(image from 'it's a wonderful life' - of course you all know that. i don't have anything to do with the copyrights on the movie though.)
One of the main attractions for starting this blog was the excuse to reach out to interesting people and get their perspective. And one of the first people i wanted to reach out to is Jimmy Trimble. Jimmy heads the Private Banking Group for Fidelity Bank, a local/regional commercial bank based in Atlanta. More importantly, he's our banker and a trusted friend who is as articulate on the various issues plaguing his industry and ours as anyone out there. He's also about the furthest from the "Wall Street" stereotype that's so pervasive and easy to absorb.
So, I wanted to pin him down to talk about the banking industry, where we're heading and what types of opportunities he's seeing come across his desk. Basically, what kinds of green shoots are out there. Below is a really minimally edited transcript of those discussions. Hope you enjoy it.
(Finally, because Fidelity Bank is publicly traded, I've got to offer the following disclaimer: "Jimmy Trimble's statements below are his opinions alone and not necessarily those of his employer or any other entity with which he is associated.")
GW -So, tell us a little bit about the last 4 years for the banking industry. Has it been as bad for your industry as it's been for the design and construction world?
JT - It has brutal for almost all banks but especially those that were not well diversified in terms of their product mix. Most of those that failed or are failing were concentrated in construction & development (C&D) lending. When the funding sources changed from wide-open to a trickle in a very short period of time, those that were heavy in C&D had nowhere to turn. The banks with reasonably diversified revenue sources have survived and, in many cases, thrived over the past few years.
I want to start out by talking about a recent topic you covered on your own blog - about the 5 'C's that banks are really looking for when making loans to customers. Can you briefly talk about those?
The 5 C's of Credit are consistent measures of underwriting used by almost every bank from large to small. The long & short of it is that Character is first, second, and third in terms of priority. Other important factors are Cash flow, Collateral, Capital – your net worth, and Conditions -micro and macro factors that affect the business and industry.
(Ed note – see the actual post here ).
As silly as this may sound to you, can you stress just how important it is to develop an actual, real business relationship with a banker? How often should you meet or give them an update? What types of information should you share with them?
Bankers should be more proactive than they are (as we all should be) and should contact their clients proactively to check in. Not all bankers do so but clients can take the proactive lead and contact their banker. Quarterly updates are a good general rule. Some clients are concerned about providing updates if there has been an overly negative occurrence because they are afraid their line of credit could be cut-off or frozen. This is a valid concern and some banks have not done a good job of standing with their clients in these circumstances. What many people don't know is that banks are required by regulators (FDIC as well as State/Federal regulators) to take reasonably diligent steps to limit losses in cases where they believe there is unusually high risk of a credit loss. For example, the $250,000 deposit insurance provided by the FDIC is based on the premise that the insured bank will take reasonable care of the insured deposits which are being loaned out. If these funds can't be recovered from the borrower - if they can't be returned to the depositors - then the FDIC has to step in. For this reason, the FDIC is very focused, as they should be, on making sure banks limit credit losses, which includes reducing or curtailing completely the access to credit for borrowers that are seen as having a higher-than-usual risk of failure. Having said that, some banks have not done a good job of managing difficult loans or of communicating that they are required to take certain actions on behalf of their depositors whose funds are being loaned out.
One of the topics that I know would be of a great interest to people reading is how the two following situations might be looked at:
1 - I've recently been laid off and been forced to make or I've consciously made the decision to open my own business. Can I get a line of credit to help pay for the expenses related to that launch?
A new business has very little chance of obtaining a line of credit from a bank – now, this isn’t for a lack of desire to support new business formation, but is more related to the returns involved. In good times, the typical Return-on-Assets for a bank is around 1%. While there is often some recovery on a bad loan, it is usually far less than the amount of the original loan. The bottom line is that a typical bank can only have 1-2% of their loans go bad and still make a profit. Since the rate of failure in start-up businesses is far greater than 1-2%, banks generally do not lend to new businesses. Exceptions are made occasionally if there is some combination of collateral or guarantor support that offsets the risk of the start-up business. The best source of funds to start a new business comes from "friends & family" or from leveraging assets that the partners have accumulated personally.
2 – My firm had a line of credit in the past and saw it cut back or cancelled over the last couple of years. How can we get our line restored to its previous level?
As mentioned above, banks have not universally done a great job of communicating the regulatory requirements they work under. They are required by Federal and State Regulators to make sound decisions relating to extending credit. Obviously, there is a common-sense element involved also and each bank has a duty to its shareholders to preserve the value of their equity in the bank. With those two factors as the backdrop, banks have indeed cut back on many credit lines but this has usually been in direct relation to the credit-worthiness of the borrowers in question. In other words, as clients (including those in the design and construction world) have suffered, so has their credit-worthiness as well as a lender's ability to extend credit. Over the past four years, the credit standards banks use to approve credit has not changed much. What has changed has been the cash flow and net worth of many potential borrowing clients which makes it more difficult for banks to make loans. Contrary to news reports, banks are trying very hard to lend money to new clients and increase loan balances outstanding with existing clients.
GW-Something that I personally think may come as a shock to some applying for that line of credit the first time is that, in a majority of the cases, you (the owner) are going to be asked to personally guarantee the line. Meaning, if the company folds, you personally will be required to pay back that loan. How soon or under what conditions will that line be allowed to be wholly transferred to the company so that its collateral will be used?
JT- Personal guarantees are generally required on most loans for small businesses. Clearly, at some point this requirement is dropped (the CEO of Coca-Cola is not required to guarantee the company's debt) but most banks will require personal guarantees from small business owners when extending credit to the company/firm. The reason is that, generally, when an individual is personally liable for a debt there is greater chance there will be more care taken to protect the bank's interests than when there is no personal guarantee. The question above is based on the premise that either with or without a personal guarantee, the partners/owners of the borrowing entity will act in a diligent fashion in protecting the bank's interests and won't act to benefit themselves to the bank's detriment. Personal guarantees are not designed for honest and diligent borrowers who seek to protect the bank's interest. They are really for those who would seek to benefit themselves to the detriment of the bank and wouldn't be willing to stand behind the debt of a business that fails. Although bankers would really like give everyone the benefit of the doubt, it is difficult to determine which borrowers are in which category so most banks require personal guarantees from almost all business borrowers.
Another reason banks require personal guarantees is that a guarantee is an affirmation by the owner/partner that they personally believe in the business and have faith in its viability. If an owner/partner is unwilling or reluctant to sign a personal guarantee it is a sign that they may not believe in the business enough to put their own assets at risk. If the owner/partner doesn't personally believe in the business it is difficult for a bank to believe in it and extend credit.
Which probably gets back around to Frank Gehry's (a famous architect) advice to new firms: Don't borrow money.
In parallel to that, one thing that may (or maybe not) surprise you, but a lot of design firm owners simply can't read a balance sheet, much less prepare one. Nor do they really understand the basics of cash flow management. Can you recommend some “essential” business primers that every owner should learn or know to help them succeed?
It doesn't surprise me because I've seen many uber-intelligent people that have specialties in areas I can't even begin to understand who don't understand the basics of financial statements. I try to have a high level of sensitivity regarding how intimidating financial statements can be and always offer to work with clients to complete financial statements. As a business grows and expands, it becomes more important for the owners/partners to understand the basics of financial statements, especially cash flow management. For example, many "profitable" companies have failed because they've run out of cash.
On the other hand, if a company has enough cash to satisfy its obligations, it can operate at a loss for an extended period of time. Many new business owners see excessive growth as a positive sign when in fact it can run a business into the ground. Slow, steady growth is one of the keys to long-term success. A good banker can guide a growing business and assist them in maintaining an appropriate level of funding to support growth.
In terms of enhancing financial literacy, there are number of resources available on Youtube or Google that can be found by searching terms such as "cash flow management", "understanding balance sheets", etc.
GW -Cash is king, as they say, now more than ever. Yet, as with most service professions, accounts receivable lagging on and on and on is a real problem. Something I just can’t imagine a bank’s ever seen. Any tips from your experiences about how to approach clients and getting them to pay up?
JT - Those clients that manage their A/R best are typically the ones that set expectations early with clients, follow up in a diligent but friendly manner, and watch their A/R ageing every day. There is a concern that persistent follow up will bother clients and put future opportunities at risk. However, not persisting can actually be much more detrimental than losing a sale.
Here is a simple perspective that may help give owners/partners the motivation to pursue receivables more diligently (which again starts with setting expectations up front) -- This calculation is called "Days Sales Outstanding" -- The first thing you need to do is completely write off your one- or two-year old receivables (you are not going to collect them). Take your current A/R balance and divide by your total billings (sales) expected for the current year. Multiply this ratio by 365 and that will result in your current level of Days Sales Outstanding a/k/a A/R Days. How does this number look in relation to last month at this time? How about two months ago or a year ago? If it is increasing it is costing you money as you can see below.
To calculate how much one A/R day is for your business, divide your total annual billings by 365. Assume for this example $5 million in sales which results in about $13,700 per day. Assume also that your current A/R days are at 45 even though you are offering your clients terms of 30 days. If you can create a system to reduce your A/R days to 40, you will have reduced your A/R by $68,500, which generates that much in additional cash for the business. This cash can be used to reduce debt or invest in new opportunities. Any way you slice it, an extra $68,500 is better than not having an extra $68,500.
As a follow up, if a firm sees that a major payment(s) is going to be really, really late – and that lateness is going to affect being able to pay the bills on time - is it better to let your banker know as soon as possible or just practice measured avoidance?
My opinion is that full communication is best. Giving the banker an early heads-up would be my recommendation. The reader needs to make a personal judgment on a case by case basis. If you have a banker that overreacts to the slightest bad news you should think twice about how you are going to present it. Personally, I would prefer early and full communication because I believe in my clients and have a high level of confidence that they will be honest with me. In the case above, I would ask my client for a copy of the documentation related to the major payment in order to prepare others in the bank for the possibility of a late payment or to lay the foundation for a temporary increase in a Line of Credit.
One of the great dilemmas of the last couple of years is just how badly the ‘banks’ (and we have to put that in quotation marks) have been demonized, especially when most people only see or hear about outsized executive payments still happening, hear about the abuses of TARP and just want to blame this whole mess on the financial industry. Like most things, though, it's a whole lot more complicated. Your blog has a great series of understandable explanations about the difference between types of banks - can you elaborate on what the fundamental differences between, say, Bank of America and a regional bank like Fidelity Bank.
One of the biggest misconceptions is that the banks were "bailed out" but in reality, the TARP program will generate a profit for the American tax payer. Certainly, some of the smaller banks that took TARP money have failed but almost all of the biggest banks have emerged and paid back their TARP funds with interest. The Treasury also holds stock warrants worth billions of dollars which will be an additional source of profits to U.S. Tax Payers. The other misconception is that the FDIC (and the failed bank loss-share program) has been funded with tax payer dollars. In fact, the FDIC's operations are funded by deposit insurance premiums paid by banks.
Regarding the question of how banks have been demonized, my opinion is that there are certainly no pristine/perfect banks just as there are no pristine/perfect individuals or companies/firms in any industry segment. However, by and large, banks are staffed by individuals, even at the highest levels of each bank, that come to work every day trying to do their best and these individuals are not seeking to profit off of others' misfortune. In my opinion, as with any group that is demonized for political reasons or to fill a hole in the 24-hour news cycle, banks are not nearly as bad as many would make them out to be. For example, almost every bank with which I'm personally familiar is working overtime to make loans to borrowers across the board but many of the reasonably well informed individuals I know genuinely believe that banks are simply not lending. Clearly there is a disconnect between the facts and what is being communicated in various information outlets.
Having said that, there are definite differences in the value propositions offered by larger banks vs. smaller banks -- neither is necessarily good nor bad but simply different. In my opinion, if you need a multi-state bank for whatever reason, you will probably prefer an institution such as Wells Fargo or Bank of America. For a business that needs a very personal level of service and a banker that really understands their business, many would say that community banks are a better choice. The best way to figure out which type of bank is best for you personally or for your business is to pose the same question or the same loan opportunity to multiple banks. In doing so, the more specific you can be in your request the better. You will learn some lessons in this process and you will become better able to manage your banking relationships over time.
Most importantly for our audience, can you talk about how each type plays a role in lending for construction related projects? I'm really interested in knowing how much goes through very small (comparatively) banks and how much really is originated through the mega-banks. My hunch is that a majority will think the major banks are the primary lenders, but that the reality is that it’s the smaller, regional and local banks.
Most small- to medium-sized construction lending (up to around $15 - $20 million) does not go through mega-banks but instead through regional and community banks. In Atlanta (where I am) for example, most small- and medium-sized construction financing is provided by community banks and regionals such as BB&T or SunTrust.
For the benefit (hopefully) of the reader, I will expand somewhat on this question to provide a little more insight into construction lending in general.
Construction has remained a very tough industry for banks to work with for a couple of primary reasons. First, there is still a high level of vacancy in residential, office, and retail properties. Many of the commercial spaces that have been rented over the past three years have rental rates far below where they were in the few years prior to this period. This lowers the profitability of these properties which in-turn lowers the motivation for real estate developers to build new commercial properties.
The residential market was supported at the lower end by sub-prime mortgages which are essentially no longer offered and this market will not recover before unemployment improves dramatically.
[Ed - There is an in-depth explanation on this here]
There are a few bright spots. One area that seems to be reasonably well funded these days is owner-occupied medical office buildings (i.e. a doctor's group that occupies more than 50% of a facility they wish to build). Other areas that remain reasonably strong include government and university buildings. Otherwise, it is tough to justify new construction these days because the profitability is just not there.
The second big reason that banks have backed away from construction is that there is construction-related risk in addition to all of the other real estate related risks. These risks include any of the potential obstacles to completing a project on time and on budget with which most readers of this post are very familiar. Using a commercial office building for example -- the building must be completed before it can begin generating rent (which is used to repay debt on the property). If the project is temporarily or permanently delayed, there will be a risk of a partial or complete loss to the bank. Existing buildings are easier for banks to wrap their arms around since construction-related risks are not an issue.
As a follow up, can you talk a little bit about how these smaller banks - that relied so much on real estate based loans - got 'caught' with too little capital and how that's affecting the current climate?
This is a complicated and lengthy issue, but here’s a short summary:
Many smaller banks relied heavily on loans related to residential land and construction. As mentioned above, the entire housing market was supported at its base by sub-prime mortgages. When Fannie Mae and Freddie Mac created the sub-prime phenomena by lowering their minimum credit standards in the late 1990's and infusing enormous levels of capital into the lower-end housing market, home owners at every level benefit from an increase in value. This occurred because home owners in the lowest tier of homes suddenly saw their values rise due to the increase in the number of potential buyers (because of the lowering of credit standards mentioned above). They were able to sell their homes at a profit and move to the next level of the housing market. Individuals in that segment of the market then profited as did owners in each successive level of housing.
Banks were involved at every level of financing related to this boom in housing and many banks were established during this time in order to specifically serve the needs of the residential housing market -- from acquisition of land by developers all the way to brokering mortgages used to purchase homes built on the land and everything in between.
Eventually, the housing market became so over-heated that it imploded and, most importantly, it did so in a very short period of time. The housing cycle can be very long, starting with the acquisition of land and ending with a finished home, which comes after months of developing the subdivision/neighborhood. When the housing crisis began, banks were involved at all levels of the financing this market and they were stuck. There was nowhere to turn because the funding sources dried up which meant there were far few buyers and the ones that were left weren't willing to pay even what the bank had in the loan -- i.e. the banks lost money on the loans.
This set housing prices back 8-10 years in many communities and took away one of the hidden sources of saving for many individuals which was the equity in their homes. This will have negative effects for some individuals for the rest of their lives. On the positive side, there are opportunities to benefit from the current market and those that study the market and diligently seek these opportunities will find them.
Is the failure of so many banks - and the revised capitalization requirements - really making it that hard to do new loans? If so, how do you see this impasse being broken?
It is really not the capital that is the issue because the majority of surviving banks are now well capitalized through retained earnings or through raising capital. The real issue, as mentioned above, is that the financial condition of many borrowers has been diminished significantly, limiting the bank's ability to lend to them. Even banks decided they wanted to change their credit culture, the regulators would be right there watching to make sure we didn't stray too far.
If we – as architects - could help our potential clients make a better case for their project (and the loan to do it), what kinds of information (if any) could we help provide them to make their loan package better?
That would be a great value-add if you could figure out how to do it. Generally, banks will look at the bottom line numbers when making a loan so if you could help establish that there is some extra tangible value that a project offers or there is some potential source of revenue that is unexpected as a result of completing a particular project, you may be able to assist in this area.
Give us a time frame - just on your opinion - how long is this recession going to last? Meaning, how long until we get back to the 2006-2007 levels of economic output?
It all comes down to jobs. Jobs will return when regulatory stability returns. I work mostly with small business owners and most of them don't mind being regulated or even working with a new health care law. In fact, that is not the issue at all -- the issue is that the pace of change in the regulatory world is too rapid. For the purpose of sharing with your readers, I asked someone I know to share with me the recent regulatory updates. They showed me one-month of regulatory updates from one agency (banks are regulated by several agencies). The regulatory changes for the month of October 2011 ALONE were three-quarters of an inch thick. This is a major issue that is slowing down hiring. Again, most business owners I know say "regulate us all you want but quit changing the rules every day........just tell us what the rules are for the next few years and we'll figure out how to make it work". So the answer to the question above is that when the regulatory dynamics slow down, the overall economy will begin to show signs of healing, hiring will return, and the pace of building will pick up.
Last question - and one that is actually extremely important to a lot of younger architects who read this site - do you think the fallout from all this has really changed behaviors within the financial industry or do you think we're looking at these kinds of swings happening frequently and with the kind of severity we've seen in 91, 2001, and now 2008?
In my opinion, the swings will continue and the financial industry will have a role in that but its influence will continue to pale in comparison to political and legislative forces. I would like to think that behaviors would have changed in Washington D.C. and in State/Local legislative arenas but, if anything, politicians seem to have become more populist and divisive over the past few years. In terms of offsetting these swings, there is no substitute for making the development of new business the number one priority.
Taking a slightly different approach to your question -- the financial industry in the U.S. is part of our overall capitalist system which, by its nature, has positive and negative aspects. For example, the profit motivation that some criticize as greedy or selfish is the same factor that gave us thousands of life-saving/life-improving drugs, technologies, and other inventions over the history of our country (as well as the design/construction of the buildings that those businesses occupy). In the same light, the financial system that has so many flaws is the same one that facilitates home-ownership, free-flowing capital to support business growth & construction, and many other positive outcomes. That is in no way a justification for bad behavior but simply a statement that our financial system is what it is. In my opinion, if we limit it with extreme regulation in the name of fairness or in order to combat greed, the offsetting result will be a lack of capital flowing into financial markets which support development and construction.
GW - Thanks for taking the time - I owe you some cookies for this one...
Central to the blog is a long running interest in how we construct practices that enable and promote the kind of work we are all most interested in. From how firms are run, structured, and constructed, the main focus will be on exploring, expanding and demystifying how firms operate. I’ll be interviewing different practices – from startups to nationally recognized firms, bringing to print at least one a month. Our focus will be connecting Archinect readers with the business of practice.