INC.: What does it take to get the best deal these days?

Skala: The small business borrowers who swing the best deals all have one thing in common. They are owners or managers who have done some planning. They've set goals and developed budgets. They've evaluated the strengths and weaknesses of their businesses, and they leverage off their strengths. As a result, with some confidence, they can do one other important thing: shop around.