A Wells Fargo bank vault (AP Photo/Jeff Chiu) Associated Press
Banks eased credit standards for business loans this quarter, reversing the tightening of late 2018. That sharp increase in banks tightening credit standards was coincident with the general doom and gloom which accompanied the federal government shutdown, stock market decline, and bad news about foreign economies. Now the shutdown is over, stock prices are up, and economic growth has leveled off in both Europe and China.
Banks tightening or easing credit standards. Dr. Bill Conerly based on data from the Federal Reserve System
Business borrowers should use this experience as a lesson about fickle banks. Not all banks are fickle, of course, but credit standards are a moving target. That said, changes in lending standard are usually lines within the gray area. Highly credit-worthy companies are always able to borrow, and businesses with weak balance sheets seldom are able to borrow, at least from banks. That gray area is where the tightening and easing occurs.
Every business should know where their credit status stands, even businesses that don’t borrow money. The ability to borrow enables a company to pursue surprising opportunities or to weather temporary storms.
The commercial lending process isn’t always transparent to customers. In the eagerness to get a loan, the CFO seldom asks just how close to the edge the credit decision was, but that’s a crucially important bit of information. If the company has a wide margin of creditworthiness, then little problems can be worked through. But if the company was right on the edge of creditworthiness, then a bad quarter could be calamitous, especially if it coincides with bank tightening.
On the other side of the line, a company with strong credit can usually get a larger line when good opportunities arise. Knowing to be on the lookout for assets going for fire-sale prices can enable strong growth in an otherwise moderate economy.
CFOs, or CEOs of smaller businesses, should sit down with their bankers. Pencil in some alternative futures, one with stronger demand, one with weaker demand. Ask how the bank would view these alternative futures. It’s probably wise to present the exercise as a symmetric learning experience: as much upside potential as down. Even if the company’s concerns are more about downside access to credit, there’s no sense in making bankers nervous.
Upside scenarios can be surprisingly difficult for banking relationships. Higher orders are good, but some companies have to lay out cash to employees or suppliers before receiving payment from customers. That’s a drain on working capital. A banker doesn’t think of good news when the customer reports running out of cash. An early conversation about cash needs in a surprisingly good business environment will help pave the way for a higher credit limit.
Some banks may not be helpful in this conversation. The spread of computer-based credit scoring reduces the knowledge that some bankers have of their own institution’s credit standards. A business executive or owner who comes up against this should consider shopping around for another bank, or at least pushing the loan officer to raise the issue with a higher level officer.
Access to credit can be very helpful, even to conservative companies that don’t like borrowing. Access is not the same as commitment. Having options is always good.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.