The Effect of the Election on Inflation and Interest Rates

 

rp-picThe Effect of the Election on Inflation and Interest Rates.
Since the election of Donald Trump, the stock market has been soaring while bond prices have mostly plunged.

This has led to a sharp increase in interest rates for US and corporate bonds, mortgage rates and certainly corporate borrowing.

 

 

Have An Adjustable Rate?

For those companies with adjustable interest rate debt, the sudden increase in rates may lead them to run seeking to convert to a fixed rate. The greater impact has been addressed by Josh Zombrun of the Wall Street Journal in a statement that a Trump administration could “boost economic growth, bring higher interest rates and inflation” while also bringing “a new set of potential risks including international trade wars.”

 

Approval Rates At All-Time High …

Small business loan approval rates at big banks ($10 billion in assets) improved to new all-time post-recession highs in October, 2016. Big banks are approving 23.5% of all small business loan requests, up one-tenth of a percent from September.

 

But Not At All Banks …

Meanwhile, small business lending approval rates at smaller banks remained flat at 48.7%. A comparison shows that approval percentages in this category of lenders is down year over year.

It has been two years since smaller banks approved more than half of their loan requests. Conversely, the most recent Small Business Lending Index shows a 63 percent business loan approval rate from alternative lenders, including Asset Based and other private lenders.

 

Where Should I Look?

As you can see from the above, many small and medium sized businesses don’t qualify for bank financing. As interest rates increase, many companies will need to increase their profitability to qualify for the traditional bank loan.

The banking and ABL market is made up of many “pools” of lenders that have different risk appetites. Within such pool of lenders there is an efficient, competitive environment. But as a borrower, you need to know which pool to “fish” in; knowing which group to approach. Approaching the wrong group may delay or halt your loan as lenders may not necessarily reveal that they are in the wrong pool for you.

 

Interest Rates & Inflation?

The double whammy of increasing interest rates and the risk of inflation is sure to impact many markets, especially those depending on consumers. As inflation is impacted, either by rising interest rates or new tariffs on trade, large purchases such as cars and homes will begin to stall.

Markets hate surprises and consumers do as well. Small purchases will probably be effected as consumers hold back purchases as they evaluate the impact of inflation and interest rates on their personal situation.

 

Inflationary Effect Of Election …

The inflationary effect of the election will cause real cost increases. Labor costs will increase, both due to a lower unemployment rate and availability of people in both skilled and unskilled positions. Imported goods will increase due to the pressure for new tariffs on import and less labor available to load, move and sell consumer products.

Higher inflation has always led the Federal Reserve to raise interest rates, increase borrowing costs and cool the economy down. But if the higher inflation is sudden enough and the decrease in consumer spending drives the country into a recession, raising interest rates will not be an option as the Fed has already used most, if not all, of its recession fighting tools.

 

Three Components Of Lending …

Interest rates represent a composite of three charges to compensate the lender for parting with their money for a period of time. The first is the time value of money; the second is like an insurance premium that covers the risk the lender won’t get paid back; and the third is the expected inflation rate as lenders want to recover the same buying power in their repayments, not just the same number of dollars.
A result of the change in administration is expected to be both positive and negative for small and mid-sized business. The negative side is inflation and higher interest rates; the positive side is increased profitability and less regulation for banks. The battle over Dodd Frank, on the regulation side, is projected to be long and difficult.

 

What To Do Now?

What is a small business to do with the amount of uncertainty in the financial markets? Lock in as much as possible before costs and rates begin escalating. Make certain that inventory, especially in consumer products, is as low as consistent with current and projected sales. Make sure accounts receivable are as current as possible and remain that way.
 
Marginal companies will go under from the new pressure and you don’t want to be left holding the bag. And lastly, if you can’t begin to solves these problems, get help. Remember, hope is not a strategy.

 

Revitalization Partners is a Northwest business advisory and restructuring management firm with a demonstrated track record of achieving the best possible outcomes for our clients. We specialize in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations.
Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

The Effect of the Election on Community Banking

 

rp-1Well, the election is over. And the United States is about to have a new President.

A lot of time, energy and horsepower is being spent on what will or will not happen to the financial markets now that the election is over.

It does seem that it may make more sense to talk about what will not change, in the short term for consumers and financial institutions, especially smaller banks.
 

What Happens To Interest Rates?

First and foremost, the market environment which has been characterized by low interest rates, will not change dramatically in the short term. Yes, interest rates will begin to increase, but as the Federal Reserve Bank of New York chief commented in a recent talk, “a quarter point either way is not a big deal.”
 
The new President’s comments regarding the Fed’s low rate policies have stoked speculation that his election may impact the policies of the Federal Reserve. Even if the President were to appoints a new Fed chair or new governors, very little would be expected to change.
 
While the Fed can change benchmarks like the interest paid on bank reserves and the target rate for Fed funds, market interest rates are likely to remain relatively stable due to the huge amount of foreign capital enter the US market, keeping bond rates low. While the demand for domestic credit is increasing, this capital continues to put pressure on bonds and interest rates.

 

The Staggering Cost Of Regulations …

Despite the statements by the President elect that he will roll back regulations in many areas of the economy, the politics of reform are very different from those in the past. The impact of Dodd Frank on banks has been staggering to the US economy.

Legal and regulatory expenses are among the biggest burdens on banks and economic growth. “The roughly $275 billion in legal costs for banks since 2008 translates into more than $5 trillion in reduced lending capacity to the real economy.” Said Minouche Shafik, deputy governor of the Bank of England, at a conference in New York.

Not only will loan demand continue pressure on banks but it is possible that the political agenda of regulators offers the possible effect of further contracting credit for businesses and consumers.

 

1/3rd Excluded From Market …

Thanks to Dodd Frank, roughly one third of Americans have been excluded from the markets for home mortgages due to new regulations imposed on the loan origination process.

Dodd Frank, for example outlaw’s prepayment penalties on home mortgages, making loans to subprime borrowers uneconomical. And rising operational and compliance costs are more difficult due to the Consumer Financial Protection Bureau.

So, what will happen to Dodd Frank and the Consumer Financial Protection Bureau (CFPB) under a Trump presidency? Obviously, the market believes there will be some changes as the KBW-Nasdaq which tracks a basket of bank stocks, rose to its highest level in more than a year. But most money managers suggest that an outright repeal of Dodd Frank is unlikely.

 

A More Likely Approach …

While Republicans control the House and Senate, Democrats hold enough seats in the upper chamber to block attempts to kill Dodd Frank. A more likely effort will be changes to the CFPB with a new director being appointed.

But even there, there is risk for the administration. While not loved by the financial services industry or congressional Republications, the CFPB has made a name for itself with the public by going after unpopular targets such as Wells Fargo.

“The CFPB is very popular with the public.” Stated Ed Mierzwinski of the US Public Interest Research Group.

Attempting to weaken the CFPB could be problematic for a new President with other priorities. And although expressing interest in loosening financial regulations, the President elect has not talked about the CFPB, payday lending rules or other specific issues.

 

Trench Warfare Is Unlikely …

Instead of financial regulation, Dennis Kelleher, chief executive of Better Markets, expects Trump to focus on other priorities.

“This big infrastructure plan and probably tax relief are the two big pillars of his domestic policy.”

“He’s not going to want to get bogged down in trench warfare over Dodd Frank.”

 

 

Revitalization Partners is a Northwest business advisory and restructuring management firm with a demonstrated track record of achieving the best possible outcomes for our clients. We specialize in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Why Banks are Saying No to Small and Mid-Sized Business

 

Despite an economic recovery that is well underway, many recovering businesses are still getting turned down for new business loans and loan renewals.

Despite the fact that the company shows signs of bouncing back from any recession based problems and management believing that their projections make a clear case for the future, often a regulated banking entity declines to make the loan.

Why doesn’t the bank see the situation the same way that management does? There are many factors that go into making that creditworthiness decision. We look at some of them here, beginning with the banking system.

Size Does Matter ...

In the end, anyone who says size doesn’t matter is lying – at least when it comes to business lending.

Size matters a lot and perhaps more than any other factor determines which bank will and won’t provide a credit facility. Borrowers that need loans between $2 million and $10 million are finding that they have the fewest choices and pay the most for their money.

All banks have legal lending limits that they cannot exceed when making loans. A bank legal lending limit is the maximum amount that any particular bank can lend to a single borrower or related group of borrowers.

Also, banking regulators want banks to spread their risk by having a diversified portfolio and don’t want them making a lot of loans at or near their legal lending limit. As a result, for most banks the effective in-house lending limit is considerably less than its legal lending limit.

 

As A General Rule …

As a general rule, borrowers that need loans with balances consistently larger than $2 million are too big for about 80% of the banks in the U.S. Surprisingly, only about 6% of the banks in the U.S. are larger than $1 billion in size and have the capital base to concentrate on middle- and lower-middle-market businesses.

After a generation of bank consolidation, the U.S. banking industry has been hollowed out from the middle. While big banks deliver diversified, professional and cost-effective products and services, they just don’t do it for small – and lower-middle-market businesses.

On the other hand, small banks lack balance sheet size, geographic reach, back office infrastructure and product mix to satisfy the needs of most middle- and lower-middle-market businesses.

Regulators that are rightfully concerned about future loan losses and credit quality are further restricting small bank credit in an effort to prevent today’s new loans from becoming tomorrow’s mistakes.

 

The Effect Of Dodd-Frank …

Bankers who say that the rules really changed after the 2008/2009 banking crisis are only partially correct. The rules for small business and lower-middle-market lending are essentially unchanged. What has been added is the effect of Dodd-Frank legislation on the regulators, recently causing them to play a greater role in enforcing their rules rather than trusting bank executives to self-regulate.

As an example, the rules for providing business loans secured by accounts receivable and inventory have been around since March 2000. And, the rules concerning floor plan lending to retailers haven’t materially changed since May 1998. These rules are set forth in easy to understand and very detailed “how to” manuals published by the Office of the Comptroller of the Currency and can be easily found on the Internet.

Unfortunately, only a few banks under $1 billion in size comply with the lending rules, and as result only a few banks can participate in the collateral-dependent secured commercial loan market without being criticized by their regulator.

 

Banks Turning Backs On Community?

That doesn’t mean that banks that don’t make an effort to comply with the rules and therefore don’t lend are bad banks or are turning their back on the business community. The problem that small banks have is that it is expensive to comply with the lending rules. Unless banks are going to make a large number of accounts receivable and inventory-secured loans or inventory-dependent floor plan loans, it just doesn’t make economic sense to spend the money required to comply with the rules.

Small banks in all but the most densely populated and largest metropolitan markets can’t make money providing collateral-dependent loans and still comply with decades-old regulations. Since regulators are now enforcing these regulations, many small banks have pulled out of collateral-dependent business lending and business borrowers are finding that their financing options have been restricted.

Many times when banks say no, it’s because they’ve looked at what the company is requesting in light of historical performance or its balance sheet, and we see that it really needs equity in addition to debt.

Obviously it’s more appealing for a business owner to pay a low percentage to the bank than to give away a portion of the company, but unfortunately, equity investments are the reality most entrepreneurs face once they’re past the bootstrap stage. Most companies can’t grow just with debt.

 

A Good Rule Of Thumb …

A good rule of thumb is that for every $1,000,000 in debt you’re seeking, you should have $300,000 in equity. If you are asking for a loan that will put your company at a debt-to-equity ratio of more than three or four to one, a bank will think you are over-leveraged.

Banks look at an application like this: if we gave them that money today, could they make the payments based on their cash flow from last year? Companies often want a lender to make a loan based on their projections. If you can demonstrate why the profit is going to be greater and have a very convincing story built around facts, often a well put together projection will get a successful hearing.

If you’re asking for a loan based on projections, nail down the proof. “The market’s great and we think we can grow 20 percent” probably is not going to be assurance enough for a bank.

 

The Curse Of QuickBooks…

Part of this problem is the curse of QuickBooks. Many companies think that because someone on their team can use QuickBooks, they barely need an accountant, much less a CFO.

People who start businesses are usually smart, capable and talented, so they believe they can manage the loan process themselves. But you need to understand the correct data and ratios that the banks want to see before you can finalize a presentation to the bankers.

One of our major services at RP is assisting our clients to get new loans. And we see these problems constantly, not just with companies that have in the low millions or so in sales, but sometimes with companies that have tens of millions in sales.

We’ll start analyzing their financials and see that something doesn’t make sense and something else doesn’t balance. We’ll see projections that don’t tie in with accounts receivable levels or current payables.

And that makes any lender looking at the data think the company has poor financial controls.

This is a problem you can fix (or ideally, prevent) by making sure that you have the talent that knows how to present your situation in the best light to the lender and that makes certain that your data and projections are accurate and tie together.