Negotiating with banks when getting a loan is not only about getting the most rewarding end of the deal. There are a lot of regulations and policies to be considered here after all, and you must be aware of each one to ensure a smooth process. Bob Roark talks with the CEO of Pikes Peak National Bank, Robin Roberts, to delve into the right approach to bank negotiations. She explains why you can’t argue with banks about submitting tax returns and financial statements, delving into why it is not an invasion of privacy. On the other hand, Robin talks about loan covenants – which are negotiable – detailing how you should discuss its specifics with the bank to come up with a satisfying agreement for both parties.
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Robin Roberts: What You Must Know When Negotiating With Banks
Have you ever wondered why banks sometimes do things that are not quite clear? In this series, I have Robin Roberts. She’s the CEO of Pikes Peak National Bank. She’s here to demystify some of the things that might be bothering you. One of the things that we talked about at length is how to negotiate with your bank. There are so many people that miss this one particular component and it is not the 1/8 of the quarter that you negotiate on the loan. Oddly enough, it might be the covenants that you might want to spend some time on. Take care, enjoy, and I hope you learn something from this episode.
What can you negotiate with your bank? If you’ve finished negotiating with your bank and you’ve got an extra 1/8 off on my five-year fixed 30-year amortization note, don’t necessarily pat yourself on the back. You may have missed basically the entire positive things that you can do. In this episode, we have Robin Roberts. She is the CEO of Pikes Peak National Bank to illuminate and demystify what you can negotiate with your bank in the commercial loan for your business.
The first thing that business owners who have not borrowed before, they equate commercial loans with getting a residential mortgage on their house or getting a car loan. That’s a consumer purpose loan and those types of loans have their purpose. They are very different. They’re regulated differently. They have different laws that cover them than commercial lending. Commercial lending is its own animal. It’s important for business owners to understand commercial lending, how it is different than getting their residential mortgage, and how the process was. Not just now when you get the loan, but over the course of the loan because the bank is much more involved with you on an annual basis with your loan than when you get your residential mortgage for 30 years. You make your payment every month and no one ever bothers you again from the mortgage company or the servicer. You make your payment and you’re good. Commercial lending is not that way and business owners can, if they understand the whole process of the loan, negotiate things at the beginning of the loan that will help them 2 and 3 years down the road.
For a lot of them, when you do your home mortgage and you do it through a bank, most don’t realize or don’t realize until they get a notice that the note’s been sold. It’s not on the bank’s balance sheet and their responsibility and concern about your note is now gone. Whereas the commercial loan is the banks are intimately interested in making sure of the quality of your note because it resides at the bank that you have the note from it and it’s not sold.Most small business loans are not sold. They're held on the bank's books to be monitored regulatory-wise. Click To Tweet
Most commercial loans and small business loans are not sold. They’re held on the bank’s books and the bank has a responsibility regulatory-wise to monitor that loan portfolio we grade it actually on an annual basis. What are these loans doing? What are the businesses that have borrowed? How do their financials look? Have they taken on additional debt since we originated the loan? Have they lost their largest customer, so their revenues are down? Has COVID affected them or lockdowns affected them? It’s a restaurant or hospitality loan, and we need to watch it for the next twelve months.
All of these things banks are paying attention to on commercial loans. A normal part of commercial lending or for a commercial borrower is that you’re going to provide financial statements and tax returns to your bank every single year. This is shocking for some new small business borrowers because they are not used to doing that and they find it to be invasive privacy-wise and I would say to don’t borrow commercially because every bank is going to ask you for your tax returns on an annual basis if you’re a commercial borrower and they’re required to do so. It’s not like this bank is doing it because they want to invade your privacy and the bank over here is not going to do it. All banks are going to do that on commercial borrowing.
Most folks think that the bank is being nosy. You go like, “Fine. I’m not going to send them my return or my financials.” What happens as far as the bank’s perspective of that note if you don’t share your return or your financials as required?
There’s a lot of things that happen. Whether you realize you did or not at the time that you borrowed the money and signed the promissory note, you agreed. It’s a covenant that you have with the bank. You agree to provide financial statements and tax returns, not on an annual basis, but whenever the bank requests them. If you decide, “I’m not doing this,” the bank can’t, from a regulatory standpoint say, “We can verify the cashflow. We know how this loan is being repaid, so it remains a good-graded loan in the bank’s portfolio.” If you stopped providing financials, they usually have to downgrade that loan in the bank’s portfolio. That makes your life much more difficult than if you had handed over the tax returns that you agreed to do when you got the loan. We’re going to probably do a new appraisal on your property. We’re going to do everything we can to mitigate the risk because we can’t verify your cashflow.
You don’t need to pay for the appraisal.
No, the customer pays for the appraisal because that’s another covenant. I’d love to talk about covenants really quickly in this commercial loan. If you borrow $50,000 as a small business loan, you’re probably not signing any covenants. If you’re buying a property and you’ve got a loan of several hundred thousand dollars or more, you’ve got some covenants on your loan. Covenants are more than just, “I agree to make this payment every month by this date.” Covenants are a separate agreement that you’re making with the bank that says, “I will provide financial statements and tax returns. If my property value changes, I will pay for an appraisal. If the bank decides that they have to do a new one, I will pay for it.”
There might be a covenant that says, “I will not borrow more than $200,000 without talking to the bank first. I agreed to maintain a certain debt coverage ratio for the entire time that I have this loan.” The covenant will say, “This is how the bank calculates your debt coverage ratio. I agree to keep a debt to net worth ratio of such and such.” These covenants are in your loan and a lot of borrowers don’t know that they’re there or they hear it at closing, but all they care about is getting the new property, the new equipment, or the money to buy a new business. They don’t care about them then. They start caring about them when the bank says, “You’re in violation of this covenant,” a year later and this is a key part of commercial lending. Just because you make your payment on time every month, it does not mean you cannot be in default on your loan.
You can be in default by being in default by not being in covenant. You’re out of covenant. Your debt service coverage ratio is out of covenant. You’ve borrowed money and you didn’t ask the bank and it is in excess of your covenant. You’re out of covenant. You can be in default on a commercial loan because you’re in default on a covenant, not on your monthly payment. This is something that I want commercial borrowers to understand. I also want them with these covenants is if you know that they’re going to be there, when you’re reviewing your loan documents, you can ask about them, and you can negotiate them. You can’t negotiate providing financial statements and tax returns. You’re going to provide those. That can’t be negotiated, but maybe you can negotiate that you don’t have to ask the bank until you borrow over $500,000 or maybe your debt coverage ratio for the bank is 1.2 and you want it to be 1.1.
You want to understand these covenants and negotiate them. Stop worrying about whether your rate is 3.85 or 4, and worry more about, “I don’t want to be out of these covenants.” Are they realistic for my business? Do I have to borrow for my business? Am I going to buy more equipment? Is this borrowing cap going to cause problems for me and limit my growth? Negotiate those covenants. Stop worrying about ten basis points on your loan rate. That doesn’t matter when you’re out of covenant three years later. You’re not going to care about your rate. You’re going to care that you’re in default on your loan.If you just stopped providing financials, banks usually have to downgrade your loan in their portfolio. Click To Tweet
Let’s say that I’m the recalcitrant business owner who says, “You’re going to have to pry my financial statements out of my cold dead fingers.” I’m now in default of my covenants. What happens then or what can happen?
If it’s a commercial mortgage, the bank can foreclose on your property. In a lot of cases, you have a default interest rate, so maybe your interest rate is 3.5% normally contractually, and now you’re out of covenant. Now you’re in default, so now you’re kicking into the default rate. Our default rate is 24%. That’s a big difference. All of a sudden, now your interest is accruing. Instead of 3.5%, it’s accruing at 24% until you get us that information. That is normal for banks to have a default rate. It’s a carrot to say, “I know you don’t want to give us these financial statements, but I also know you don’t want to pay 24% interest rates. How about you abide by the covenant that you said you were going to abide by?” Generally speaking, banks do not want to foreclose on your loan. It’s not good for them. They don’t want your collateral. They want you to repay the principal with interest. There are things that they’re going to do to try and get you to abide by your covenants and a default rate or a penalty, some financial penalty is built into your loan, into your process.
Let’s say that you’re the business owner and you go, “I don’t understand the covenants in my potential loan,” and so I presume you say, “I’d like to see the loan documents and I want to run it through a counsel.” I would imagine, that’s not your typical everyday attorney that can look at covenants in lending.
If it’s a real estate loan, you’d want a real estate attorney to look at that. Generally speaking, a real estate attorney can look at any or any contract attorney because it is a contract. Many contract attorneys can look at your promissory note and your loan agreement. Your loan agreement is what has the covenants in it and can look through them and say, “Let’s ask for this ratio to be changed or this cap.” A lot of times attorneys try to tell us, “We want this and this.” There are things that the bank won’t move on. It’s a negotiation. You come to some agreement. I will tell of the thousands of commercial loans I’ve done, I’d say 2% of borrowers ask to see their loan documents a day before closing so that they can read them or ask for them so their attorney can review them. It’s very rare that somebody does that, but I think they should.
It’s money well spent if you’re going to have your contract renewed and you go, “What happens if I violate this covenant? What happens if I violate that covenant?” You have a risk-reward that you can take and quantify mentally, and you go, “I want to be the bank’s best friend and give them the financials,” therefore, you must have them or at least have good financials. If you have a tax return or if you have your tax return always filed late in October, you probably should let the bank know.
On the financial covenant, sometimes a bank might say, “We want audited financials.” It depends. If you’re a larger business, maybe you don’t do audited financials. Audited financials are very expensive. Maybe you want to negotiate that covenant. Not that you’re not going to give them financials, but that you want qualified financials maybe instead of audited financials or compiled financials instead of audited financials. Those things can be negotiated. You’re still going to get financials. But what is the quality of the financials? What is the cost to you to provide what they’re asking for? If you don’t read that beforehand, now you’re at the closing table, maybe the sellers there too, and the sellers waiting for their money. You feel under pressure and you’re signing things that you know that you can’t abide by. Knowing these things beforehand before you get to the closing table is helpful. Just ask your banker, “Can you send me a PDF of all of my loan documents? I’d like to review them before I get to closing,” and they will.
Robin, at the negotiating table, that quarter or 1/8 of a point that you thought you’d negotiated well really isn’t nearly as meaningful as you might have thought. Thank you for sharing and providing that insight. That’s a good thing and you’re right, most business owners don’t know. Thank you for the insight and we’ll wind this one up here.
About Robin Roberts, CRC
Community Banker with a passion for serving the banking and lending needs of small business owners. Particularly effective with businesses with gross revenues of less than $2 million annually. Can assist investors in commercial and residential real estate and businesses looking for commercial real estate. Banking executive with broad experience with management, recruitment, and the legal aspects of business.
Volunteer counselor and instructor at the Colorado Springs Small Business Development Center, helping new and existing business owners with funding needs, explaining the SBA and small business lending process, business plan review and financial projection development, and commercial banking needs.