Proactive Planning In the Dry Lending Climate - Economy & Credit
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SECTION: Economy & Credit

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Proactive Planning In the Dry Lending Climate

By Rich Moskwa

Article Date: 01-01-2011
Copyright(C) 2011 Associated Equipment Distributors. All Rights Reserved.

As recovery reveals itself slowly, dealers must choose their course wisely amid lingering economic uncertainties and less-than-friendly midmarket credit conditions.

The aim of this article is to provide a brief overview and set of opinions as to:
  • Today's general economic situation
  • Borrowing environment
  • Recent actions seen, taken and being considered by dealers and distributors and like sectors
I will also look at what other professionals in my field have seen relative to the construction and equipment dealership sector. My perspective is taken from the point of view of an ex-lender (30-plus years) who is now involved in turnaround and restructurings. My comments are focused on the executive level, especially the CEO and CFO, but hopefully of interest to a broader AED audience.

The Economy and the "Great Recession"
Economists, financial sector specialists, governmental data, political rhetoric and just plain pundits are all over the map when discussing the status of our economic situation and its anticipated direction. My view of today's economy can be summarized as follows (I am not an economist so my views are influenced more by what I see and hear from a practical "on-site" sense):

The so-called "Great Recession" is not over. For some, there have been positive changes but for the majority of consumers and small to midsized commercial enterprises that is simply not the case. The recovery has been described in a variety of ways: (A) as being in a consistent up-swing mode; (B) a double-dip recession and hence a wavy-like recovery, or (C) shallow and pro-longed malaise that will eventually enter a durable and sustainable recovery. I tend to adhere to the latter.

Despite some improvements in the credit markets that are centered on larger midmarkets and large credits, many smaller companies still remain highly constrained and need to remain reliant on their existing lenders. This is not easy for many as their traditional lenders reassess their portfolio holdings and, in some cases with an "amend and extend," with the intention to request their borrowers to seek refinancing elsewhere when consistent growth hits.

We are indeed in a recovery, but it is a slow one, uneven in its positive impacts and will take at least a couple of years for the country to reposition itself (but certainly not to the euphoric pre-2006-to-2008 levels). We have entered a new and evolving "normal."

At a high-level, what needs to be maintained in order to keep (and get) us going, I view simplistically with the following fundamental drivers and dynamics – there are more, but I am selective given space limitations.
  1. Unemployment remains high. Data show us that unemployment still stands at about 9-plus percent. If we assume we have a workforce in the U.S. of about 150-160 million, this translates roughly into 14-15 million unemployed. No one can argue that this is a big number. What I am concerned about is that this data does not include everyone, such as those who have given up looking for a job; those no longer receiving unemployment benefits; those working parttime due to a lack of full-time jobs; and new graduates. Certainly zero percent unemployment can never realistically be achieved, but we have a lot of ground to regain in order to return to the 6 percent that economists call full employment.
  2. High unemployment, static or lower wages, fear of job losses, war and global uncertainty, as well as other factors affect consumer spending. It is simple logic to me that if people don't buy goods, goods don't need to be produced in quantity, and hence true economic recovery suffers. Until the consumer starts to purchase more goods on a relatively systematic and increased basis, the basic business models will continue to suffer.
  3. Any lingering concern must be eliminated that the banking sector is unstable, especially unstable due any real or perceived hesitation to lend, due to any consequences of "amend and extend," * or due to classic forbearance agreements (in which poor risks may have, in fact, been postponing an inevitable second lending [i.e. re-payment] crisis). *Also sarcastically known as "amend and pretend" or "a rolling loan gathers no loss."
    Although many such extended commercial loans are fine, it remains hard to judge how many loans more than likely need to be "worked-out," with dire consequences to those borrowers, and indeed the lenders themselves. (One estimate is $38 billion in the midmarket of such loans and $750 billion in all loan-due payments by 2014)
  4. An additional concern to the general economic picture is the effect of commercial real estate loans. Estimates seen indicate that as much as $1.7 trillion (not billion!) will be due to pay off lenders starting in 2012-2013. Any mounting concerns here may, as one understandable consequence, force banks to reassess their lending to middle-market and/or downstream businesses as they work to protect their CRE portfolios.
  5. With the above, an easing of credit is critical. Banks and other lenders (sitting on a reported $1 trillion in cash) need to provide sufficient capital to static (due to inability to borrow) or growing companies. There is certainly an easing demonstrated for many of the larger entities but the same has not trickled down to the middle-market area where American business resides. This is especially true in sectors such as the construction business. Commercial banks still remain hesitant to lend to the middle market (More on this in a moment.)
  6. Resolution of tax uncertainty for investors one way or the other, the "Bush Tax Breaks" being key in the short term. (Editor's Note: We now know this has occurred.)
  7. Construction-related businesses in general continue to show weaknesses. In the turnaround arena and listening to lenders, borrowers and equity investors, as well as assessing basic data, the following are clearly visible:
    1. Commercial building activity has not picked up, space remains abundant (although some inroads have been made) be it office or plant.
    2. Infrastructure appears static as the governmental stimulus package has not been fully realized. Will there be another push in 2011?
    3. No increase in oil and gas and OCTG plant and/or equipment needs
    4. Relative stagnation characterizes (with some decrease in certain metals) the mining (deep and open cast) and metal fabrication businesses.
    5. Ethanol, bio-diesel and other government-aided programs are suffering with no new builds visible.
The Borrowing Environment
It goes without saying that the commercial banks and other lenders (be they nationals, regionals or other) have had a tough time in recent years. I leave discussion of the blame for this to others, although the consequences certainly affected the borrowing environment. What is important today from a practical perspective is how capital sources are perceived to operate.

Most lending institutions remain skittish, and some may call it "lender malaise." Whatever the appropriate terminology, the fact is that in the middle-market, where the vast majority of you operate, lenders are generally viewed as hesitant to lend. In many cases, this is entirely justifiable when lenders look at their new risk/reward criteria. What we see, however, is the prevalence of some or all of the following from lenders for new loans or refinancings:
  • Deeper due diligence is pervasive. Lenders have learned from the past and are no longer just accepting things at face value. In many cases lenders may ask outside advisors to assist in certain due diligence tasks.
  • We see more conservative loan-tovalue coverage (i.e. less leverage), be it for ABLs or Cash Flow lending. This may imply additional owner contributions in some cases.
  • Increased rates over the yard-stick basis (usually LIBOR). The basis is certainly lower today, but the spread remains higher for the lender to compensate for risk-taking (although it has come down on the larger credit names).
  • In general, all-in effective rates for the borrower may actually be lower, but consideration must be taken of the whole picture if you are even considering doing a refinancing or even a new loan with a willing lender. Does the effective lower rate actually provide cheaper and better financing when all facets are taken into consideration? (See last three bullets for examples.)
  • Watch for increased and tighter covenants, including more sensitive triggers of technical and contractual defaults.
  • Note the increased up-front fees.
  • There are lower advances or ratchet-downs on borrowing bases. As an example, refinancing may only permit a 75 percent advance against eligible receivables versus 85 percent in the "old days."
  • When reviewing any risk profile, the astute lender will certainly look at the financial data and (like a turnaround professional) at cash flow (which remains king). But from an operating perspective, the credit officer will now equally look at the following as items with which many companies have struggled and continue to struggle – and equipment dealers and distributors seeking financing are no different:
  1. Inventory oversupply
  2. Weak used-equipment pricing
  3. Soft new business pipeline
  4. Low(er) utilization
  5. Declining rental rates
  6. Management and company morale
  7. Decreased margins
  8. High existing debt levels
  9. Bloated org. structures
Recent Actions Seen, Taken and Considered
Since the economic malaise started, certain helpful actions have been taken by "stressed" members of the dealer distribution and related and/or like sectors, from both operational control and financial stances. These include the following and are especially significant in today's soft dealer market:

  • Ensuring that members of the executive team work as a unit: (not an easy task in many family run businesses) Too many times the CFO's contribution and expertise is not fully utilized.
  • A definitive succession plan to have the right people ready to step in (this may actually bypass family members in such a controlled entity if these individuals cannot objectively meet the needs of the task ahead). Succession planning, depending on the size of the entity, should not be restricted to the CEO/CFO office but must include sales, operations and the like.
  • Financial planning tools such as a running 13-week cash flow and a weekly review of sources and uses will give not only the CFO but the entire executive team a good grounding in what is available and what can be done on a near real-time basis. As a side but significant benefit, it is a useful tool for your lenders to review when needed, since such tools can be the basis for illustrating not only financial acumen but also credibility of data.
  • Talking to lenders more often: Lenders do not like surprises, so keeping them informed on a timely basis will help in getting them to work with you in times of stress and make them more receptive to new ideas and requests.
  • Restructure the balance sheet in general if it makes sense: Consider financing alternatives that may reduce cash outflows. (Again, cash has been and remains king.) Alternatives may include refinancing existing loans at lower effective rates or infusion of equity as needed (may be necessary to attract new lending). Do not neglect, however, the potential impact of new covenants or ratchet downs, etc., discussed above.
  • Managing both AR and AP through a weekly sources and uses sub-set of the 13-week cash flow mentioned above.
  • Operations, sales and management must work together to decrease floor planning to a "must have" level: The same applies to spare parts inventory. As simple as it sounds, excess inventory costs money.
General Cost Containment
  • Cutting SG&A to the bone: In privately held, family-run enterprises there is the need to get past emotional issues.
  • Cutting the albatross of legacy costs (such high or unnecessary locations) by pulling in the horns (fewer locations) on a pragmatic basis.
Human Capital
  • Freezing salaries and hires if the needs arise: A tough decision to make for sure – if it's necessary, do it. But do it right.
  • Reducing/optimizing the size of the workforce: Many companies have become bloated due to the retraction of business/sales from the peaks of a couple of years ago.
  • Decrease fleet inventory of used equipment.
  • Decrease spare parts inventory.
External Support
  • Bringing in external operation and financial advisors who will tell you what you should know and not necessarily what you want to know. It is important not to look for a financial advisor alone, but one with operational capabilities.
Other Considerations
  • Consolidation is still very much a viable alternative to some stressed situations: There is strength in size, providing economies of scale (personnel, market penetration, floor plan, etc.)
  • Market positioning: Building and maintaining a viable and dynamic business is not an easy task. Too many times, owners and management neglect to view their position relative to competition, technological advances, their own business advantages and value-adds relative to competition, their weaknesses, and so on. It may sound dramatic and certainly harsh, but a basic question to ask yourself in difficult times is: Will this company be missed if it were to simply go away?
In short, the economic conditions remain difficult for many in the construction equipment distribution sector.

Slow business, strained margins, competitive pressures, operational dynamics coupled with a more stringent lending environment, all lead to the need for the CEO and CFO to reassess their business plans to the new "normal," make some hard choices and execute a new operating model for the company.

Urgency, communication and realistic executable actions are the key and critical elements for many in the industry as a means of "surviving" until markets stabilize, thus providing the foundation for permanent improvement.

Rich Moskwa is a managing director in BDO Consulting Corporate Advisors New York office and has more than 35 years of experience in risk assessment and due diligence, and crisis management in lending institutions, turnaround planning and strategic advice to company owners, management, lenders, creditors and investors. He can be reached at

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