Keep an Eye on Your Commercial Loans
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Borrowing money for your business and keeping the banks happy is a challenge. Here’s how to handle it.
You’ve undoubtedly heard that mortgage interest rates are rising, but have you asked yourself whether that will affect your current business loan or line of credit?
The answer is definitely “yes” -- and, not only that, it will make small business loans harder to get in the future.
Banks and other business lenders base their rates on what it costs them to obtain the money they lend out. Most lenders actually borrow that money from other banks, and they do so based on the federal funds rate. While the Federal Reserve has recently left this rate unchanged at near zero, many anticipate that it will begin creeping up in the near future, forcing the prime rate to eventually increase.
The net takeaway here is that all companies that lend or borrow are subject to interest rate risk. The overall risk to each company can be affected by a number of factors:
Length of loan term. One of the largest determinants of the interest rate risk a company is exposed to is the loan terms on its borrowings. As its short-term borrowing rate increases, the company may find its bottom line affected if it has to refinance its bank debt without being able to pass this increased cost on to its customers.
Credit risk. A company’s credit risk is, in part, determined by its debt-to-equity ratio. As interest rates rise, equity falls because the company is paying out more interest. This increases the overall credit risk of the company, which, in turn, causes lenders to raise the interest rate on new borrowing. The more debt exposure a company has, the higher its overall interest rate is.
If you currently have a variable rate loan or line of credit, you can expect your interest rate to go up this year and next.
And if you have a fixed-rate loan, you bank may try to have you renew your loan at the higher rates as those rates move up.
Getting a business loan will become increasingly harder in some respects. Loans are underwritten based on a borrower’s ability to make loan payments (both principal and interest). But if the interest rate increases, that means that the overall payments will rise, making it harder for a business to qualify.
Offset the challenges. So, here are some things you can do to offset these challenges:
If your loan is asset based, make sure that the values of those assets are up-to-date.
If your line of credit is receivable-based, make sure receivables are collected according to the terms of the line of credit.
If your loan is inventory based, make certain that as prices decline, you take the appropriate inventory write-downs or, if prices increase, that you can demonstrate the increased value of your inventory.
Above all; even if the bank has allowed forbearance for a small covenant violation, be sure that you are back within the covenant as soon as possible.
Position yourself well. What can you do to be one of those businesses that are highly qualified to borrow?
The first thing is to focus on your cash flow and profit-and-loss statements. Be able to clearly demonstrate that you can make payments on the loan you are asking for today, and if interest rates rise, make payments under those circumstances, too.
Be able to demonstrate that the loan you're asking for is not being used to fund losses but to help your business grow and become more profitable.
Begin to lock in as many fixed rates as you can today, before rates and prices increase.
Look at longer-term supply agreements, rent and even labor agreements while rates and inflation remain low.
Lastly, if you believe that your bank might not be inclined to renew your loan when it comes due, don’t be too proud to ask for help.
The more time you have to restructure your financial statements, the more likely you’ll be to find a lending institution that's willing to say “yes.”