When the Banks Say “No”

Parts Warehouse is a 14-year-old Lynden company that makes and distributes to wholesalers and repair shops replacement items for dental equipmentvinyl covers for the foot rests of reclining chairs, holders, arms and trays, foot controls, suction tubes, bulbs for lightsbut not, says co-owner and controller Cindy Heins, dental drills. Nothing that hurts, she explains.

For many small and midsize businesses during the recession, what they might encounter in a dentists chair hasnt been nearly as uncomfortable as dealing with their bankers. As they scramble for working capital to keep the doors open or long-term financing to support growth, theyre running into banks that in many cases have slammed shut the door to the vault, even for business customers with a track record of success and a long-standing relationship with their lenders.

Im finding that the banks arent quite as flexible with lines of credit, Heins says. The expectations are tougher.

Related: The Largest Northwest Banks in Washington State.

Companies like Parts Warehouse are typical; theyre not fly-by-night startups with high burn rates of capital, and theyre not looking to sell off much of their equity to venture investors. They need working capital, and the traditional source for it, the bank loan, is getting hard to come by even for healthy businesses.

The credit crunch is absolutely for real, says Scott Hardman, managing director for Seattle-based investment banking firm Alexander Hutton. Its difficult for companies to get financing. Many companies that had long-term relationships have seen those scaled back. Requirements change. When renewals come up, covenants are tighter, and banks often will lend less against receivables and inventories than they used to.

The tightening of terms made us look a little more actively for financing, Heins says. And it turned out the key was in her business.

Parts Warehouse also has customers in Canada, Sweden, Russia, Japan, Malaysia and Ireland, thus generating foreign accounts receivable. Banks generally wont loan against those receivables because of the hassles of collecting, but Parts Warehouse and Heins found someone who woulda California company, CFS International, that provides credit insurance on those accounts and lending against them. The cost of going that route, she adds, proved to be less expensive than conventional financing. It was very helpful.

Heins experience isnt unique. With the credit crunch choking off traditional bank loans and lines of credit, businesses have been looking for alternative sources of financing. What theyve found runs the gamut from Small Business Administration (SBA) assistance to asset-based, hard-money, mezzanine and specialized lenders to revolving loan funds sponsored by the federal Economic Development Administration and to a variety of equity investments.

John Michener, programs manager for the Northwest Economic Council in Whatcom County, a sponsor of a revolving fund for manufacturers, recently returned from a seminar on such financing. The instructor said it was the largest class shes taught in the five years shes been doing it, Michener says.

With the downturn in the economy, we have had more requests than we can support, adds Tani Gunn of The Lending Network, based in Chehalis.

Given just how bad the recession has been, one might be given to wonder where all this demand is coming from. Shouldnt the demand for credit be falling even as the supply does, too?

Calvin Goings, SBAs regional administrator in Seattle, says even in a downturn, businesses still need capital to keep doors open, keep employees paid and have some merchandise on the shelf that a prospective customer would be interested in.

In the financing realm, SBA has been best known for offering guarantees, often 75 to 80 percent, on loans made through banks. Passage of federal legislation allowed SBA to up that guarantee to 90 percent, Goings says, and to eliminate, reduce or waive loan fees, which can amount to $10,000 to $50,000, depending on the size of the underlying loan.

SBA also launched a micro-lending program aimed at businesses whose owners have been financing operations on their own credit cards. That program offered zero-interest, deferred-repayment loans of up to $35,000.

Goings says lending volumes for SBA programs in Washington are up 90 percent in the past year, outpacing the national increase of 70 percent.

An option for larger businesses in search of working capital financing is asset-based lending. Tom Cleveland, a veteran of the regional banking scene (he started and later sold Enterprise Bank), is the co-founder of Bellevue-based Access Business Finance.

If you have a good company, if you have a good balance sheet, if you have equity and earnings on your balance sheet and income statement, its very easy to get a loan today, Cleveland says. If you put a decent deal out in the market, there will be a lot of banks that want to do it. The banks will stumble over themselves and get in street fights to do it. Theyll lower prices and theyre starting to lower conditions on good deals.

But even those companies that have seen their balance sheets chewed up by the recession arent out of luck. Access Business Finance works with dozens of banks that refer customers to whom they cant lend more or whose loans they want to clear off their books.

Clevelands firm finances accounts receivable and inventories, but only after an analysis not just of the borrower but also of the companies represented by those receivables. For the borrower, We want to know the managements good, theyre honest, they have good operations internally and they have good bookkeeping and that sort of stuff, Cleveland says. Secondly, we want to hear the story of the turnaround. They have to put it on paper and sell it. Its not a soft-shoe dance. For the customers, We want to know who that receivable is.

Cleveland is seeing the impact of the recession and the credit crunch on the volume of business from those seeking alt-financing and in the quality of applicants. In the old days, we would do 30 percent of the deals we looked at, he says. Today, we do probably 10 percent of the deals we look at, but the volume of deals were looking at has quadrupled.

Sometimes, the source of short-term alt-financing is a company not nominally in the lending business at all. Weve seen a number of manufacturers [that], in order to keep their distribution channels open, have provided extended terms, which in a sense, is a loan from the suppliers to the customer, Hardman says. If normal [payment] terms used to be 30 days, theyd extend it to 60 days to provide a little more working capital cushion to these customers. Obviously, anyone doing that [runs] the risk of seeing the receivable grow too large and then problematic.

Those looking for longer-term sources of funding can opt to sell their companies entirely, and some have gone that route. One thing driving the M&A market is companies being constrained, and public companies have large amounts of cash on their balance sheets and cash available for acquisitions, Hardman says. Weve seen an uptick in M&A activity.

Private equity is driving that activity, too. Youve got a private-equity market thats burgeoning with dollars and youve got lots of funds to commit, says Michael Brustkern, managing director of Seattle investment bank Exvere Inc. If you dont commit, youre going to have to give back to the investors, which is not good news for anybody. They cant charge fees on money thats not invested and the investors didnt give it to them to collect a passbook rate of return. So nobodys happy.

That outcome might account for the willingness of equity funds to do recapitalizations of firms. The business owner doesnt have to sell out entirely, and the private equity firm gets to put money to work while also holding the possibility of buying the rest of the company, Brustkern says.

Alt-financing isnt a panacea for the lack of traditional bank lending. While in some cases, such as Parts Warehouses, borrowers may be able to land attractive deals, in others, companies may face more onerous rates and terms.

The best news in this environment is that rates are relatively low, Brustkern notes. If the mezzanine lenders are going to be eight to 10 points on yield higher than the senior banks, at least theyre in the low teens at this point rather than being in the low 20s as they can sometimes be.

Adds Hardman, Typically, youre going to find these alternative sourcesasset-based, mezzanine financinghave substantially higher interest rates than what you might normally see from a commercial bank line of credit. But if the commercial line of credit is not available and you need financing, then the access outweighs the cost and people will step up and pay the higher cost.

With all the interest and activity in alt-financing, what happens when normalcywhatever that looks likereturns to commercial banking? Will firms go back to more traditional modes of financing or is alt-financing now an established part of the business landscape?

Cleveland votes for the latter, if only because that was the trend even before the credit crunch. The allure of real estate and consumer lending drew banks attention away from commercial and industrial lending, so alt-financiers (including arms of such giant companies as GE and UPS) moved in to fill the gap. The majority of C&I [commercial and industrial] lending is not done by banks anyway, he says.

Hardman says the new normal wont look like the days before the recession because those were distorted and unsustainable. Its pretty obvious the flood of very cheap, abundant debt weve experienced over these last few years is not going to be available. Therefore, the balance sheets of companies will be leaner, will be less leveraged.

Brustkern says alt-financing will continue to have a major role simply because banks are still trying to figure out the regulatory landscape. Right now, theres a discontinuity in the market, he says. Theres a mismatch between supply of credit and demand for credit thats caused by the confusion of government interference. In days gone by, bankers would be able to make credit judgments based on their particular experience and history balanced with the conditions of the moment.

But until banks get some certainty, I think were going to be in this mismatch.

Which means continued opportunity for alt-financiers. Says Cleveland, Even deals that wouldnt qualify for a bank, if the storys good and the sales are there, you can get it financed. Banks are not the only place money gets loaned.