A leading small-business lender offers his advice on how companies should be approaching their capital needs in these uncertain times.
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?
Treptow: If your business was fairly labor intensive, I'd want to see some analysis showing why the plant expansion, with the continued labor intensity, was the right way to go. I'd want to know why you weren't spending some money on automation equipment to increase productivity. Over the long term, that might serve you better. In the end, the question is how you're going to get the product out the door for the lowest cost. Obviously, you can't focus on cost and ignore concerns about quality. More and more manufacturers today are requiring strict quality control because the market demands that they do it.
INC.: If you were to advise chief executive officers on how to read the economy, what kinds of signals would you say they should be watching?
Treptow: People should keep an eye on some of the economic data that's published on a regular basis. I get a publication called Economic Indicators, which is put out monthly by the Council of Economic Advisers. And while I don't bother following money supply, I do keep track of things like the consumer price index, personal income growth, consumer spending, and capital investment.
These kinds of numbers can help you keep track of what's happening, but it's more important to have detailed discussions with each of your significant customers about their own projections for their business. I'd want to know everything they could tell me about their demand for the kinds of products or services that I provide. I'd also watch for signs of what the competition is doing. But your own customers are probably the best intelligence sources you have.
INC.: You've seen a few recessions in your time. What are the most important lessons that managers should keep in mind for the future?
Treptow: The biggest single mistake that many businesses made in 1982 was to construe the recession as an ordinary downturn, with the expectation that eventually we'd be back to business as usual. It didn't happen, because, in large part, the last recession reflected our entrance into an increasingly global economy. It's hard to insulate yourself anymore. The materials you buy, the products or services you compete against -- they're all affected by international forces.
INC.: Contrary to many expectations, interest rates have been falling in recent months. Should companies try to take advantage of the decline now?
Treptow: This is probably a very good time to stretch out long-term financing commitments if you can lock in favorable interest rates. I don't think rates can go much lower than they are now. But a word of caution: I happen to believe we're in a noninflationary of deflationary economy that may last for some time. Interest rates may be down, but borrowing could possibly be more expensive now than it was previously, when rates were higher. With today's lower inflation, borrowers pay something closer to a real rate of interest -- you can't count on paying the loan back tomorrow with cheaper dollars. Managers need to be aware of that.
And I also want to reiterate the point I made earlier about paying close attention to earnings and cash flow. If you're making a good, productive investment and you're planning to borrow for it, rates are better than they've been in many, many years. But because of volatility in the economy overall, as well as in specific markets, I think you have to be especially careful about the earnings coverage -- the return on assets, for instance -- and the cash flow associated with an investment. Volatility means that a lot of individual companies will have upward spikes in profitability, and they will also have down periods. Those companies will have to make enough money in the upturns to get through the downturns. If you go by the old guideline that you should be averaging a 10% to 15% return on your equity, you should probably aim for substantially more than that in the good times.
INC.: You're saying, in effect, that this is not a good time to pile on unnecessary debt. But isn't it an awfully good time to be renegotiating existing loans?
Treptow: Yes, but that may not be so easy to do. If you, as a borrower, think rates are at a low point, you'll be looking to get a fixed rate at today's levels. But if your banker shares that view, he won't want to do that. Even so, it's certainly worth asking. Your banker's view of the future might be different from yours. That's what makes a market.
INC.: How confident are you that interest rates have bottomed out?
Treptow: Speculating on interest rates is a very tricky business. If I were really confident that rates were at their lowest point, I'd stop lending money to businesses and invest all the money we've got in the bond market. Granted, there are a lot of indications that we're pretty near the bottom. To begin with, you have the federal deficit. And if rates go much lower consumers will have very little incentive to put money in banks. But I'm not prepared to bet everything on my interest rate forecast.
INC.: Do you have any tips for companies negotiating loans?
Treptow: To be successful, you have to exhibit as much strength as you can. In my judgment, you can do that best by having a very well-conceived business plan, which allows your banker to feel extremely comfortable about the company's credit quality. Once you've satisfied the bankers on quality, negotiating the price on a loan is no different from negotiating the price on nuts and bolts and washers. But there's no point even trying to negotiate rates or terms unless you've satisfied them as to your credit quality.
INC.: Overall, you're not sounding very bullish. In fact, you sound almost gloomy. Do your banking colleagues feel the same way?
Treptow: The unique thing about this period is that you can find bankers and economists to support almost any economic scenario you can come up with. I've never seen such a wide diversity of economic forecasts as we're seeing right now. It's almost chaotic. And maybe that should make everyone a lot more concerned.