Credit Risk, the Economy and Your Business.

On December 19, 2000, at its regular meeting, the Federal Reserve Open Market Committee warned of the drag on the economy from rising energy costs, eroding consumer confidence and shortfalls in sales and earnings. On January 3, 2001, reiterating its concerns, it lowered the federal funds target by 50 basis points and dropped the discount rate 25 basis points. In doing so, it stated that it believes that "risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future." [i] Recession, not inflation, is now the monetary bogeyman, and all who extend or obtain credit must consider changing business practices to reflect this new economic wisdom.

Banks have been feeling the pressures of increasing credit risk for several years. With great competition for loans during the recent economic expansion, banks accepted lower quality credits to bolster earnings. That strategy now appears to be backfiring. For all FDIC insured banks, the dollar volume of non-current and charged-off loans has risen from a 4th Quarter 1997 low of $7.5 billion to a high of $17.7 billion in the 3rd Quarter of 2000. From the 3rd Quarter of 1999 to the 3rd Quarter of 2000, loan loss provisions rose 25.9 percent, net charge-offs rose 16.5 percent and commercial and industrial loan charge-offs rose 43.7 percent. [ii] These harsh statistics indicate the general weakening of lending standards and underwriting practices as banks have stretched for earnings.

Fear of recession and regulatory sanctions will now cause banks to be more selective about new credits and more demanding of current borrowing customers. They still want to lend money, but terms will be tougher. Even though the Federal Reserve has lowered some short-term interest rates, rates at which most companies borrow will not fall significantly. Rather, credit availability will be more restricted, forcing slower growth. What can a company that requires bank credit to continue to grow its business do to ensure that needed credit is available? And what can a business do to protect itself against tighter credit standards imposed not only on itself, but also on its customers?

The most important fact to remember is that banking is a relationship business, and as in any relationship, communication is a vital factor. Bankers can deal with problems; they are less effective in dealing with surprises. Conversation and documentation can go a long way in helping your banker work with you to obtain needed funding. For example:

* A regular discussion with your banker describing the health of your business and its challenges and opportunities will help your banker understand your needs more fully. Circumstances will dictate the frequency of such conversations, but they should occur regularly so that you and your company are known entities to bank personnel.

* If you have completed a strategic and/or business plan, share it with your banker. It will be kept in confidence and will give your banker valuable insight and a map by which your progress can be followed. If you do not have a business plan, you should devise one. Remember the adage, "those who fail to plan, plan to fail." In order to make timely and effective credit decisions, bankers need good financial information. The primary source of repayment on any loan is the cash flow of the business. Timely delivery of full and complete financial statements, cash flow forecasts and tax returns are vital to demonstrate the borrower's ability to repay funds. Incomplete or untimely financials make bankers nervous.

* No banker ever wants to foreclose on collateral--that is an exercise in futility. Foreclosure takes valuable time, breaks relationships, and the ultimate financial recovery is never sufficient to pay the indebtedness. Considering that, the banker will still want sufficient collateral and proof of value to lower the bank's risk in the loan. If the collateral is real estate, the banker will want a current appraisal written to the bank. If the collateral is equipment, receivables, inventory, furniture and fixtures, or other business assets, the bank will perfect its interest by making UCC filings in each appropriate jurisdiction. Loans will be made against a discounted value of collateral.