A Small Problem of Collateral

JANUARY 2, 2012

A Small Problem of Collateral

Earlier this week, a reader wrote to the Freakonomics blog site to ask why his bank wasn't willing to give him (and his partner) a loan in the amount of $50K.

To make a long story short ( and you really should click on the link and read the story for yourself), the two offered to put up $50K in order to get an equal amount back as a loan. They hoped this would help build their credit rating and their relationship with the bank.

Didn't happen.

Instead, after much delay, their loan officer came back with the news that the "underwriters" wouldn't approve anything more than $25K - regardless of the amount or type of collateral.

The original poster asked why would the bank not loan them money when they had offered the entire amount to the bank as collateral? One of the authors of the Freakonomics blog asked whether or not this was an unusual circumstance or not.

Sadly, it isn't.

There were many responses; most of which ranged from the fanciful to the unhelpful. A few posters responded that the bank wasn't truly secure even with cash inside their vault. And that perhaps, under certain circumstances, the bank might experience a loss (of some kind); that's why they only offered fifty percent of the amount.

Trust me: most people will never find themselves in this position and don't have any experience with this type of situation. If you've never had to ask for a business loan, then you probably don't get it.

For most small business people, especially if you are "self-employed", the world of banking can be a scary place. And while newspapers and talking heads on TV talk about "credit easing" or "credit tightening", those terms don't really mean very much when you're sitting outside the loan officer's door hoping to make payroll, fund a closing, or grow your business.

This is the answer I posted on their website. There wasn't room for more detail, but don't worry – we'll come back to this another day.

"You got the typical "Big Bank' run around. They love to take deposits, but aren't interested in making loans -- especially small business loans. The bit about the underwriter is pretty much all "BS".

Here's the deal:

  1. You picked the wrong bank;
  2. You have the wrong loan officer;
  3. You made the wrong pitch; or
  4. All of the above.

I put my money on number 4.

Research your bank – not all of them actually make loans, you know. Check with a local insurance agent, they can usually tell you which banks are more "business friendly".

Research your lender.

Call reports are public information. For example, if I saw too much fed funds, government paper, or anything other than loans, I would be taking my business elsewhere.

Refine your pitch.

Why do you need the money? What is the primary collateral? How will you repay the loan? And my favorite - If all hell breaks loose, how will the bank be repaid? In other words, a secondary form of repayment.

Formal "take out" agreements (preferably from well qualified clients of the bank in question) often work great as do compensating balances (banks love to play with client money - as if you didn't already know this). Just make sure you understand your proposal as well or better than the banker. That means you should be able to secure releases of that collateral when you've proved yourself (as the loan performs).

From your letter, you have all the right pieces. Just put in a little more thinking, practice a bit, answer the questions, and make sure you choose your target (lender) wisely.

You may think banks act logically and base all their decisions on numbers, but that isn't always the case. In fact, I would suggest that you run away from this bank as quickly as possible.

You will never be a first class client of a major (or regional bank). You are simply too small to be worth the trouble. They are trying to tell you – in banker speak, to go away. Pay attention. This may be hard to accept, but true.

Take your business to a bank that can make loan decisions locally. Trust me, you will be much happier."

If you're one of the people who depend upon banks for your daily bread, who know what it's like to have the door slammed in your face despite your best efforts, or who's line of credit is as important to them as breathing, pay attention.

How you approach the bank, how you present yourself and your loan proposal - even how you choose which bank to use - all are of critical importance. Make the wrong choices and both you and your company will suffer the consequences.

Choose wisely and you will happily live to work another day.