If you’ve ever had or worry about the terrible experience of having your bank pull your loans, this is the podcast episode for you. Join Kevin Kervick as he helps us understand the world of working with your banker and what you can do to protect yourself.
Kevin owned a printing company that had a few bad things happen. Before he knew it he was in the middle of a workout session with his bank. Because he didn’t know what you’re about to learn, he ended up losing his business as well. This is a podcast episode you’re not going to want to miss.
Here are some of the things I talked about with Kevin:
- What you can do to keep your business from being liquidated.
- Why your bank really is never your friend.
- The reasons you always need to have a back up bank in the wings.
- If you end up in workout, what you can do to protect yourself.
- Why community banks might be a much better match for your privately held business than a money center bank.
Narrator: Welcome to The Sustainable Business Radio Show podcast where you’ll learn not only how to create a sustainable business but you’ll also learn the secrets of creating extraordinary value within your business and your life. In The Sustainable Business, we focus on what it’s going to take for you to take your successful business and make it economically and personally successful.
Your host, Josh Patrick, is going to help us through finding great thought leaders as well as providing insights he’s learned through his 40 years of owning, running, planning and thinking about what it takes to make a successful business sustainable.
Josh: Hey, this is Josh Patrick. I’m really glad you’re with us today at the Sustainable Business podcast.
Today, our guest is Kevin Kervick. Kevin’s been a friend of mine for—gosh, 25 or 30 years. We met when we were in Young Presidents’ Organization together. He and I have had an unfortunate experience that we’re going to talk about today. That unfortunate experience is what to do when your bank doesn’t love you anymore. It’s something that we’re all scared about. Most of us are scared about it unnecessarily but some of us are scared about it and have good reason to do so. Kevin’s going to help us understand what you can do to fire-proof your loans.
So, without further ado, let’s bring Kevin in and we’ll start talking about the exciting topic of keeping your bank at bay and understanding if they’re just another supplier.
Hey, Kevin, how are you today?
Kevin: I’m doing great, Josh. How are you?
Kevin, why don’t you start off? Shortly, tell us your story about your horror story with your bank?
Kevin: Well, I had a company that was in the printing business. I had a couple of disasters that befell me in very close, rapid succession. One was the bankruptcy of a large client. The other was a press fire on my largest, most productive piece of equipment that put that piece of equipment down for about four months. Our on-time deliveries went from 99% to 60%. It was kind of a disaster. And unfortunately, it affected not one but two fiscal years because these events crossed over.
So, on my first fiscal year of these lousy events, I lost about $100,000. In my subsequent fiscal year, I lost $300,000. I had lost that $300,000 primarily in the first half of the second year. And in the second half of the second year, I was actually at break even. My bank was aware of it. They were getting unaudited quarterly financials. And after we submitted our audited financials at the end of the first quarter of year three, in the story, they put me into something called “Workout” which I had never heard of before.
But workout is where the bank puts you when they call your loan and they essentially fire you as a customer. There’s three ways things can go. They can either, after a period of time, restore you to the good side of their ledger, you can refinance that with somebody else, or they will liquidate you and use your collateral to repay the loan. Unfortunately, I fell into option #3.
Josh: So, they just came in and liquidated and they had no interest nor did they care about what you had done to fix your company?
Kevin: That’s correct. By the time they liquidated me, I actually had just completed my fourth consecutive quarter of operating above breakeven – after those disasters. Now, I wasn’t wildly profitable but I was to the north side of break even.
One of my problems was—and there’s many problems, but one of my problems was I was way over collateralized. I had collateral coming out of my ears. So for them, it was kind of a no-brainer. “We don’t like this loan anymore. We can either gamble and hope things turn around and he refinances that with somebody else, or we can just shut him down right now and get paid ¢100 on the dollar” and that’s what they did.
Josh: I’m assuming that all that collateral you had was sold for pennies on the dollar?
Kevin: Actually, we did okay but I had to fight quite a defensive action again the bank. Banks don’t have a great reputation for realizing full collateral value. They tend to liquidate at fire sale prices. Part of that is because, in their experience, collateral values never really increase. They only decrease so they try to dump the collateral as fast as they can.
I mean, think about, just in the private mortgage market, a house that’s been on the market, unsold for a year, deteriorating, lawn growing and that kind of stuff. That collateral is not getting any more valuable. It’s becoming less valuable. And the same thing kind of happens in the business world so they tend to move fast. They tend to dump at not the best prices. And I really had to fight quite a rear-guard action to make sure that we got decent value for the collateral. And in the end, in most cases, we did get decent value for the collateral. But they did leave probably about a million bucks on the table.
Josh: A million bucks, I’m assuming, in your world, would be real money.
Kevin: Absolutely, absolutely. Primarily, that was in the ongoing business value of the business.
We had quite a few large Fortune 500-type customers that were very valuable. And had we been still in operation and just sold the business, apart from the equipment, the real estate, the receivables and all of that, probably would have been three-quarters of a million to $1 million.
The guy who liquidated on behalf of the bank wasn’t that bright. He had been doing this job for, I don’t know, 20 to 25 years, but three or four weeks after he shut me down, he said that he was going to try to get some business value out of this thing. I was just sort of scratching my head saying, “Wait a minute, my sales force has all left to go to competitors. My customers are very mad at me for a variety of reasons. We ran inventory and fulfillment programs and a lot of them had stranded inventory with us that the bank wouldn’t release. They were doing everything possible to get our customers upset with us – or our former customers. And, you know, three or four weeks after that, he gets the bright idea that he’s going to try to get some business value out of the sale of business and I just said, “You’re nuts. You’ve completely blown it from the business value perspective.”
But in terms of the building, the receivables, the equipment, we didn’t do too badly. But again, that was after fighting a bit of a rear guard action on that stuff.
Josh: Sure. So, you took your experiences, then you started doing your research project to understand and learn finally how banks think and how borrowers can protect themselves.
So, let’s start off with – how do banks think. How do they think? That’s assuming they think in the first place, by the way.
Kevin: Well, I don’t want this to be necessarily beat up banks day, on the Askjoshpatrick Show.
Josh: Why not? It’s lots of fun.
Kevin: But different banks thinks differently. I interviewed a ton of bankers after this happened to me. I was part of a business network that you had mentioned, YPO – the Young Presidents Organization. And through there, I was able to meet an incredible number of bankers. I gave them some pretty intensive interviews.
For instance, one of the questions that I asked is, “If you are over-collateralized with an account that’s in workout – so you just have so much collateral, you know you’re going to get ¢100 on the dollar. Are you more likely to liquidate quick – just to get that loan paid for and move on? Or you have to give the client more time, because it’s safer for you to give them more time?” I got answers all over the place. Some banks said, “Oh no, we would extend more time because there’s less risk to do that.” Others said, “Absolutely not, we would just shut it down fast and take the money.”
Josh: Okay. So I have a question for you about this. The type of bank that gave you different answers, did you notice if community banks gave you a different answer than the money center banks?
Kevin: Absolutely, absolutely. And in terms of the work that I now do for clients, in terms of advising them on how to structure their banking relationships, probably the most important factor is bank selection. Nobody selects their banks for the right reason. I ask people all the time, “How did you select your bank?” and I hear, “Well, my loan officer was my college roommate” or “This bank was a quarter point cheaper.” Or “I didn’t this bank, they’re the bank that acquired the bank that acquired the acquired that acquired the bank that I was initially with.”
And so, I think, when you’re selecting a bank, one of the most important factors is to find a bank that has a better workout culture. Usually, those are the smaller community banks that don’t necessarily have a separate workout department with a separate workout guy. When I was first put into workout by my bank, I called my accountant and my accountant said, “Don’t worry about it. You’re actually in pretty good shape. Your problems have been in the past. You’ve fixed it, haven’t lost money in a while. Things are going well for you. We’ve had customers in much worse shape than you are now and they’ve survived through workout so you’re going to be fine.”
When I called my lawyer, my lawyer said, “Well, I would agree with everything the accountant said except for who your bank is and who’s running your workout.” My lawyer had a very low opinion of that bank and their workout practices. And from there, I just kept meeting people who kept telling me how lousy my bank was and how terrible they were in workout and how I was going to be in for a real rude awakening.
And it dawned on me, I said, “Why does everybody know this about my bank except me? Why was I the only one that was unaware of how my bank handles workout in their workout culture?” So, that’s a critically important thing to get right. I think it’s worth paying a quarter point more to be dealing with a bank that will go the extra mile for you should they place you in workout.
Josh: Or even e half point or a full point more.
So your first recommendation would probably be, if I’m hearing you correctly is, stay away from the money center banks if you need less than $10 million in loans and find a community bank that you can work with that actually understands your business.
Kevin: Absolutely. And there’s other things to look for. I mean, it’s not just a community bank, there’s a whole list of things that I would want to know about that bank and when I interview banks, I like to find out all sorts of things about that bank.
Josh: Okay. So, what other things do we need to know about?
Kevin: Well, you want to be with the smallest bank that’s big enough to comfortably handle your business. Now, you don’t want to be the largest loan that that banker has because if you’re the largest loan and you start going south, they get real nervous, real fast and nervous people do stupid things. So you don’t want to be in that situation. You know, there’s an old saying that “When I owed the bank $1 million, they owned me. But when I owed them $100 million, I owned them.” That’s not necessarily true. When you’re dealing with a smaller bank that is probably a little less sophisticated in workout, and you’re their largest account. Like I said, they get very nervous.
So you want to find out, “What’s their in-house loan limit?” Now, chances are they’re going to have a whole bunch of customers clustered right around that in-house loan limit and you want to be kind of comfortably below that. You want to know the reporting structure between the loan officer and the CEO. So, “who are you dealing with?” And that person reports to a boss, maybe a vice-president of commercial loan. And that person reports to the CEO. You want to know how the loan approval process works. Who’s on the loan committee?
Josh: Or is there a loan committee? Sometimes, they just use a sign off method.
Kevin: Absolutely. And it depends on the amount of money you’re borrowing. And it depends on the size of the bank that you’re dealing with but that’s something that you definitely want to find out.
The closer you can get to the people who are the real decision makers, that’s critical, because even before things start going south in your business, you want to know who the real decision makers are. It might be your contact’s boss. Maybe that person is on the loan committee or that person has the sign off ability on loans, say, less than $2 million or what have you. You just want to understand the complete politics of the bank. And then you want to step back and say, “How can I forge a relationship with the people that matter? Where does the bank president hang out?”
Josh: Ah, good question.
Kevin: Absolutely. You want to have a good personal look-in-the-eye relationship as high up that chain as you can, whether it’s with the VP of commercial lending, whether it’s the bank president or what have you. But those personal relationships will be very helpful in the future, should things go a little south on you.
And I’ve got to say, you know, I’ve talked to a lot of people that don’t think their business will ever have a rough spot. I’m going to give you a quote here from a management consultant who’s, I think, a pretty sharp guy. He said, “In a 10-year business cycle, you’ll have six good years, two great years and two horrible years that can put you out business. And what you need to do – or what the borrower needs to do is work on the totality of the relationship so that if they hit those two bad years, they’re going to be much better insulated from harm than they otherwise would’ve been.
Josh: So, when you’re having bad years, this is something which I find really important to think about, you might want to think about the increasing the communication you have with the bank while things are not well.
Josh: Can you comment on that a little bit, Kevin?
Well, the first thing that you even want to do before you have a bad year is build credibility with the bank. What I recommend to my clients is that every quarter, they send a two- or three-page written narrative to their bank about what that last quarter has been like and find bad things to tell them.
That sounds a little counterintuitive but if you lost a big customer – say, you’ve lost that big customer. If your electric rates have gone up, tell them that. If you’ve had an increase from a supplier, tell them that. If you’ve had a major piece of machinery go down, tell them that. The reason that you want to tell them is that it builds credibility. If you’re always telling the bank how good things are—
Because let’s face it, entrepreneurs are optimists. Things are always going to be better the next quarter. There’s always something great coming down. And your banker, frankly, is a pessimist. Now, I don’t mean that in terms of how he/she live their life. But I mean, in terms of your business prospect, the bankers is always a pessimist. And they always hear these optimistic entrepreneurs telling them how good things are, right up to the point where they go bankrupt. And the banker always views the business with a pessimistic attitude.
And so, how do you build credibility with a pessimist? And that’s to let them know the bad news when you have it. If you do that consistently, through the good times—you know, share the bad news, share the good news on a quarterly write up. When it comes time when you really are in the downturn and you need their help, you’re going to have built a lot of trust with them. They’re going to look at you as somebody that, if you say something, it’s true. And it’s very, very important to have that credibility. And it’s tough to tell an entrepreneur that you have to curb your enthusiasm, that you have to not just keep telling everybody how great things are and it’s critical, in this relationship.
Josh: Well, one of the things I can tell you about trust is, if you’re reliable, that goes a long way towards helping. And reliability means telling the truth which is the bad as well as the good. And I can tell you that from personal experience.
Josh: So, Kevin, there’s two things I really want to talk about. One is structuring your business ownership and personal assets and handling guarantees because I think both are done incredibly poorly by almost every business I ever see, so can you talk about both a bit?
Well, most people misunderstand what guarantees are all about. Most people take a binary approach to guarantees. I don’t want to give the bank a guarantee and the bank wants my guarantee, and you have this sort of clash.
A couple of things to really know about guarantees is whether you’re guaranteed or not, is a function of a couple of things, one (1) is your total credit rating with the bank. If you’re kind of on the border, you know, you’re good enough to lend money to but you’re not much better than that, you’re probably not going to escape some form of a guarantee.
So, one of the things that I always like to know from a bank is, “How do you rate my credit?” And most banks use a 1 through 9 scale, 1 is best, 9 you’re in workout and you have one foot in the grave. Seven is typically that borderline of “well, you’re still okay. We haven’t stuck you in workout but you’re on the watch list.”
And so, let’s say you’re a 5 or a 6 – maybe a 4, what I always want to know from the bank is “Why do you rate me that way? And what do I have to do to jump up a level?” And then you’re going to get into a lot of different conversations about how the bank is viewing you. It might be a cashflow issue. It might be a collateral issue or what have you. But once you have that figured out, you can start talking to the bank about all sorts of different variations on guarantees. You can have a vanishing guarantee. You can put right into your loan agreement that “If I hit a certain financial benchmark, the guarantee goes away.” You can have a limited guarantee. You know, if it’s all about a collateral shortfall and you find out what that collateral shortfall is, you say, “Well, how about if we do a limited guarantee where I’m only on the hook for $250,000 or half a million”, or what have you. That’s better than being on the hook in an unlimited way. If you have a partner in the business and you’re 50/50 partners, maybe you each guarantee 50% of the amount. So, there’s many ways of structuring a guarantee.
But here’s the kicker, everyone thinks not having a guarantee is the best thing ever. And I’ve got to tell you something, it’s not necessarily that great because what’s going to happen is if you hit a slump and your business deteriorates, you’re going to run afoul of one of one of your covenants. Maybe a debt service coverage covenant or a current ratio, whatever those covenants are that are in your loan agreement, and your bank’s going to come back to you and they’re going to say, “Well, I’ll tell you, we need to see a little good faith here. Now, if we’re going to waive this covenant and continue to do business, we’re going to need you to step up to the plate and now sign a guarantee.”
So, the banks are sometimes okay with letting you off the hook on a guarantee when times are good. But as soon as times are bad, they’re going to come back and ask you for that guarantee. And that’s going to be the worst time for you to try to finance that with somebody else. So, what you need to do is, on the personal asset side, now you need to be prepared to give your guarantee and you need to do that by structuring your assets properly.
Josh: What do you mean by structuring your assets properly, Kevin?
Kevin: Well, you have to give the bank a personal financial statement that lists all of your assets. Now, that isn’t used in any credit granting process. The bank is granting you credit based on how good your business is. The only reason they ask for your personal financial statement is they want a treasure map to all of your assets, should they want to chase you for your personal guarantee.
So, what you want to be able to do is you want to look at what would go on to your personal financial statement and you want to “pauperize” yourself. You want to turn yourself into a pauper. There’s a lot of ways you can do that. You never want to lie because on the personal financial statement, you actually have to sign off that this is true. And in your loan agreement, you also are signing off that you have disclosed to the bank all your personal assets.
But the first thing I would do is, put your house in a trust. Get it off the table. If it’s in a trust, that can’t be pledged and they can’t come after it. The second thing is that there’s a great federal banking regulation known as Reg B – regulation B. And in that regulation it says that “If you’re applying for a loan as a business owner, the bank cannot ask to see your spouse’s assets and they cannot ask your spouse to co-sign the loan. So, what you want to do is always make sure, when you fill out your personal financial statement that you’re doing it just for you and not for your spouse.
By the way, this Reg B is only true if your spouse is not an owner in the company, is not an officer or director of the company. So you want to make sure that your business is titled in your name and that your spouse is not even a 1% owner. And you want to make sure that all your other assets are on your spouse’s name. And then when you fill out your personal financial statement, you’re just putting down your assets. Your spouse is not putting down his/her assets, and that person is not signing the personal financial statement. And you want to keep things as separate as possible. Because the bank may also ask you for your personal tax return, I even advice clients to think about filing taxes separately from their spouse – not to file jointly because, again, a lot of the assets that are in your personal financial statement will be on your tax return.
Now, just because the bank can’t ask your spouse to co-sign or to pledge anything, it doesn’t mean that your spouse is not allowed to do that. It’s just that the bank can’t ask for it. So, let’s say, for instance, your house is in your spouse’s name, they can look that up very easy. They can find out exactly who owns your house and then they say things like, “Well, you know, we really are going to need an extra $300,000 of collateral here, where do you think you can get that?” Now, they’re not asking your spouse to co-sign or to put any assets into the deal but just by the fact that that’s what’s being presented to you, “Where are you going to find it?” You’re probably going to find it by pledging the house. If the house is set up in a trust, you can’t go anywhere with it. It’s impossible to go anywhere with it. And then, if the other assets are in your spouse’s name, they have a much harder time finding out what those assets are, especially if you’re filing your tax returns separately and not jointly.
And so, you just really want to separate all that. So when the bank comes to you and says, “I’m going to need your guarantee.” You can actually sign it and say, “Well, okay, I’m willing to give you the guarantee because you’ve really protected yourself personally. And I’ve got to tell you, most people don’t do this. And unfortunately, most lawyers aren’t advising their clients to do this. I see people going to the bank, negotiation a deal, then they give the loan agreement to their lawyer. The lawyer basically says, “Yeah, okay, this loan agreement accurately documents the crappy deal you just made with your bank” and that’s as far as it goes. They’re not getting the lesson about titling personal assets, protecting themselves within the guarantee and all of that.
Josh: So, Kevin, I hate to interrupt but we are out of time.
I am sure that some of our listeners are going to want to get in touch with you because (a) this is a hugely big deal for business owners and (b) you’re one of the few people in the country that can speak in English about this very important topic.
Kevin: Well, thank you.
Josh: So, if somebody wanted to get in touch with you and have a further conversation about their situation, because I know that you do that with people, how can they find you?
Kevin: Well, you can certainly go to the website which is kervickdevelopment.com, so that’s Kervic K-E-R-V-as in Victor-I-C-K development.com. Or just even shoot me an e-mail and that’s Kevin@kervickdevelopment.com. And again, that’s Kervic K-E-R-V-as in Victor-I-C-K.
Kevin, thanks so much for your time. I’ve got to say this is a great episode.
For those of you listening, I hope you’re going to take to heart some of the nuggets that Kevin left us with. We’ll see you next episode.
Thanks so much for being on.
Kevin: Thanks, Josh.
Narrator: You’ve been listening to The Sustainable Business podcast where we ask the question, “What would it take for your business to still be around 100 years from now?” If you like what you’ve heard and want more information, please contact Josh Patrick at 802‑846‑1264 ext 2, or visit us on our website at www.askjoshpatrick.com, or you can send Josh an e-mail at firstname.lastname@example.org.
Thanks for listening. We hope to see you at The Sustainable Business in the near future.