The good, bad, old and new business banking

When Jas Brar left a meeting with a Scotia­bank representative to discuss moving his business account there, he felt more optimistic than most CEOs looking for better bank credit. Brar, president and CEO of Oakville, Ont.-based Entripy Custom Clothing, says the bank told him his firm’s solid financials meant he’d have no problem securing a $150,000 operating line of credit. That was in the fall of 2007. But by the time Brar did switch banks a year later, the story was very different.

The major banks, moving to shore up their balance sheets amid the global financial crisis, were tightening up on credit. Scotiabank told Brar it could approve only $100,000—a third less than his request—despite no change in Entripy’s financial footing.

“Our account manager said things were really bad out there, so they were being really cautious,” says Brar. “But if you looked at my individual situation, it was an overreaction as far as I was concerned.”

Even though Entripy’s sales grew by 24% in 2009, says Brar, “we could have grown even more” with a $150,000 operating line. The next spring, Scotiabank again turned down his request for this amount. To fill the gap, Entripy secured a term loan at a higher rate of interest from the Business Development Bank of Canada.

Brar’s experience during the financial crisis and its aftermath typifies that of many Canadian entrepreneurs. Although SMEs didn’t face a brutal, U.S.-style crunch, they did undergo a significant squeeze. A triennial survey of Canadian Federation of Independent Business members shows the banks’ loan-rejection rate jumped from 13.7% in the spring of 2006 to 19.3% in the spring of 2009. And Bank of Canada figures show a 13% peak-to-trough decline in bank loans to business from December 2008 to June 2009—and in December 2010, they remained 10% below the peak. (No breakout is available for loans to SMEs, but bankers say the pattern is similar.)

This squeeze wasn’t severe enough to alter the banks’ fundamental treatment of SMEs. Still, the banks’ approach has changed in several respects. It pays to know what has and hasn’t changed in what banks look for, and how you can boost the odds of getting the financing you need.

One change is increased scrutiny. Not that bankers were softies before 2008. “The banks have always been more stringent with SMEs,” says Vince De Luca, managing director at PricewaterhouseCoopers Corporate Finance in Toronto. But during the crunch, they stepped up their due diligence—for instance, by asking clients for a more thorough analysis of how they stack up against rival firms. And, says De Luca, “If you had a current loan, there was zero tolerance for lateness or inaccurate reporting to them.” But he says the emphasis on timely and reliable reporting is a good thing that he expects will continue.

De Luca says banks increasingly expect exporters to have solutions to the challenges posed by currency fluctuations: “They want you to explain what a one-cent change in the value of the loonie would do to your EBITDA [earnings before interest, taxes, depreciation and amortization] and what you’re doing to hedge currency risk.”

The crunch also has made the banks keener to do business with SMEs that use several of their services, such as cash management, business credit cards and foreign exchange—and the owner’s personal banking. “Business owners can be quite well off, and a lot of banks recognize the value of capturing the whole relationship,” says Nick Stitt, vice-president of business credit products at TD Canada Trust in Toronto. During the crisis, says De Luca, “The banks’ spreads [between the interest they charge and their own cost of capital] tightened due to what was happening in the credit markets, so they were looking for ancillary revenue from you. That made them more inclined to look on your firm favourably if you were also buying more services from them.”

Another change since pre-crisis days concerns the financial ratios banks use to help gauge their clients’ ability to repay loans. Typical ones include debt/service (net income relative to debt payments), debt/equity and the current ratio (assets available in the next year relative to liabilities that will fall due then). The specific parameters haven’t changed; rather, the context in which the banks analyze them.

David Wilton, director of small-business banking at Scotiabank in Toronto, offers the example of a firm whose debt/service ratio remains the same 1.5 it was in 2007. “If, in 2007, you had five contracts that would generate incremental sales over the next year, that would have been a factor in looking at that ratio,” says Wilton. “But if, in 2011, you have no new contracts, only existing clients—and some of them are weaker than in 2007—then a 1.5 ratio might not be as comfortable for the bank as it was in 2007.”

Bankers stress that ratios are useful tools, but not the keys to their loan-approval decisions. “Ratios are indicators of a healthy company,” says Derral Moriyama, BMO’s senior vice-president of commercial banking for Greater Vancouver. “But we’re not so rigid as to say that you can never miss on a ratio, and if you do, we don’t want to deal with you anymore.” Moriyama says banks take a holistic view, focusing more on factors such as management quality, the amount of equity in the firm and whether it has “reasonable cash flow and a good story.”

A good story need not be a flashy one. Moriyama says that if a sound business that’s faring well within its sector seeks money for expansion or to smooth out cash-flow cycles, “we’d give it a nod over someone coming in with an idea they think will work but that they’d like us to take the risk on.” One thing that hasn’t changed is that banks aren’t in the business of financing high-risk ventures.

Bankers emphasize that the way they deal with SMEs remains largely the same. To win them over, you should heed some timeless advice. Bankers hate to be surprised—so, if you’ve breached a covenant, tell your banker ASAP and explain why it happened. Invite your account manager for a visit so she’ll understand your business well enough to go to bat for you within the bank. And plan ahead: as growth boosts your working-capital requirement, don’t wait until just before you need the money to ask for it.

The good news is that it’s not all up to you to cultivate a good relationship with your lender. The crisis has made the banks keener to do more business with SMEs. “It’s a great way to spread risk over a large number of borrowers,” says Moriyama. “There’s competition out there, and we’re fighting every day on deals.”

This competition is spurring the banks to rethink aspects of their dealings with entrepreneurial firms. Stitt says TD, like other banks, is trying to simplify its relationships with SMEs, especially smaller ones. Rather than annual reviews, TD does monthly “health checks,” then follows up only with companies it wants more information from or to have a conversation with. And the bank does these checks using data, such as credit scores, that it can get without having to bother the firm.

As well, says Stitt, “We’re asking ourselves, ‘Do we really need all these conditions?’ If we’re providing an operating line financed by receivables, you would have a coverage condition. And if you have that, why also have a current ratio test?” He says, for example, that using just two tests makes it feasible to give a client an answer on a loan application within two days.

There’s more good news. With credit conditions pretty much back to normal and the economy strengthening, more SMEs are approaching their banks to finance moves such as buying equipment—or a rival. And bankers are more likely to green-light such requests. Entripy’s Brar is about to request a higher operating line, and says he’s confident that this time he’ll hear a “Yes.”

Wilton sums up an outlook that has bright­ened markedly in recent months: “These days, we’re seeing more opportunities than challenges.” –JIM Mcelgunn