Credit Crunch in California

The market for business loans is placing renewed emphasis on cash flow and business loan interest rate spreads are returning to historical levels.

This was just one of the juicy tidbits on business lending I heard at the November 8th event at the Milken Institute which focused on the credit crunch in California resulting primarily from the implosion of the residential subprime markets.

It was an impressive panel including California Secretary of State, Debra Bowen, and representatives of Wells Fargo Bank, The Milken Institute, Ares Capital Management and the private equity firm of Riordan, Lewis & Haden.

Here's what else I heard...

• Underwriting of loans in the last few years has not been prudent to be sustainable in the long term. Too many marginal companies have been able to borrow at rates that did not compensate lenders for the risk entailed. Why? In my opinion, too much money and stupid bankers.
  
• In the future, business borrowers will need to do a better job of showing their ability to repay a loan obligation from cash flow generated by the business. Notwithstanding the reduction in prime rate, small businesses might pay more to borrow money.
• According to one panelist, the recent credit crunch experienced by large business borrowers has not been driven by performance issues such as non-payment or covenant defaults. In my opinion, this was one of the more curious comments of the night. The reason there haven't been many covenant defaults is that "covenant light" and "PIK" deals have made defaults very unlikely.
  
• Other shoes that could drop and exacerbate a corporate credit crunch in California include an implosion in commercial real estate loans, a possible 10% across the board budget reduction for the state of California (worry about the multiplier effect), more writedowns in the residential subprime market by major lenders and a softening of the job market.
  
• Government intervention in a credit crunch must be done very carefully, if at all. Too often when the government has intervened in the past, it has merely delayed the day of reckoning. Market forces will (and should be allowed to) work and determine who survives. Yes, some businesses will get hurt in the process. But that's capitalism.

While the panel all seemed bullish on California for the long run, it was predicted that the next 18 months could be quite challenging for business borrowers. Small business could find itself squeezed for capital to grow and survive.

If I heard her correctly, Madame Secretary Bowen stated that small businesses in California provide 88 percent of the state's jobs. If you're a small business in California, be prepared for a tightening of credit.

An impending credit crunch have you worried? Need help finding the right lender or telling your story the right way? Read "Matchmaking for Business Loans" and give me a call!

Tags : California , small business , credit crunch , Milken Institute , cash flow , business loans