The summer of 2007 marked a pronounced shift in the credit markets. Leaving aside any discussion of the myriad factors driving this change, the end result is a general tightening in credit conditions. Pricing of credit has risen, and investors and lenders are decidedly more risk-averse. But, this is not “financial doomsday.” The change in attitude is part of the normal cycle of adjustment that the credit markets follow. Currently, the supply of credit is much less than the overall demand for credit. The economy is reacting to the continuing housing and mortgage saga and softening employment, which will mean that credit demand will ultimately decelerate as well. If credit fundamentals weaken as they are apt to do in a slowing economy, the credit markets will tighten further.
In late 2006, I wrote about a number of strategies growth-oriented businesses should consider in managing risks that arise during downturns in the credit cycle. At the time, I believed as many did, that the credit cycle was nearing a peak and would inevitably begin adjusting. In view of all the dynamics impacting the market, it’s appropriate to think about strategies to employ before business borrowers see the full impact of the cycle change.
With credit tightening a reality, I want to underscore some of those same strategies as well as offer a few others that are significant, now that we find ourselves dealing with a decidedly different credit climate.
• Engage your lenders and other credit-capital providers in an open and honest dialogue.
Discuss company strategies and plans, giving equal weight to potential problems as well as recent successes. Do this proactively, not just when there is a specific need or request. During a period of tightening credit, your bankers and capital providers will be under increasing scrutiny themselves within their own institutions. Arming them with useful information and being forthright in your dialogue will assist them in dealing with this increased oversight, while helping them continue to support your relationship.
• Be aware of the difference between “market conditions” and “local conditions.”
The term conditions represents that set of prevailing attitudes and practices exhibited by creditors/lenders broadly (the “credit market”) vs. those evident “locally” in industry groups as well as local markets. There is often a lag in the credit cycle adjustment dynamics of local conditions relative to market conditions. Having a sense of where the cycle is during the adjustment process can be valuable to a borrower’s ability to capitalize on the best set of credit terms and pricing while minimizing execution risks. Currently, we are in the early stages of the adjustment process. This means “market conditions” are likely to be somewhat more restrictive than corresponding “local conditions.” But when the credit cycle has reached a trough, it is just as likely that “local conditions” will be more restrictive than the broader “market conditions.”
• Seek the advice of a well-informed and active credit arranger.
This is particularly important if you are attempting to access multiple forms of credit capital and/or need multiple investors to complete your offering. Such an arranger will typically have the best view on conditions overall, not just the broad market or the local market. They may not always deliver the “best news” or offer the “most positive spin” on your financing request. But, you should not automatically discount their message in favor of a less active arranger who at that moment may have a more positive attitude. A business needs to balance certainty of execution with the need to obtain the absolute best set of pricing and terms possible. In times of uncertainty and volatility, a well-respected arranger and a conservative (yet acceptable) structure can provide many nights of comfortable sleep.
• Enhance your relationship with current credit-capital providers.
With credit capital less readily available compared to recent history, current credit-capital providers are even more important to your business. Awarding lucrative non-credit business to the most important relationships can be an effective way of building goodwill and deepening the relationship with credit suppliers during this critical period. With changes occurring almost daily in the credit cycle, if not the economic cycle, there may come a day when you need them more than they need your business. Between now and that time, you should position the relationship so those providers will feel they are being well rewarded for committing their capital.
• Increase your focus on managing liquidity.
You may need to review your liquidity forecasts in real time. Step up any efforts aimed at managing the level of working capital investment in the business. Keep your receivables as close to practical payment terms as possible. Ensure that inventories track sales and excess inventories are identified quickly with appropriate actions to reduce or eliminate them. Re-evaluate your capital projects. Often, capital budgets are set well ahead of the actual beginning of a project. Reassess these projects periodically in view of any changes in the operating environment. When the operating environment is weakening, give similar treatment to the initial factors supporting the project.
These are but a few of the steps a business can undertake at this point in the credit cycle. The natural reliance on credit capital by a growth-oriented company can present unique challenges during periods when access to credit-capital tightens. A watchful eye on the credit cycle’s impact on your company and strong relationships with credit providers are the keys to weathering this temporary period of adjustment. •
Phil Worden is senior vice president, senior business development officer, for Bank of America Business Capital, Center Region.
