Borrowers Can Find Credit but Need to Be Careful

The recent drop in interest rates probably doesn’t mean the end of stormy weather for California’s small and mid-size business borrowers, but those who make themselves smart borrowers may weather the current slowdown.

How? They make the most of what lenders offer in parlous times--meaning, at the moment, two things:

* They borrow against real estate.

* They keep their eyes open if they must borrow against other assets such as inventory, receivables and equipment.

Behind this strategy lies an important fact about commercial banks: Interest rates aren’t the only factor influencing their willingness to finance your operations with debt capital, especially when you offer inventory, receivables and equipment as collateral in a slowing economy. Far more important is the condition of the typical banker’s nervous system--and at the moment, it’s probably not good even with interest rates down.

But banks remain willing to lend against real estate, which they consider secure, and this gives those who own it a means of raising cash that can spell the difference in the coming months. Meanwhile, commercial finance companies and other non-bank lenders still lend against inventory, receivables and equipment, though at higher interest rates and often under stiffer terms than they did as recently as a year ago.

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Thus business borrowers can find debt capital but must take care in raising it, said Larry Hurwitz, whose Brentwood firm, Lawrence Financial Group Inc., specializes in arranging debt financing for sub-prime business borrowers, including many small and mid-size businesses.

“The regulators are very tough on banks,” Hurwitz said, “and that drives weaker borrowers into the arms of commercial finance companies and other non-bank lenders.”

Lenders began seeing an increase in applications to refinance commercial real estate some months ago as interest rates dropped, with some business owners eager to cut interest costs and improve their cash flow and others intent on hoarding cash as a hedge against a slowdown in the economy.

The slowdown is now here, making many commercial banks reluctant to lend against anything other than real estate, Hurwitz said. But don’t despair if your assets consist only of inventory, receivables and equipment, he said. Commercial finance companies and other nonbank lenders still lend money under the right circumstances, although they work far more cautiously than they did last year.

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Hurwitz sees three trends among such lenders:

* They want companies with solid collateral--meaning that they don’t lend against intangible values such as intellectual property.

* They offer far less even against solid collateral than they did as recently as last summer--for example, 50% or 60% against inventory or receivables, down from 75%, sometimes more, a year ago.

* They don’t overlook the blotches in a borrower’s credit history.

“A year ago it wasn’t unusual to see lenders advance as much as 90% or 95% against high collateral values,” Hurwitz said. “Now they ratchet the ratios back to 50% or 60% at most. And it’s hard to pay off an existing lender who gave you 90% with a new lender who gives you only 60%.”

And the debt financing comes at a hefty price, Hurwitz said: Interest can range from prime plus four to considerably more, plus fees and countless other charges, and some lenders want equity “kickers” as well--commonly warrants giving them the right to buy stock in the borrower’s company.

Clearly, he said, this can make borrowing expensive in more ways than one, and that alone may keep many borrowers out of the marketplace. But it can make sense if you keep your eyes open and use the debt financing to grow.

“The strategy has to be to look internally and clean up your operations first--maybe cut off less-profitable lines, cut costs, defer capital expenditures, defer hires, even perhaps sell off divisions whose products don’t have big potential,” Hurwitz said. “And if you must borrow, borrow carefully.”

Next: The 12 commandments of smart corporate finance.

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Recent Financing and Insurance columns are available at www.latimes.com/finin. Juan Hovey can be reached at (805) 492-7909 or at jhovey@gte.net.