Hidden Perils In A Volatile Economy

A leading small-business lender offers his advice on how companies should be approaching their capital needs in these uncertain times.

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Ever since Dean Treptow abandoned a promising career as a chemicals salesman in order to try his hand at banking, he has been quietly building a national reputation as one of the shrewdest small-business bankers around. He has done it, moreover, from the unlikely vantage of Brown Deer, Wis., a small suburb of Milwaukee. There, as president of Brown Deer Bank, he has combined skillful marketing with imaginative lending practices to transform a sleepy little consumer-based institution into an exemplar of innovative banking, catering principally to closely held smaller companies. The bank's assets, meanwhile, have grown from $14 million in 1973 to more than $80 million today.

Along the way, Treptow has emerged as an authority on the capital needs of smaller companies. He is frequently called on to testify in Congress on small-business matters and to serve on special commissions. And two years ago, when INC. set out to identify some of the country's leading small-business bankers (see "The New Small Business Bankers," May 1984), he was at the top of everyone's list.

So it is hardly surprising that his name came to mind recently as we were puzzling over the latest rash of confusing, and often contradictory, economic prognostications. We invited Treptow to share his views on the state and direction of the economy, and on how smaller companies should be approaching their capital needs.

INC.: What kind of advice are you offering business borrowers these days, given the possibility of a major slump, at least in some sectors of the economy?

Treptow: In these times, businesses need to place a real emphasis on their earnings coverage and cash flow related to capital investments. Forget the tax rules. The question people should be asking is, Can you recover the investment in fixed assets within the likely product- or equipment-life? I believe that recovery periods on fixed assets need to be shortened in view of shorter cycles. You used to buy a machine that had a useful life of 15 years and depreciate it over 7 years. Now we're talking about useful lives on machinery or major components of more like 3 to 7 years -- in some cases, their useful lives are substantially less than their tax depreciation lives.

This means companies are going to have to maximize their flexibility on fixed costs and scrutinize their investments, particularly on items that aren't directly related to increasing productivity or turning out a product. Now isn't the time to be buying office buildings and other trappings. When you're dealing with shorter economic cycles, you need to be careful about adding fixed assets that don't increase your productivity but still have to be fed, whether business is growing or not.

INC.: Are there other things companies should be watching?

Treptow: I think companies need to be tightening their internal controls as much as possible, particularly in the areas of inventory management and trade credit. There's been a lot of discussion of inventory management programs, such as Just in Time. But I think trade credit has the potential to become a far more dangerous problem for businesses. There's greater pressure on banks these days, and so more and more credit risks are being shifted from banks to individual businesses, which typically offer customers credit of at least 30 days. Increasingly, you'll see banks holding the secured portion of the credit, protected by collateral, and vendors will be the unsecured lenders.

INC.: Why is it any more risky for a company to extend trade credit today than it was, say, a year ago?

Treptow: The speed of change is causing many companies to be more fragile and less creditworthy. Combine that with the fact that banks are scrutinizing their customers more closely than before, forcing businesses to find other sources of working capital.

INC.: Why is that?

Treptow: Because of the number of bank failures we've seen in the past couple years. The federal bank regulators are more concerned now about the safety and soundness of the banking system, so they're asking banks to improve their credit quality. In fact, there's a lot of pressure on banks to increase their capital-to-asset ratios from a minimum of 6% of assets to 9%. It isn't mandated yet, but in all likelihood banks will have to do that over the next few years. The upshot is that bankers will be more careful about the assets they will be putting on their books and will be inclined to make loans at a slower rate.

INC.: So it sounds as though many companies may be heading for trouble with their bankers.

Treptow: Banks are going to be asked to function with less leverage on the balance sheets than before. You can improve capital ratios in only one of two ways. You sell stock or slow your asset growth. I predict bankers will be more cautious in their growth rates so as to minimize the need for additional capital. There will be less appetite to grow with risky investments, and they'll be weeding out some of the customers they have.

INC.: We're hearing some talk about a slowdown in the economy. Do you think that a major recession is inevitable in the next couple of years?

Treptow: I don't believe we're going to see a general recession in the next two years. But I do think that we're going to see a series of selective recessions in different industry and product groups.

INC.: If you believed that a customer's business might be hit by the ripples of a recession a year or so out, what would you be advising him now? Would you tell him, for instance, to scrap his capital-spending plans?

Treptow: If I saw some softness in the market, then I'd certainly tell him to pull in his horns. I'd tell him to concentrate on the areas that are most profitable in the short term. But I'd also advise him to stay in markets where he had long-term confidence, even if it meant losing money.

Of course, those two may be in conflict, in which case you'll have to choose between them. It's easier to make such choices when you have a good understanding of what you do best, and where it fits into your overall strategic plan.

INC.: Let's say I was outgrowing my production facility and asked you to finance a plant expansion. What kinds of concerns might you have?

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