April 16, 2008 was my last post. Since that date, much has change in the commercial loan market and myself. One of the things that I've come to realize is that real estate investors and commercial business owners need more help than ever before with finding financing.
Abandoning these two important economic gas petals to the economy is not the right answer. Hiding behind a tough if not impossible commercial loan market is not the answer. I apologize for using these excuses as a way out of finding hard fought solutions for customers and prospects. You deserve better.
Now that I have that off my chest. The Commercial Loan Market is more strained and declining than the media is letting on. I laughed in a way that hid my nerves when I read recent news articles by local institutions such as the CBIA, and the SBA. Those two articles suggested that lending standards have not been tightened and in fact the Bankers polled in the articles suggested that they see customers and prospects being more cautious about future business expectations and therefore are postponing capital expansion. Sure, its not their fault, its the business owners not asking for loans!!!
Well I'd like for them to meet a successful owner of a insurance agency (been in the insurance business for over 30 years) in Hartford County who was looking to refinance an adjustable rate mortgage on her building. A mortgage rate that was adjusting to upwards to 13% as of this post. This person's credit was ok, not great, but enough to show that this person could handle their obligations. As of right now, this person who has a successful business and good personal credit can't find a loan to help the business stay competitive. The owner is approaching the point of laying of customer support staff because of the rising mortgage payment.
I'd like for them to meet the owner of an auto painting shop who has good credit, and has been in business for over 15 years and is an institution in his community. Finding a lender to refinancing him out of a hard money loan currently paying 12% has been impossible. This owner is worried about the current lender foreclosing on his property because the loan has matured. Each month his current lender charges the owner a $4,800 fee for not paying of the loan. All the lenders solicited to look at this loan avoided this loan like the plague. He employs six full time mechanics that he might have to lay-off because of his financial situation.
I'd like for them to meet a young entrepreneur that owns three commercial properties on a main street in a busy town. He owns a robust service business and his credit has been damaged by a dishonest residential loan broker who convinced this person that his personal mortgage refinance was going to close soon so don't pay your current mortgage. Well that is financial disaster for your credit report. Two of the commercial properties were leased out and cash flow positive. He wanted money for the third to bring it up to code so he can lease it out. He was asking a low Loan to Value on the properties that were already leased and cash flow positive. No dice. Lenders look for any excuse to say no - often times taking months to finally say no. They look at the personal credit and walked away. There so many reasons to justify the loan, but they needed only one to decline the loan.
Large borrowers aren't immune to what's going on. I've gotten calls from many of my old banking customers telling me that their banks are no longer funding capital expenditures required for future growth or required cost savings. Many of these companies employee well over 200 each. The lack of financing has further caused a business contraction and potential lay-offs.
So don't tell me that the credit crunch hasn't hit main street. I'm sure the business owners mentioned above where not asked in the polling conducted by these media institutions. I have an idea. Speak these business owners after they have to lay-off productive, important people because they are trying to meet their current loan payment that increases 15% a month.
The credit crunch is real, its here, and won't be gone for a long time. I know a lot of bankers that are telling me privately that their Bank's have posted "Closed for the Summer and Winter" signs on the Commercial Lending departments. Let's hope they might be open for the spring!
Showing posts with label Banks. Show all posts
Showing posts with label Banks. Show all posts
Monday, August 18, 2008
Tuesday, April 15, 2008
"Is it the beginning of the end or the end of the beginning."
An article in Monday's Financial Times titled "The beginning of the end or the end of the beginning" filled me with enthusiasm that we were approaching the end of the "Credit Crisis". The author pointed to the market's gain since the Fed's bailout of Bear Stearns as the benchmark event that was the tipping point towards a bright future.
The author must of performed a gut check when GE shocked the market on Friday. Not only did GE's earnings debacle create concern regarding the health of the US economy (given GE's product diversification), but the write-downs in GE Capital and other Real Estate business lines reminded many that the credit crisis was still around. After deep thought the author published the article on Monday, perhaps I would have done the same.
On Monday, it was announced that Wachovia needed a $7 billion capital infusion due to write-downs and an unexpectedly worse US economy. This announcement came on the heels of Washington Mutual's $7 billion capital infusion by a private equity firm.
The author must of performed a gut check when GE shocked the market on Friday. Not only did GE's earnings debacle create concern regarding the health of the US economy (given GE's product diversification), but the write-downs in GE Capital and other Real Estate business lines reminded many that the credit crisis was still around. After deep thought the author published the article on Monday, perhaps I would have done the same.
On Monday, it was announced that Wachovia needed a $7 billion capital infusion due to write-downs and an unexpectedly worse US economy. This announcement came on the heels of Washington Mutual's $7 billion capital infusion by a private equity firm.
Wachovia's announcement peaked my interests because much of the capital infusion went to build capital reserves against a failing US economy. While the US economy was heading towards little to no growth projections prior to the credit crisis hitting the financial markets, the almost collapse of the banking system could mark the next phase of the credit turmoil: The Credit Crunch Phase.
Financial institutions can shore up capital ratios by injecting capital to the business and/or restricting lending. Withholding credit pinches the checkbooks of many main street businesses. Business owners then look to pare payrolls, shelve capital expenditures plans, and reduce other employee benefits (higher health care deductibles. This circular equation puts the economy in a precarious situation and could ultimately lead to a prolonged recession.
The point is with many financial stocks reporting earnings this week, we should get a glimpse into the health of the US financial system. J.P Morgan, Merril Lynch and Citigroup all report earnings this week with more to follow next week. Watch and read carefully the earnings reports and watch for signs of credit restrictions and dire predictions for the US economy. Pay close attention to the smaller regional banks that so far have been hidding behind the headlines.
So only after this and next week will we know if it's the beginning of the end or the end of the beginning.
Monday, March 31, 2008
Remember This: There are a 1,000 of THEM and only ONE of YOU!!
It can be down right scary. What if I say the wrong thing? What if my credit score isn't high enough? What if he shoots holes in my business plan? What if she doesn't believe that I can increase the occupancy rate to 90%? Oh, I need to get this loan closed in 30 days or I'll lose this great opportunity. My lender won't call me back. Have you felt these emotions when you last dealt with your bank? In short, do you look or feel like the picture below when dealing with the commercial loan process?
.jpg)
.jpg)
Let me tell you a secret. A secret that your banker doesn't want you to know. You can now obtain your loan to buy that business or buy that property from ANYWHERE on terms Better than what your loan officer can give you. You can buy that property with the help of a private lender in California. A hedge fund in Texas will help you acquire your competitor. Why or how did this happen? Well I'll get to that later, but it's important to know more about this nasty little secret.
Why doesn't your banker want you to know this devastating secret? Because, if you knew this secret (and now you do!) then he or she would have to return your phone calls or worse they would have to close your loan on your time table, versus, the banks. Better yet, they wouldn't be able to make you jump through hoops with questions and documents only to say NO leaving you with no options, and no time to find another lender. Well, thanks to the globalization of finance, Main Street USA now has access to capital from Asia, Europe, and all over the United States.
See, despite what you see on television regarding the residential mortgage crisis or the collapse of Bear Stearns, the United States has one of the most efficient capital markets system. Even with all of its warts (savings and loans debacle of the 80's, the collapse of the hedge fund Long Term Capital Management as examples of our warts), the United States' financial system attracts capital from all over the globe.
What this means for you- the Main Street investor or business owner? Well, the massive amounts of capital invested in the United States continues to chase fewer and fewer larger transactions. This puts pressure on putting the money to work, prompting these capital providers to lower their loan size requirements.
So now, that real estate owner in Newington looking for $50,000 cash out on his properties can obtain his loan from a private lender in Pennsylvania who's largest investors are private banking clients from Europe.
So the next time you call your banker, I bet he or she will take your call. Suddenly, they're hoping you take their loan; hoping that they don't say something that will make you go elsewhere. Remember, there are 1,000 of them and only One of You. You're driving the bus.
Thursday, March 20, 2008
Real Small Business Loans for Real Small Businesses
If you were looking for a $300,000 business loan, would you pay and additional $67,000 over three years in order to get a two percentage point reduction in the interest rate?
Unlikely.
But that's what plenty of small business owners do because they seek bank financing with seemingly low rates of interest, versus a so-called stated income/asset loan that carries an apparently higher interest rate.
How can this be?
Simple. The low rate loan is a full documentation, conventional loan. The seemingly higher rate loan, the stated income/asset loan, requires limited documentation and no income verification. For small business owners, there is a world of difference. The reason is because the owner of a small and or cash based business may have a very low salary, but quite legitimately derive economic value from the business in excess of $100,000. But stating this to satisfy a bank can at the same time provoke tax authorities, and generate significantly more taxes well into the future.
Thus the savings from the apparently lower rate of interest are illusory. Worse, because of potential tax liabilities, low rate loans may result in an effective interest rate that is much, much higher.
We are all brought up to believe that banks finance businesses. And there is a myth that small banks and small businesses fit hand and glove with one another. But the truth is that banks and small businesses are actually a tough fit.
The bankers aren't bad guys. It's simply that banks - even regional and community banks that have a vested interested in funding businesses where they operate - are structurally incapable of serving the needs of small and or cash based businesses. Banks need plenty of hard assets to collateralize loans. In addition, they are subject to scrutiny by federal regulators on their underwriting policies and practices, and have an expensive monitoring process that favor larger borrowers - those that need to borrow $500,000 to $1 million or more.
By contrast, smaller, cash based businesses typically do not possess a lot of hard assets, may have uneven financial performance that make regulators wince, and typically require loans of less than $1 million. The reality of this "structural mismatch" can be vexing and frustrating for small business owners who often diligently visit every bank in town only to get turned down by each one.
For these reasons, non bank lenders and stated income/asset programs can be a viable alternative for cash businesses, 'mom and pop' shops, self employed individuals, businesses with environmentally sensitive properties (i.e. auto repair shops, dry cleaners) as well as property owners that want to cash out, or leverage up to purchase additional properties. In the highly regulated environment of a conventional bank, these borrowers present insurmountable obstacles. In the more entrepreneurially driven non bank lender environment, these borrowers present a myriad of opportunities for which creative solutions can be developed.
What is the secret of non bank lenders that offer stated income/asset loans? First, they operate in an underserved market: small businesses seeking loans of less than $1 million. By virtue of this, non bank lenders can identify promising businesses that traditional banks would not even see. Second, non bank lenders are not regulated. This means they can adopt policies that while sound, would nonetheless go against the grain of federal regulators provoking questions and inquiries that bank executives would like to avoid altogether. Finally, non bank lenders believe in the value of real property as collateral. By lending prudently against the value of real property, non bank lenders need go no further in assuring the safety of their capital. Putting all these factors together means that non bank lenders offering stated income/asset programs can provide small businesses with solutions that are more consistent with the challenges they face.
For example, many traditional lenders require cross collateral agreements. These are agreements in which the borrower, after pledging all of the businesses' assets and real property as collateral, pledge their personal property as well. This arrangement can complicate loans, especially when there are multiple business owners whose active participation in the business may vary. Because stated income lenders focus on the underlying value of the businesses' real estate, in addition to its cashflow, they generally do not require cross collateral agreements.
Stated income/asset lenders are also more comfortable with so called cash out loans. For example, suppose you own a property that houses your business, and you want to leverage the value of your equity, and take cash out. Perhaps this cash will be used to expand the business. Or perhaps you might view this cash as a just reward for years of carefully managing the business and the property.
Traditional bank lenders are uncomfortable with cash out loans. They often feel that such arrangements leave them vulnerable. By contrast, stated income/asset lenders, which again place an emphasis not only on the business's cash flow but the underlying property as well, actively seek such loans. Their appetite for these loans is a valuable source of liquidity for small business owners.
As one more example of how stated income/asset lenders are more geared to the needs of small businesses, consider typical loan covenants. Traditional lenders often seek the right to audit the books of the borrower and have the borrower issue a covenant pledging that the business will perform at its current level or better. A breach of this covenant, over which the small business owner may not have complete control, can result in the borrower being in default, and the lender initiating foreclosure proceedings.
Again, there is nothing wrong with this per se. After all because banks are the stewards of consumer deposits that are insured by federal funds, i.e. taxpayer dollars, they must avoid risk at all costs. This is why banks operate in what is often characterized as 'an abundance of caution mode,' and adds bulk to the explanation of why banks are not built for the kinds of risks that small businesses typically present.
It also explains why there is such a void in the market for loan and credit services to small businesses. However, stated income/asset lenders have stepped into this void and are actively seeking out companies to provide loan solutions to help businesses maintain their track record of success, or take a giant step forward to the next level.
Unlikely.
But that's what plenty of small business owners do because they seek bank financing with seemingly low rates of interest, versus a so-called stated income/asset loan that carries an apparently higher interest rate.
How can this be?
Simple. The low rate loan is a full documentation, conventional loan. The seemingly higher rate loan, the stated income/asset loan, requires limited documentation and no income verification. For small business owners, there is a world of difference. The reason is because the owner of a small and or cash based business may have a very low salary, but quite legitimately derive economic value from the business in excess of $100,000. But stating this to satisfy a bank can at the same time provoke tax authorities, and generate significantly more taxes well into the future.
Thus the savings from the apparently lower rate of interest are illusory. Worse, because of potential tax liabilities, low rate loans may result in an effective interest rate that is much, much higher.
We are all brought up to believe that banks finance businesses. And there is a myth that small banks and small businesses fit hand and glove with one another. But the truth is that banks and small businesses are actually a tough fit.
The bankers aren't bad guys. It's simply that banks - even regional and community banks that have a vested interested in funding businesses where they operate - are structurally incapable of serving the needs of small and or cash based businesses. Banks need plenty of hard assets to collateralize loans. In addition, they are subject to scrutiny by federal regulators on their underwriting policies and practices, and have an expensive monitoring process that favor larger borrowers - those that need to borrow $500,000 to $1 million or more.
By contrast, smaller, cash based businesses typically do not possess a lot of hard assets, may have uneven financial performance that make regulators wince, and typically require loans of less than $1 million. The reality of this "structural mismatch" can be vexing and frustrating for small business owners who often diligently visit every bank in town only to get turned down by each one.
For these reasons, non bank lenders and stated income/asset programs can be a viable alternative for cash businesses, 'mom and pop' shops, self employed individuals, businesses with environmentally sensitive properties (i.e. auto repair shops, dry cleaners) as well as property owners that want to cash out, or leverage up to purchase additional properties. In the highly regulated environment of a conventional bank, these borrowers present insurmountable obstacles. In the more entrepreneurially driven non bank lender environment, these borrowers present a myriad of opportunities for which creative solutions can be developed.
What is the secret of non bank lenders that offer stated income/asset loans? First, they operate in an underserved market: small businesses seeking loans of less than $1 million. By virtue of this, non bank lenders can identify promising businesses that traditional banks would not even see. Second, non bank lenders are not regulated. This means they can adopt policies that while sound, would nonetheless go against the grain of federal regulators provoking questions and inquiries that bank executives would like to avoid altogether. Finally, non bank lenders believe in the value of real property as collateral. By lending prudently against the value of real property, non bank lenders need go no further in assuring the safety of their capital. Putting all these factors together means that non bank lenders offering stated income/asset programs can provide small businesses with solutions that are more consistent with the challenges they face.
For example, many traditional lenders require cross collateral agreements. These are agreements in which the borrower, after pledging all of the businesses' assets and real property as collateral, pledge their personal property as well. This arrangement can complicate loans, especially when there are multiple business owners whose active participation in the business may vary. Because stated income lenders focus on the underlying value of the businesses' real estate, in addition to its cashflow, they generally do not require cross collateral agreements.
Stated income/asset lenders are also more comfortable with so called cash out loans. For example, suppose you own a property that houses your business, and you want to leverage the value of your equity, and take cash out. Perhaps this cash will be used to expand the business. Or perhaps you might view this cash as a just reward for years of carefully managing the business and the property.
Traditional bank lenders are uncomfortable with cash out loans. They often feel that such arrangements leave them vulnerable. By contrast, stated income/asset lenders, which again place an emphasis not only on the business's cash flow but the underlying property as well, actively seek such loans. Their appetite for these loans is a valuable source of liquidity for small business owners.
As one more example of how stated income/asset lenders are more geared to the needs of small businesses, consider typical loan covenants. Traditional lenders often seek the right to audit the books of the borrower and have the borrower issue a covenant pledging that the business will perform at its current level or better. A breach of this covenant, over which the small business owner may not have complete control, can result in the borrower being in default, and the lender initiating foreclosure proceedings.
Again, there is nothing wrong with this per se. After all because banks are the stewards of consumer deposits that are insured by federal funds, i.e. taxpayer dollars, they must avoid risk at all costs. This is why banks operate in what is often characterized as 'an abundance of caution mode,' and adds bulk to the explanation of why banks are not built for the kinds of risks that small businesses typically present.
It also explains why there is such a void in the market for loan and credit services to small businesses. However, stated income/asset lenders have stepped into this void and are actively seeking out companies to provide loan solutions to help businesses maintain their track record of success, or take a giant step forward to the next level.
Tuesday, March 11, 2008
Easy Bake Commercial Loan Dictionary!!
EASY BAKE COMMERCIAL LOAN DICTIONARY
When its time to go talk to the bank do bad memories or nightmares come to mind. They asked you questions with words and terms that sound from a far, far away land. Well, I’ve compiled a list of the most important and interesting terms for the next time you talk to a bank or more importantly to help better you understand before signing that loan!
Advance Rates: This rate expressed as a percentage determines how much the Bank will lend on certain assets. For example, accounts receivable typically carries an 80% advance rate. So if your company had $100,000 in account receivable, the bank would lend you $80,000. Machinery and equipment and inventory are typically margined by advance rates. Real Property typically is valued at 80% of the appraised value.
Affirmative Covenants: Affirmative covenants are the contractual provisions in a loan that the company and its management agree to fulfill after the loan is complete. In other words, this is what you PROMISE TO MAINTAIN OR DUE POST CLOSING. Common affirmative covenants include:
· Access to records. The company will give the investor or bank and its representative’s reasonable access to company records and personnel.
· Financial reports. The company will furnish the bank with regular financial reports on the status of the company. Balance sheets, profit and loss statements, and cash flow statements are usually provided monthly, quarterly, and annually. Audited annual statements are often required. Sometimes a short "state of the company" statement is also required from the company president on a monthly basis.
· Budgets. The company will prepare annual budgets which must be approved by the board of directors.
· Existence and maintenance of property. The company will preserve its corporate existence and all rights necessary to conducts its business and own its properties. The company will keep its properties in good repair.
· Insurance. The company will maintain adequate insurance. Often, the company also agrees to purchase key man insurance on the lives of management.
· Payment of debts and taxes. The company will pay its debts and taxes in accordance with normal terms.
· Compliance with laws and agreements. The company will comply with all laws applicable to it and perform its obligations under its agreements.
· Litigation and other notices. The bank will be promptly notified of any lawsuit, default under a major agreement, or other event that could have a material adverse effect on the company or its operations.
· Proprietary rights protection. The company will take reasonable steps to protect its patents, trade secrets and copyrights. These steps may include securing secrecy or non-competition agreements from company employees.
· Use of proceeds. The company will use the funds provided by the investor or in the manner described typically in the loan application.
· Accounting system. The company will maintain its current accounting system.
Borrowing Base: A borrowing base typically a monthly calculation that is attached to a line of credit or revolver. The borrowing base is the total amount of lendable assets – after the application of an advance rate. This number represents the total amount a bank will lend you for that month. If your borrowing base falls below the amount borrowed the bank will seek a reduction on the line of credit balance to below the new borrowing base.
Capitalization Rate or Cap Rate:
The capitalization rate is a measure of a property’s performance without considering any mortgage financing. If you paid all cash for the investment, how much money would it make? What’s the return on your cash outlay? Cap rate is a standard used industry wide.
Cap Rate = net operating income / sales price
Since a cap rate measures the property’s profitability it can also help you determine the appropriate sales price for the property. For example, let’s say you want to earn at least 10% on your property investments. The property you are currently evaluating is listed at $2,750,000 and has a $250,000 NOI. Well for you to earn 10% on your money, you would want to negotiate a purchase price of $2,500,000 ($250,000 / 10%).
Cash-on cash Return:
The cash-on-cash return measures how long it takes for your down payment to come back to you. For example, if your down payment was $20,000 on a property how soon would your monthly cash flow (NOI – Debt Payments) takes to add up to $20,000. General real estate guidelines suggest that a 10% or greater cash-on-cash return is preferred.
Defaults or Events of Default: This is here as a reminder that you and your attorney need to understand what triggers a default in your loan. A default can result in higher fees, higher interest rate, and even an acceleration of the loan – meaning the bank wants the entire loan paid back today. Other defined terms in this dictionary are triggers for default such as affirmative and negative covenants.
LIBOR Rate: LIBOR stands for the London Interbank Offering Rate. It is the basic short-term rate of interest in the Eurodollar market and the rate to which many Eurodollar loans and deposits are tied. The LIBOR is similar in concept to that of the prime rate in the United States except that it is less subject to individual bank management.
Loan to Value: The ratio of money borrowed on a property to the property's fair market value. On a purchase contract, the bank will use the lesser of the appraised value or the purchase price of the property. Most commercial banks advance 80% on the appraised value of the property.
Interest Rate Swap: A deal between banks or companies where borrowers switch floating-rate loans for fixed rate loans. These can be either the same or different currencies. The advantage to this is that one company may have access to lower fixed rates and another company may have access to lower floating rates... so they trade.
Prime Rate: The interest rate that commercial banks charge their most credit-worthy customers. Generally a bank's best customers consist of large corporations. Default risk is the main determiner of the interest rate a bank will charge a borrower. Because a bank's best customers have little chance of defaulting, the bank can charge them a rate that is lower than the rate that would be charged to a customer who has a higher likelihood of defaulting on a loan.
Material Adverse Change: While this might seem obvious, but this provision in a loan agreement can give the bank substantial room to call a loan. Essentially, this provision protects the bank in the event a negative event happens to the borrower that would impair the borrower’s ability to pay back the loan. Examples might include the loss of a big customer, a substantial lawsuit, loss of a key owner/manager. Many borrowers don’t try to limit the range of this provision – What is Material? If its not changed then the definition is defined by how the bank wants to define it. Make sure you and your lawyer look at this provision and are comfortable with its range.
Negative Covenants:
Think of a negative covenant as a promise not to do something. Usually, negative covenants limit the amount of dividends a firm can pay to shareholders and restrict the ability of the firm to issue additional debt. Generally, the more negative covenants exist in a loan, the lower the interest rate on the debt will be since the restrictive covenants make the loan safer in the eyes of bank. This is very important aspect of the loan agreement. For example, let's say you bought a property for its net monthly cash flow. If your loan agreemetn prevents dividends or distriubtions then any payment of the net monthly cash flow would be a violation of the loan agreement.
Net Operating Income:
The net operating income or NOI is the dollar amount that’s left over after you collect all your income (rent) and pay out you operating expenses. This amount is what is used to pay the mortgage, and what’s left after the mortgage payment goes into your pocket! Here is the equation:
Net Operating Income = effective gross income – operating expenses
What is effective gross income? Your effective gross income is the net amount of income after vacancies with the property.
What are operating expenses? Your operating expenses of the property include taxes, insurance, utilities, management fees, payroll, landscaping, maintenance, supplies, and repairs.
When its time to go talk to the bank do bad memories or nightmares come to mind. They asked you questions with words and terms that sound from a far, far away land. Well, I’ve compiled a list of the most important and interesting terms for the next time you talk to a bank or more importantly to help better you understand before signing that loan!
Advance Rates: This rate expressed as a percentage determines how much the Bank will lend on certain assets. For example, accounts receivable typically carries an 80% advance rate. So if your company had $100,000 in account receivable, the bank would lend you $80,000. Machinery and equipment and inventory are typically margined by advance rates. Real Property typically is valued at 80% of the appraised value.
Affirmative Covenants: Affirmative covenants are the contractual provisions in a loan that the company and its management agree to fulfill after the loan is complete. In other words, this is what you PROMISE TO MAINTAIN OR DUE POST CLOSING. Common affirmative covenants include:
· Access to records. The company will give the investor or bank and its representative’s reasonable access to company records and personnel.
· Financial reports. The company will furnish the bank with regular financial reports on the status of the company. Balance sheets, profit and loss statements, and cash flow statements are usually provided monthly, quarterly, and annually. Audited annual statements are often required. Sometimes a short "state of the company" statement is also required from the company president on a monthly basis.
· Budgets. The company will prepare annual budgets which must be approved by the board of directors.
· Existence and maintenance of property. The company will preserve its corporate existence and all rights necessary to conducts its business and own its properties. The company will keep its properties in good repair.
· Insurance. The company will maintain adequate insurance. Often, the company also agrees to purchase key man insurance on the lives of management.
· Payment of debts and taxes. The company will pay its debts and taxes in accordance with normal terms.
· Compliance with laws and agreements. The company will comply with all laws applicable to it and perform its obligations under its agreements.
· Litigation and other notices. The bank will be promptly notified of any lawsuit, default under a major agreement, or other event that could have a material adverse effect on the company or its operations.
· Proprietary rights protection. The company will take reasonable steps to protect its patents, trade secrets and copyrights. These steps may include securing secrecy or non-competition agreements from company employees.
· Use of proceeds. The company will use the funds provided by the investor or in the manner described typically in the loan application.
· Accounting system. The company will maintain its current accounting system.
Borrowing Base: A borrowing base typically a monthly calculation that is attached to a line of credit or revolver. The borrowing base is the total amount of lendable assets – after the application of an advance rate. This number represents the total amount a bank will lend you for that month. If your borrowing base falls below the amount borrowed the bank will seek a reduction on the line of credit balance to below the new borrowing base.
Capitalization Rate or Cap Rate:
The capitalization rate is a measure of a property’s performance without considering any mortgage financing. If you paid all cash for the investment, how much money would it make? What’s the return on your cash outlay? Cap rate is a standard used industry wide.
Cap Rate = net operating income / sales price
Since a cap rate measures the property’s profitability it can also help you determine the appropriate sales price for the property. For example, let’s say you want to earn at least 10% on your property investments. The property you are currently evaluating is listed at $2,750,000 and has a $250,000 NOI. Well for you to earn 10% on your money, you would want to negotiate a purchase price of $2,500,000 ($250,000 / 10%).
Cash-on cash Return:
The cash-on-cash return measures how long it takes for your down payment to come back to you. For example, if your down payment was $20,000 on a property how soon would your monthly cash flow (NOI – Debt Payments) takes to add up to $20,000. General real estate guidelines suggest that a 10% or greater cash-on-cash return is preferred.
Defaults or Events of Default: This is here as a reminder that you and your attorney need to understand what triggers a default in your loan. A default can result in higher fees, higher interest rate, and even an acceleration of the loan – meaning the bank wants the entire loan paid back today. Other defined terms in this dictionary are triggers for default such as affirmative and negative covenants.
LIBOR Rate: LIBOR stands for the London Interbank Offering Rate. It is the basic short-term rate of interest in the Eurodollar market and the rate to which many Eurodollar loans and deposits are tied. The LIBOR is similar in concept to that of the prime rate in the United States except that it is less subject to individual bank management.
Loan to Value: The ratio of money borrowed on a property to the property's fair market value. On a purchase contract, the bank will use the lesser of the appraised value or the purchase price of the property. Most commercial banks advance 80% on the appraised value of the property.
Interest Rate Swap: A deal between banks or companies where borrowers switch floating-rate loans for fixed rate loans. These can be either the same or different currencies. The advantage to this is that one company may have access to lower fixed rates and another company may have access to lower floating rates... so they trade.
Prime Rate: The interest rate that commercial banks charge their most credit-worthy customers. Generally a bank's best customers consist of large corporations. Default risk is the main determiner of the interest rate a bank will charge a borrower. Because a bank's best customers have little chance of defaulting, the bank can charge them a rate that is lower than the rate that would be charged to a customer who has a higher likelihood of defaulting on a loan.
Material Adverse Change: While this might seem obvious, but this provision in a loan agreement can give the bank substantial room to call a loan. Essentially, this provision protects the bank in the event a negative event happens to the borrower that would impair the borrower’s ability to pay back the loan. Examples might include the loss of a big customer, a substantial lawsuit, loss of a key owner/manager. Many borrowers don’t try to limit the range of this provision – What is Material? If its not changed then the definition is defined by how the bank wants to define it. Make sure you and your lawyer look at this provision and are comfortable with its range.
Negative Covenants:
Think of a negative covenant as a promise not to do something. Usually, negative covenants limit the amount of dividends a firm can pay to shareholders and restrict the ability of the firm to issue additional debt. Generally, the more negative covenants exist in a loan, the lower the interest rate on the debt will be since the restrictive covenants make the loan safer in the eyes of bank. This is very important aspect of the loan agreement. For example, let's say you bought a property for its net monthly cash flow. If your loan agreemetn prevents dividends or distriubtions then any payment of the net monthly cash flow would be a violation of the loan agreement.
Net Operating Income:
The net operating income or NOI is the dollar amount that’s left over after you collect all your income (rent) and pay out you operating expenses. This amount is what is used to pay the mortgage, and what’s left after the mortgage payment goes into your pocket! Here is the equation:
Net Operating Income = effective gross income – operating expenses
What is effective gross income? Your effective gross income is the net amount of income after vacancies with the property.
What are operating expenses? Your operating expenses of the property include taxes, insurance, utilities, management fees, payroll, landscaping, maintenance, supplies, and repairs.
Friday, February 22, 2008
Lessons from the top and my old boss??!!!!!!
When pricing out a loan, my old boss would tell me that "pigs get fed and hogs get slaughtered". After reading several articles on Harry Macklowe's problems with his lenders, my old boss's voice echoed in my head. Ironically, Mr. Macklowe's issues can provide a lesson to all real estate investors: Don't get greedy.
For those who might not be following the situation, Mr. Macklowe - a very successful real estate investor - is tied in a knot with his Senior, Subordinated and Bridge Loan lenders over the $7.1 billion he borrowed (fifteen months ago) to buy seven Manhattan office buildings. To get the deal completed he offered his crown jewel as collateral to secure a $1.2 billion short term bridge loan from Fortress Investment Group. The crown jewel is the prestigous General Motors building on the southeast corner of Central Park. Mr. Macklowe purchased the General Motors building for $1.4 billion from Donald Trump, who bought the approximately 2.0 million s.f. office building for $800 million in 1998.
Well, last week, Mr. Macklowe turn over the property to Fortress, but kept the title to avoid expensive New York City transfer taxes. Yesterday, three bidders put forth term sheets to acquire the property for $3.0 billion. While the 114% appreciation is nice, the equity in the property is going to go to Fortress and the rest to Mr. Macklowe's other lenders.
Mr. Macklowe got greedy with his desire to purchase the seven Manhattan office building portfolio from the Blackstone Group. He put in less than 1% of his own money, and borrowed the rest on short term money. His assumption was that he could easily refinance the short term money after acquiring the property, but today's credit market felt differently as many of the banks were suffering from large write-downs on both their residential and commercial loan portfolios. What seemed as a safe bet in putting up his crown jewel as collateral is now in someone else's hands. So what can we learn about Mr. Macklowe's situation?
For those who might not be following the situation, Mr. Macklowe - a very successful real estate investor - is tied in a knot with his Senior, Subordinated and Bridge Loan lenders over the $7.1 billion he borrowed (fifteen months ago) to buy seven Manhattan office buildings. To get the deal completed he offered his crown jewel as collateral to secure a $1.2 billion short term bridge loan from Fortress Investment Group. The crown jewel is the prestigous General Motors building on the southeast corner of Central Park. Mr. Macklowe purchased the General Motors building for $1.4 billion from Donald Trump, who bought the approximately 2.0 million s.f. office building for $800 million in 1998.
Well, last week, Mr. Macklowe turn over the property to Fortress, but kept the title to avoid expensive New York City transfer taxes. Yesterday, three bidders put forth term sheets to acquire the property for $3.0 billion. While the 114% appreciation is nice, the equity in the property is going to go to Fortress and the rest to Mr. Macklowe's other lenders.
Mr. Macklowe got greedy with his desire to purchase the seven Manhattan office building portfolio from the Blackstone Group. He put in less than 1% of his own money, and borrowed the rest on short term money. His assumption was that he could easily refinance the short term money after acquiring the property, but today's credit market felt differently as many of the banks were suffering from large write-downs on both their residential and commercial loan portfolios. What seemed as a safe bet in putting up his crown jewel as collateral is now in someone else's hands. So what can we learn about Mr. Macklowe's situation?
- Don't stretch for a property. Evaluate every property on a stand alone basis. I know that real estate fortunes are framed by the Donald Trump's of the world, but leveraging everything for that big deal doesn't make sense. Also, leave emotion out of the buying equation.
- Have a back up plan! Structuring the deal as Mr. Macklowe did is sometimes required especially when you have to put a deal together quickly. However, having your eggs in one basket isn't smart. Be prepared to bring partners into the deal if necessary. I know I said the "P" word, but the equity give up by bringing in a partner is less than the cost of a bank coming after you for their money.
- Be aware of where you are in the Real Estate and Credit Cycles. If you are going to put your net worth at risk, make sure you are fully aware of where you are in both the real estate and credit cycles. Yes, that's right credit availability goes up and down just as the value of your building or house. Banks quickly adjust credit standards and availabilty overnight based on market developements. Usually the adjustments are to harsh and take time to settle out. Talk to commercial realtors, bankers and other real estate investor's before pulling the trigger.
So remember the words of my old boss: "Pigs get fed and Hog's get slaughtered" and you should be ok.
Monday, December 3, 2007
How do I buy my competitor? Will my bank help me?
Acquisition financing has always been challenging for banks. Why? Typically, the multiple being paid exceeds the tangible assets found on the acquired company's balance sheet. This collateral shortfall - as perceived by the bank - is a hurdle that most banks require an equity contribution to cover. The bank would also want you to have "skin" in the game by requiring an equity contributions. Equity contributions have hovered between 20% to 40% since 1996.
To figuire out how much your bank would lend on an acquistions, you must calculate the lendable value of the tangible assets, determine the debt service capability of the acquired company, and calculate the overall balance sheet and cash flow leverage at closing. Let's review each one seperately.
Lendable Value of the Tangible Assets:
Create a simple spreadsheet and put the assets in the first column, and the values found on the balance sheet of the acquired company. Typical assets include: Account receivable, Inventory (excluding Work-in-Process Inventory), Machinery and Equipment, and the Real Estate. Other assets such as customer lists, trade names are all assets, but not lendable assets from the bank's point of view.
In the next column put the following advance rate percentages next to each asset class: Account Receivable at 80%, Inventory at 50%, Machinery and Equipment at 50% of net book value, 70% of the orderly liquidation value, 90% of the forced liquidation value, and 80% on the value of any real estate. Total the net lendable value to determine the total lendable value of the acquired assets. Subtract 15% from the lendable value of the accounts recievable and inventory to account for working capital availibility that all banks will require.
Determine the Debt Service Capability of the Acquired Company's Cash Flow:
Start with the acquired company's EBITDA (Earnings before interest, taxes, depreciation, and amortization). Then adjust the cash flow from any expenses that are eliminated by the fact you are acquiring the company. These expenses might include: Prior owner's excess compensation and benefits, Miscellaneous professional fees, and rent. Once you've calculated the adjusted EBITDA, take the total lendable value of the tangible assets calculated above (minus the 15% working capital adjustment), and amortize that amount over seven year period to determine your annual principal payment. Most banks will set loan amortizations and maturities on acquisition debt to be between 5 to 7 years. In some cases, I've seen 10 years - when supported with an SBA guarantee or other credit enhancement. Apply a conservative interest rate on the debt to determine the total annual interest exepense. Add the total interest expense and principal payment to determine your total debt service.
Then take your total adjusted EBITDA and project your future capital expenditures. Subtract the capital expenditures from the EBTIDA to determine your free cash flow to service debt. Take that cash flow and divide into it the total annual principal and interest payments. This ratio cannot be lower than 1.20x. If it comes in below that figure, then more equity needs to go into the transaction. Siginificant cushion over the ratio might be a way to justify a lower equity contribution!
The last step is to determine the Day One balance sheet and cash flow leverage. Balance sheet leverage is determined by dividing your total liabilities by your total shareholders' equity. This ratio should be below 4.0x, although some bank's might be fine with 5.0x. Total calculate your cash flow leverage, divide your adjusted EBITDA by your total liabilities. This ratio should be below 5.0x and again some bank's might accept 6.0x.
Your banker will help you if you present to information calcluated above in the form of a formal presentation which would include projections. The quality of the presentation is a signal to the bank as to wether you are on the ball with this significant transaction. Listen to suggestions from your banker. Your banker might even suprise you and lend you 90% of the acquisition price, or he might say that this transaction would push your total debt over the risk tolerance of the bank. In that case you've got to go find a bank to help you complete the transaction.
To figuire out how much your bank would lend on an acquistions, you must calculate the lendable value of the tangible assets, determine the debt service capability of the acquired company, and calculate the overall balance sheet and cash flow leverage at closing. Let's review each one seperately.
Lendable Value of the Tangible Assets:
Create a simple spreadsheet and put the assets in the first column, and the values found on the balance sheet of the acquired company. Typical assets include: Account receivable, Inventory (excluding Work-in-Process Inventory), Machinery and Equipment, and the Real Estate. Other assets such as customer lists, trade names are all assets, but not lendable assets from the bank's point of view.
In the next column put the following advance rate percentages next to each asset class: Account Receivable at 80%, Inventory at 50%, Machinery and Equipment at 50% of net book value, 70% of the orderly liquidation value, 90% of the forced liquidation value, and 80% on the value of any real estate. Total the net lendable value to determine the total lendable value of the acquired assets. Subtract 15% from the lendable value of the accounts recievable and inventory to account for working capital availibility that all banks will require.
Determine the Debt Service Capability of the Acquired Company's Cash Flow:
Start with the acquired company's EBITDA (Earnings before interest, taxes, depreciation, and amortization). Then adjust the cash flow from any expenses that are eliminated by the fact you are acquiring the company. These expenses might include: Prior owner's excess compensation and benefits, Miscellaneous professional fees, and rent. Once you've calculated the adjusted EBITDA, take the total lendable value of the tangible assets calculated above (minus the 15% working capital adjustment), and amortize that amount over seven year period to determine your annual principal payment. Most banks will set loan amortizations and maturities on acquisition debt to be between 5 to 7 years. In some cases, I've seen 10 years - when supported with an SBA guarantee or other credit enhancement. Apply a conservative interest rate on the debt to determine the total annual interest exepense. Add the total interest expense and principal payment to determine your total debt service.
Then take your total adjusted EBITDA and project your future capital expenditures. Subtract the capital expenditures from the EBTIDA to determine your free cash flow to service debt. Take that cash flow and divide into it the total annual principal and interest payments. This ratio cannot be lower than 1.20x. If it comes in below that figure, then more equity needs to go into the transaction. Siginificant cushion over the ratio might be a way to justify a lower equity contribution!
The last step is to determine the Day One balance sheet and cash flow leverage. Balance sheet leverage is determined by dividing your total liabilities by your total shareholders' equity. This ratio should be below 4.0x, although some bank's might be fine with 5.0x. Total calculate your cash flow leverage, divide your adjusted EBITDA by your total liabilities. This ratio should be below 5.0x and again some bank's might accept 6.0x.
Your banker will help you if you present to information calcluated above in the form of a formal presentation which would include projections. The quality of the presentation is a signal to the bank as to wether you are on the ball with this significant transaction. Listen to suggestions from your banker. Your banker might even suprise you and lend you 90% of the acquisition price, or he might say that this transaction would push your total debt over the risk tolerance of the bank. In that case you've got to go find a bank to help you complete the transaction.
Subscribe to:
Posts (Atom)
