Commercial and Industrial Lending Temporary High

Two weeks ago we broke news about credit markets beginning to loosen up. The sun was shining in early January.

We also reported "volatility is the only thing that seems to be predictable right now." Well, sure enough, the volatility has continued.

Three themes for this week:

1) Lending at largest banks has declined

2) Commercial and industrial lending is higher, but history predicts big falls in the coming months.

3) January's Commercial Paper gains are erased


1) Lending at largest banks has declined

The Wall Street Journal reported on Friday that lending at many of the nation's largest banks fell in recent months, even after they received $148 billion in taxpayer capital that was intended to help the economy by making loans more readily available.

According to WSJ analysis, ten of the 13 big beneficiaries of the Treasury Department's Troubled Asset Relief Program, or TARP, saw their outstanding loan balances decline by a total of about $46 billion, or 1.4%, between the third and fourth quarters of 2008.

2) Commercial and industrial lending is higher, but history predicts big falls in the coming months.

Looking exclusively at the largest banks does not, however, give you an accurate picture of lending activity.

According to data from the Federal Reserve Bank of St. Louis, in December 2007, commercial and industrial loans were up 20% year-on-year. In December 2008 (one month ago), lending levels were up another 10%, at their highest level in years. One explanation could be a rush at the end of 2008 to refinance existing debt.

If you take a look at commercial and industrial lending rates in the last 50 years, history suggests there are big falls on the way. According to data from the Federal Reserve Bank of St. Louis, in previous recessions, commercial and industrial lending has declined up to 10% year-on-year within a year of the recession ending and hit the lending low several months after the recession was over.

Astute business owners are not waiting for tougher times ahead, but are sourcing replacement debt refinancing today.

The FED is doing the best they can with the TARP money, but it would be bucking a historical trend if lending rates increased this year. Take a look at the chart below from the Federal Reserve Bank of St. Louis:

The shaded areas indicate previous US recessions.

You can see from this chart that in 2002, after the recession had officially ended, commercial and industrial loans declined around 8% from the previous year.

The biggest problem with replacing or sourcing new debt is inspiring confidence in the lender that they will see their loan repaid. Oftentimes, much more can be done by the Borrower to present clear and accurate data and projections, as well as promising real-time financial reporting to the lender.

In good times, lenders will take more risk where there is uncertainty. In tough times, lenders are more cautious and require more certainty. It is up to you, the Borrower, to give the lenders that certainty.

3) January's Commercial Paper gains are erased

As we reported two weeks ago, Commercial Paper was trading at the fastest pace since May 2008. Unfortunately, we may have spoken too soon.

As a reminder, commercial paper is an IOU from a large bank or corporation, which matures within 9 months. Some commercial paper is backed by assets and some is traded purely on the bank or company's reputation and credit-worthiness. As you would imagine, it is used for short-term debt obligations and trades at a discount to the face value of the paper.

It is a sign of confidence when commercial paper is being actively traded, but according to Federal Reserve data, volumes have now declined for the second week in a row and wiped out much of early January's gains.

I guess we'll just have to get used to this volatility - it doesn't seem to be stabilizing anytime soon.

The total commercial paper market is down over 20% in the last eighteen months to $1.69 trillion from the peak of $2.2 trillion during the summer of 2007.

Hopefully, we'll bring you better news in the coming weeks, but please take this away with you.

If the historical worst case happens as in previous recessions, we may see a 10% reduction in commercial and industrial lending. A 10% reduction still means that lending is at 90% of the levels that we see in the good times.

Just make sure you're not in that 10%. It's easier said than done, but with careful planning and accurate forecasting, you can even get troubled companies through new or replacement debt financing. You just have to be open, clear and communicate well with new lenders and present them with reliable and reasonable forecasts. You should also map out best case and worst case scenarios.

Lenders want to make loans - you just need to make them feel comfortable that they'll get their money back.

All rights reserved. Copyright: ClearRidge Capital, LLC, 2009.

ClearRidge provides Merger & Acquisition, Restructuring and Corporate Finance services advice for midsize companies.

M&A includes buyer and seller representation for companies with $20 million to $500 million in revenues.

Restructuring includes financial, operational, strategic and pre-Sale restructuring.

Corporate Finance includes raising and replacing senior debt, subordinated debt, mezzanine and equity financing.

Bankruptcy and Turnaround services include debtor and creditor advisory, bankruptcy support and turnaround management.

Lessons from Troubled Companies - 5 and 6

LESSON 5 - ACCOUNTS RECEIVABLE

The Business Cycle is not complete until you collect the money. Sales and Gross Profit can be extraordinary, but if you do not collect the money you can't pay the bills or make payroll.

Accounts Receivable management requires not only that your company has discipline, but also that your customers pay on time. The temptation to be flexible with customers is greatest when sales are stagnant and competition is high.

Many management teams of troubled companies are pursuing revenue growth so aggressively that they fail to enforce payment terms on certain customers, and they may even take on customers who are trying to avoid tough credit policies with their competitors. Guess which customers are most likely to default on their credit.

Many companies borrow against or factor their receivables to shorten their A/R turnover (sale to cash days). The importance of prompt collections does not go away. Generally, businesses can only borrow 85% of their receivables that are not more than 30 to 60 days past due. The business then incurs the interest charges and is still burdened with the delinquent dollars.

Successful companies have a strict credit policy and they begin from Day One with firm and consistent application of this credit policy. The truth is that your customers will have more respect for your company if you maintain your discipline.

Your A/R discipline is a reflection of your company's ability to deliver and perform on difficult tasks and in tricky situations. Failure to follow this discipline registers with many customers and competitors as a sign of weakness. Short-term success may be followed by failure in the long term.

LESSON 6 - DEBT

In today's tough business environment, too many businesses are drowning in debt. Companies may have industry leading profit margins, but with leveling or declining revenue growth these companies are struggling to cover their interest costs and debt service requirements. As discussed earlier, many companies, especially start-ups and troubled companies, must determine how much debt is the cap. If you're burning cash too fast and you have to float more debt or raise more capital, then start back at lesson number one and read the lessons over again. There are underlying issues that need to be cured.

All successful businesses have a fundamentally sound, effective, and efficient finance function. Whether a company is an early stage company or a mature company in a consolidating industry, the basic financial scorecards must be kept and studied. Troubled companies' management teams are usually in denial when it comes to the financial trends and scorecards.

If all of this sound likes the basics of business, it's because it is the basics. Unfortunately, there are too many CEOs, CFOs, and Management Teams that do not maintain the intense and persistent focus that is necessary to build and sustain a successful business.

Bankers, private equity professionals, successful CEOs and CFOs are fundamentalists. They guard cash as if the business' life depends on it. They develop and study the business plan and then challenge the assumptions that the Company's success hinges on. They hold the management team accountable for the development and execution of sound cash, operational, and CapEx budgets.

Before they invest or loan funds, they are confident in the quality and commitment of the Management Team, feel secure that the business has adequate HR and technology resources, efficient systems and processes, and they are convinced that there is a viable core business purpose within the industry or marketplace. Every business owner would be well served to employ the same discipline and best business practices on a day to day basis.

All rights reserved. Copyright: ClearRidge Capital, LLC, 2009.

ClearRidge provides Merger & Acquisition, Restructuring and Corporate Finance services advice for midsize companies.

M&A includes buyer and seller representation for companies with $20 million to $500 million in revenues.

Restructuring includes financial, operational, strategic and pre-Sale restructuring.

Corporate Finance includes raising and replacing senior debt, subordinated debt, mezzanine and equity financing.

Bankruptcy and Turnaround services include debtor and creditor advisory, bankruptcy support and turnaround management.

Lessons from Troubled Companies - 3 and 4

LESSON 3 - CONTROLLING COSTS

Controlling costs is usually the most effective and quickest method of increasing profitability in any company. Reducing manufacturing costs and inventory purchase costs, as well as reducing operating costs increases profits dollar for dollar. A dollar increase in sales is discounted by the Cost of Goods Sold before it improves profitability.

Budgeting is the only sure method to controlling costs. Study the cost data and its drivers for every manufacturing, purchasing, and operating account or category. Conduct a consistent monthly evaluation of cost variances, actual to budget, and study their cause and effect. Use this data for future action items or increased accuracy in planning.

Lean and efficient companies are process oriented. All repetitive tasks (actions) should be incorporated into standardized Standard Operating Procedures (SOPs) that can be measured with Key Performance Indicators (KPIs). These KPIs need to be monitored daily, weekly, and monthly to provide assurance that costs are under control. This allows for immediate action to stop the cash burn when performance is outside the acceptable range.

Utilizing technology is becoming the favored method of reducing costs. Technology utilization can improve processes with streamlined data capture, processing, and reporting the right information, processed within approved methods, and reported in a user-friendly, consistent and timely manner. Technology also improves employee productivity by eliminating unnecessary steps and in turn reducing unnecessary staff and payroll costs.

The most cost effective companies have developed a lean culture to reduce spending on anything unless it is necessary to provide quality products or service.

LESSON 4 - FIXED ASSETS AND INVENTORY

Fixed Assets and Inventory make up the largest dollar investment for most companies. Unfortunately, too many business leaders do not focus enough attention on the Return On these Assets (ROA).

Accounting systems should be in place to report the profit earned from these assets individually and as a category.

When the management team repeatedly studies ROA, they will be able to determine any action that may be necessary such as reducing inventory levels, securing new outlets for excess inventory, quicker manufacturing cycles, and changing the inventory mix to increase those with higher ROA.

In respect to fixed assets, a CAPEX budget should be a component of every company's business plan. The CAPEX budget begins with the line managers creating a list and estimated cost of new machines or equipment (or major repairs) they believe are necessary to maintain or improve quality, service, or cost reduction through efficiency gains. Most companies only have a limited amount of funds available for CAPEX one year ahead, so the focus on ROA will ensure better decision making with facility and equipment investments.

All rights reserved. Copyright: ClearRidge Capital, LLC, 2009.

ClearRidge provides Merger & Acquisition, Restructuring and Corporate Finance services advice for midsize companies.

M&A includes buyer and seller representation for companies with $20 million to $500 million in revenues.

Restructuring includes financial, operational, strategic and pre-Sale restructuring.

Corporate Finance includes raising and replacing senior debt, subordinated debt, mezzanine and equity financing.

Bankruptcy and Turnaround services include debtor and creditor advisory, bankruptcy support and turnaround management.

Breaking News from Banks and the Credit Market

Banks have confidence in each other again.

Commercial Paper is trading again.

In this blog, we highlight and decipher this week's leading indicators from the credit markets.

The spread needs to drop below 0.5% (50 basis points) to really signal a healthy banking credit market, but we are sure getting close. And a lot closer than we thought possible just a few weeks ago. Volatility is the only thing that seems to be predictable right now.

Take a look at the chart below, which shows 12 months of the TED Spread and you can see for yourself.

TED SPREAD - LAST 12 MONTHS
















HOW DID IT HAPPEN?

In late 2008, Central Banks across the World were collaborating to end the crisis. They were slashing interest rates and lending cash at an unprecedented rate. And it worked!

That is not to say the credit crisis is over for good. And just because the banks are lending to each other doesn't mean they are lending to companies. There's no guarantee credit markets won't freeze up again, but it's certainly a very healthy sign.

Commercial Paper is trading at the highest volumes since Lehman Brother collapsed in September.

Investors are snapping up new corporate bonds at the fastest pace since May, driving down yields from record highs once they begin to trade.

Just this week, some companies are starting to take advantage while the good times last, most notable of which is McDonald's, the world's biggest restaurant company, which raised $750 million in 10-year and 30-year bonds this week.

In 2009, rising confidence in corporate bonds may help many companies that need to replace $135 billion of debt this year in the U.S.

We certainly need this increased confidence. Commercial lending to businesses has a lead time of many months and any increased confidence in corporate bonds will take time to trickle down to middle market companies.

Business owners may not witness the effects until late 2009, but at least there is something to look forward to.

OUT OF THE WOODS?

A normal TED Spread number would be around 0.25% (25 basis points), so at 0.98%, we're still 4 times higher than normal.

The rate on three-month Treasury bills was 0.06% (6 basis points) on Monday. One year ago, three-month Treasury bills were 3.16% (316 basis points).

Banks are still wary of lending to each other. Financial institutions held more than 300 BILLION euros ($400 billion) in overnight deposits yesterday with the European Central Bank. The daily average in the first eight months of 2008 was 427 MILLION euros.

Let's take time to digest that number. This weeks, banks in Europe were holding almost 1,000 times as much money overnight with the European Central Bank than they were this time last year. They want to sleep soundly at night. Better lower overnight rates than waking up with the bank you lent to last night in default.

So, here's the $350 billion question. What should our President-Elect do with the other half of the TARP dollars. Does he need to do anything with it at all?

All rights reserved. Copyright: ClearRidge Capital, LLC, 2009.

ClearRidge provides Merger & Acquisition, Restructuring and Corporate Finance services advice for midsize companies.

M&A includes buyer and seller representation for companies with $2 million to $25 million in EBITDA and $10 million to $500 million in revenues.

Restructuring includes financial, operational, strategic and pre-Sale restructuring.

Corporate Finance includes raising and replacing senior debt, subordinated debt, mezzanine and equity financing.

Bankruptcy and Turnaround services include debtor and creditor advisory, bankruptcy support and turnaround management.

http://www.clearridgecapital.com

Lessons from Troubled Companies - Part 1

Turmoil in the Credit Markets may have a much broader impact on companies than most people imagine. From defaults on loan covenants and worsened terms for debt financing to reduced sales from nervous consumers, ongoing business operations are going to be tough for many companies.

If you are called in to rescue a company in distress, the first rule is to get back to basics. Each situation is different, but the common denominator in most distressed companies is poor management practices. That doesn't mean lack of effort, desire or motivation to perform. It does, however, mean that there have been some fundamental errors in judgment, strategy and decision-making in the years leading up to that point.

Managers must have access to relevant, current financial and operating information if the company is to have any chance of success. But that's not all. They must not only have access to that information, but they must be willing and able to analyze the information correctly and employ a disciplined approach which enables them to act on the information to move the company forward and/or protect it from distress.

You could write several books on the lists of reasons that companies get into trouble and in a long career of restructuring troubled companies, there are many stories to tell. To start with, though, over the next few weeks, we're going to bring you 2 lessons each week that will go a long way to ensuring business success.

LESSON 1 - CASH MANAGEMENT

Cash is the lifeblood of every company. Without cash, the company will cease to exist. Every CEO and CFO should demand a strict control and reporting system for cash management. No excuses. The tone is set at the top and begins with expenditure control. A policy should be in place with a dollar limit on normal and necessary manufacturing and operating expenses that can be incurred by the designated managers. Line managers overspending will quickly drown a company.

In distressed situations, a rolling 13-week cash forecast, along with a comparative cash flow analysis is mandatory. In fact, a consistent rolling cash forecast should be mandatory for every company.

These reports should identify cash inflows from customers, debt issues and investors, and the sale or disposal of assets or business units. You need to identify cash outflows from operations, to suppliers, debt service, and the purchase or investment in assets and other businesses.

If the company has more cash flowing out than flowing in, you are "burning cash".

If the company is a start-up or troubled company, the cash burn rate is critical. Management must know how much cash the company expends every week, month, and quarter. It is their responsibility to ensure that cash expenditure is within projected budgets given to Investors and Lenders. Remember, they made their decision to fund your company based on your business plan.

LESSON 2 - PROFIT AND PROFITABILITY

Profit and profitability (margins) come a close second to cash. In order to increase cash levels, companies become profitable or increase profitability, increase equity in the form of debt or capital issues, and sell off assets.

Even if management exercises one of the latter two options, sooner or later, if the company wants to be a successful enterprise, it has to become profitable. Again, the company culture or attitude starts at the top. Everyone in the company must think and act towards growing sales and revenues, and reducing costs.

Gross Profit is the amount of sales dollars left after the costs of the product or service. In order to set a Gross Profit target, you should consider the minimum dollar amount the Gross Profit needs to be in order to cover the operating expenses, interest payment requirements, debt service requirements, and the net return expected by the shareholders. From this, you can work out what the minimum Gross Margin needs to be. If this minimum targeted Gross Margin causes the sales prices to be noncompetitive, then management needs to study their business and competitors to identify the reasons.

Comparison to a much larger competitor will identify their advantages due to size and volume in areas such as per unit manufacturing costs and increased purchasing power. Conversely, larger companies have a higher fixed cost platform to overcome, which will give them bigger challenges in times of stagnant or declining revenue.

Mid size and smaller companies need to differentiate themselves by unique features and benefits such as location, breadth and depth of inventory, improved technical expertise, customer service and responsiveness, unique products, or any other added value that allows the customer to justify paying a higher price.

Management needs to continually evaluate ways to improve efficiency and reduce operating costs. These may include reducing the number of key management personnel that have become less productive but remain highly paid, reducing the number of locations or space to reduce overall occupancy costs, review company participation in employee benefits, evaluate services that are being outsourced or maybe should be outsourced, consider risk management alternatives to reduce insurance costs, replacement versus high repair costs on machinery and equipment and contributing or raising capital to reduce interest costs. Today's successful business leaders will dedicate resources to technology utilization which has proven to be an effective tool to increase productivity and improve efficiencies while reducing operating costs.

A fair return to the shareholders is required, but when shareholders have unreasonable ROI demands, management may increase their debt burden, raise their prices to cover debt service requirements and these unreasonable earnings goals which create a non-competitive product or service that will reduce sales and revenues as customers are unwilling to pay the higher price.

Successful business managers constantly study and compare their company to its competitors in product or service offerings which include pricing structures, gross margin percentage, operating costs as a percentage of revenue and actual dollar amount, and operating income (usually EBITDA) as a percentage of revenue.

ClearRidge provides Merger & Acquisition, Restructuring and Corporate Finance services advice for midsize companies.

M&A includes buyer and seller representation for companies with $2 million to $25 million in EBITDA and $10 million to $500 million in revenues.

Restructuring includes financial, operational, strategic and pre-Sale restructuring.

Corporate Finance includes raising and replacing senior debt, subordinated debt, mezzanine and equity financing.

Bankruptcy and Turnaround services include debtor and creditor advisory, bankruptcy support and turnaround management.

http://www.clearridgecapital.com