Commentary & Analysis
Pouring Another "Cup O Joe": Lenders Talk About Lending (Part 1)
As everyone knows, the recession has made business financing hard to come by. In this two-part "Cup O Joe," lenders to the printing industry report that loan products are available and discuss how printers can obtain them.
By Patrick Henry
Published: August 22, 2011
Editor's note: each month, the partners at New Direction Partners join their colleagues at the financial management firm MargolisBecker in a "Cup O Joe": a conference call with printers on a selected topic of interest. The call's namesake is MargolisBecker founding partner Joe Becker, whose brainchild the monthly teleforum is.
Recently, with the participation of Mickey Urquhart, senior vice president, People's Capital and Leasing Corp.; Jeff Wright, senior vice president – business development officer, Hennessey Capital; Tom Williams, partner, NDP; and Joe Becker, Cup O Joe examined options in financing and refinancing for printing companies. Addressed were the various types of lending products available to printers and the basic requirements of qualifying for them. An edited version of the discussion is presented here in two parts, starting with commentary by Mr. Urquhart
This is Part 1 of a 2 part series. Part 2 can be read here
As everyone knows, it's been difficult for businesses to obtain financing during the last two to three years. The printing industry has been a particularly hard one in which to attract lender activity. But at People's Capital and Leasing Corp., a wholly owned subsidiary of People's Bank, the printing industry is still a big part of what we do. We continue to lend into it, and we continue to work closely with the key vendors of sheetfed presses and finishing equipment.
We offer the full gamut of finance products. We offer loans and leases, and then within loans there are the loan subsets-the direct type or commercial paper loans, where we lend the money and the borrower borrows it on a conventional basis. We also offer SBA (Small Business Administration) 504 loans, which are very popular right now. In the past, people had an aversion to SBA 504 loans because of all the paperwork, restrictions, and fees. But, anyone thinking of financing a project in excess of $1 million should look at the SBA 504, because the SBA has done a good job of streamlining the whole process and lowering the fees. We are qualified to do SBA 504s in every state.
Times Change, and So Do Terms
In conventional loans for most new printing equipment, we will try to spread it over a seven-year term with 10% equity in the deal. That's a big change from three to four years ago, when we typically financed 100% of the equipment cost over an eight-year term. The reason we need more collateral in the short term is obvious-collateral values have suffered in the last few years. The SBA loans are attractive because they typically span 10 years, compared to the seven-year term of a conventional loan. This means that you can get a lower payment and rate on the SBA loan because you are dealing with a longer loan period.
Another product, the investor revenue bond, is a good choice for people looking for low interest rates. In an investor revenue bond, we take our commercial loan and apply a 65% rate factor to it-so that if we are lending at 5%, we can provide a bond in the 3.5% range because it's a tax-exempt product to us. This lets us flow the tax-exempt benefit through to the underlying borrower in the form of a lower rate.
The downside to a bond is that the borrower doesn't get the benefit of accelerated depreciation, which this year is 100%. The IRS provides the cheap rate by making the bond a tax-exempt security, but then it turns around and obliges the borrower to depreciate the asset on a straight-line basis over 10 years. We show our loan customers a spreadsheet based on their tax positions and give them what we think is the best product from a rate and term standpoint. To most of the printers we work with, an accelerated depreciation on their tax returns is not as important as getting a cheap rate or a lower monthly payment.
Must You Give A Personal Guarantee?
As we assess the risk of making a loan, we have to address the question of whether a personal guarantee is going to be necessary. The answer depends on the loan product. In SBA loans, it is required by law. The borrower must provide a personal guarantee for the SBA portion of the loan, which comes to 40%. For the 50% advance from the senior lender-for example, an entity like People's Capital-the call is discretionary. On bonds, it's also discretionary.
In most cases, if a company is tightly held, has two or three owners, has been in business for less than five years, and has demonstrated the ability to provide personal guarantees to its primary lender, then an equipment lender is going to want the same personal guarantee. Exceptions can be made when the borrower is in its sixth year of operation or beyond; has demonstrated the ability to retain some profits in the company; and can show balance sheet liquidity in tough times to support the balance going forward. Then, a personal guarantee might not be insisted upon.
If a borrower refuses to give a personal guarantee regardless of its financial condition-if the requirement for the personal guarantee is a real deal-breaker-People's Capital might prefer to go forward having more cash into the deal. If the borrower can provide a hard asset, a piece of printing equipment, or more cash into the deal in lieu of a personal guarantee, we might opt for that arrangement.
As lenders, we also take into account where asset values are right now-how they compare today with where they were a few years ago. Looking at pre- and post-production equipment, it's safe to say that we would give orderly liquidated values (our basis for lending) as high as 80% on day one in 2008 and before. Now we're down to 65% on the low side, 70% on the high side. We're looking at much lower day one values, and we're looking to do shorter terms with some money into the deal.
On a go-forward basis, we used to depreciate the asset by 10% per year, so that with a starting value of 80% on day one, the value would be 72% at the end of the first year. In contrast, starting at 70% on day one now, we're currently depreciating the value by 12% to 15% per year. It's clear that at the end of three, four, or five years, we will have seen a major adjustment in a lender's valuation of printing equipment compared with three or four years ago.
Help the Lender Help You
In response, we've shifted the emphasis from our collateral position to the quality of the printing company-not just the financial position, but the quality of the borrower's presentation. People who want to finance equipment sometimes have very little concept of what that piece of equipment is actually going to do for them. That's why it's really important for borrowers to invest a few extra dollars in making a convincing presentation on a financial statement. The lender takes a lot more comfort from seeing an accountant-reviewed statement than from getting a handwritten tax return or hearing the borrower say, "I want to buy this because it will save me $10,000 a month in labor."
Put it down on paper. Give financial projections that support the purpose of the investment. As lenders, instead of asking, "What's my collateral position going to be in years two, three, or four?", what we really want to know is, "What will this equipment do for this customer, and how have they demonstrated that it is going to support them financially?" Help us help you by taking pride in your financial presentation with historical and prospective financial data that justify the deal.
Lenders also can help clients who are not in a position to purchase or finance new equipment. Printers with multiple loans and long-term debt on their balance sheets may find it advantageous to refinance all of their loans into one facility. Refinancing can reduce the cash flow requirement to service long-term debt while providing additional cash to run the business.
The Penalty Is Almost Painless
Most printing companies with existing loans probably will have to face inherent prepayment penalties in order to get out of them. More often than not, there will be an acceleration premium to pay. That being said, with rates as low as they are, we're finding great opportunities for customers to refinance their existing loans. We're currently lending on a five-year term at an average of 4.5%. With an existing loan at 6% or 6.5% and a 1% or 2% prepayment penalty, the inherent penalty is only 50 to 70 basis points in the form of a rate. Even with prepayment and the acceleration premium, refinancing existing debt still is worth taking a look at.
From an equity or collateral standpoint, we as lenders are actually better off lending against an existing loan that has been in place for several years. This is because eventually, the loan reaches a tipping point, an equity positive point. When financing a new piece of equipment, the lender probably still has a negative equity position based on the percentages noted above. But in term loans that are two to four years old, that equity has become positive, making it a better deal for the lender to refinance these loans provided that they can offer an attractive term and rate.
All in all, refinancing is something that every printer should look at for its potentially positive impact on the balance sheet. Cleaning up the balance sheet and moving current debt into the long term make for more favorable operating ratios.
Coming in Part 2: Asset-based lending options that provide workable line of credits secured by receivables and inventory.