Large commercial banks are not very well known for their solicitude toward smaller companies. As we have noted in this column before, most major lending institutions are more eager to service the megaborrowing needs of big corporations and foreign governments than they are to take care of the working-capital needs of the small businesses in their own backyards. But over the past few months, one commercial institution, Wells Fargo Bank, headquartered in San Francisco, has begun taking the interests of smaller companies more to heart. The nation's 11th largest bank has recently introduced a new, unsecured line of credit available to solid businesses with sales from $200,000 to $3 million. In effect, this puts them on equal footing with the best of the bank's big customers.
Before the new credit-line program was unveiled last September, Wells Fargo, like most commercial banks, required many of its smaller, unsecured customers to obtain approvals from their lending officers each time they needed to borrow money. Not surprisingly, many small business owners found this to be a major source of migraines. Some complained about the inconvenience of having to review detailed bank documents every few months. Others sounded off about the frustrations of tracking down their loan officers when they needed approval for small loans. For still others, the approval process was destructively slow. There were the times, for example, when they missed important discount opportunities offered by suppliers. Wells Fargo heard many of these woes when it organized focus groups attended by customers in Los Angeles and San Francisco. Says Terri Dial, vice-president and manager of business-product development, "We began thinking of ways to improve our service."
Wells Fargo studied the complaints and, behold, it began to see opportunities for trimming its own costs of making a loan. Assembling pages and pages of loan documents to spell out all the conditions of a loan is labor-intensive and extremely costly, explains Dial. The expenses mount when the process has to be repeated more than once a year. So Wells Fargo began rethinking its bureaucratic ways in hopes of finding a more cost-effective method of lending to smaller businesses. Indeed, many of the things borrowers were looking for were well aligned with the bank's own eagerness to slash costs.
Before granting an unsecured line of credit, Wells Fargo conducts a thorough financial analysis of the company's credit, just as it does for any loan. Among other things, the bank likes to see several years of operating profits, a stable management team, and no more than moderate leverage. If a business passes the test, it is offered a credit line from $10,000 to $250,000, depending on its circumstances. In fact, the bank has set up a special toll-free number that customers can use to request credit advances to their checking accounts. Unlike most other types of working capital loans, moreover, the only payment that is mandatory at the end of each month is interest -- and only on the portion of the line that has been used.
By automating many of its monthly monitoring procedures, Dial says that Wells Fargo has been able to offer its better small business customers interest rates that are one-half to one percentage point less than they might otherwise receive from the bank. As for the basic role of the lending officer, that shouldn't change very much, she says. "Instead of spending a lot of time on minutia and filling out forms, we're hoping this will enable bankers to understand their customers better. Banking is very much a relationship business. We want our lending officers to become more valuable as contacts."
How does a penny-pinching public company raise a new dose of equity without paying all those fees to underwriters and attorneys? Calumet Industries Inc., a $55-million maker of specialty lubricating oils, tackled this question last winter and thinks it has found an intriguing method.
Calumet, located in Chicago, went public in 1962. As the business expanded over the years, it managed to finance its ongoing growth with earnings and bank debt. When industrial demand for its products began stretching capacity in 1981, management elected to go deep into debt to finance a major new refinery in Louisiana. Their notion was to go ahead and build the $18-million facility, then seek more permanent financing later on.
The timing was dreadful. Demand for Calumet's oil-based products softened in the wake of the 1982-83 recession and the worldwide oil glut. Interest expenses on its bank loans soared, and its earnings shriveled from $1.45 per share in 1981 to just 26? in 1982. Given the grim state of affairs and the general weakness of the capital markets, there were not a lot of attractive options for refinancing, notes president and chief executive officer S. Mark Salvino. So Calumet proceeded to pull in its horns. As part of a strategy for saving cash, it halted quarterly dividend payments to shareholders.
But toward the end of 1983, the crunch began to ease. Demand for Calumet's products was looking up, and the company set out to find a way to reduce its leverage. As it stood, the balance sheet was weighted with debt, by a ratio of three to two. That made the bankers nervous. "We were hoping to get out capitalization back in order," Salvino explains -- to a debt/equity ratio of more like two to three.
Salvino, a former president of a natural-gas holding company, investigated the possibility of doing a $2-million or $3-million equity offering, but to him the costs of a small public offering seemed staggering; together, the underwriters and attorneys would claim about 8? for every new dollar raised (about $160,000 on $2 million). On the other hand, there was no getting around the fact that Calumet needed to attract money. So Salvino began searching for alternatives.
Early in 1984, Salvino conjured up an idea for, in effect, killing two birds with one stone. He suggested that Calumet raise the new equity capital directly from its existing shareholders. The investors had been without dividends since the end of 1981. Why couldn't the company design an attractive offer just for them -- something to reward the shareholders for standing by Calumet during tough times but, at the same time, encourage them to buy new shares?
Salvino asked the company's law firm to explore the technicalities of declaring a special type of dividend -- one consisting not of cash but of a warrant to purchase new stock at a favorable price. Much to Salvino's surprise, the attorneys were unable to locate any company that had successfully raised capital in this way. At the same time, although unconventional, the technique seemed perfectly legal as far as Securities and Exchange Commission regulations were concerned. If it worked, it would be tens of thousands of dollars cheaper than selling a secondary stock offering through an investment bank.
Last spring, Calument decided to give it a try. The company prepared an eight-page prospectus and mailed it to shareholders. For every five shares owned, a shareholder received a warrant to buy one share at the discounted price.Shareholders have until May 1, 1985, to purchase a total of 332,693 new shares. When and if all of the warrants are converted, Calumet stands to raise a bit more than $2 million, even after printing and legal expenses of about $35,000.
Last December, with the stock trading at $7.75 per share on the over-the-counter market, Calumet's financing strategy seemed to be on track. Its architect, Salvino, was pleased. "We kind of backed into this," he shrugs. "Our motivation was to raise equity capital at the lowest available cost. And we wanted to give our shareholders something. . . . We just couldn't give them cash."