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Assessing the Impact of the Financial Crisis

TD: Welcome to Plante & Moran’s Perspectives, a presentation dedicated to examining the issues that affect our clients most. Our comments today are titled “What is the Impact of the Current Financial Crisis on your Business.” We will offer you some practical thoughts on how to react to these challenging times. Thank you for tuning in. We welcome your feedback and questions. Please visit us at www.plantemoran.com for our latest commentary and insights on today’s financial crisis.

So, let’s get started. Craig, why are we here today?

CF: We are here to discuss the challenges that are now and will continue to be facing so many of the manufacturers located in the heartland of our country and to explore what you can do practically to manage these challenges. Manufacturers, in general, and the Detroit 3 have been in an aggressive restructuring phase for the last four or five years with many enterprises making substantial progress in a number of important areas.

Despite this substantial progress, the rapidly slowing economy, increases in oil prices, declining consumer confidence, and a very tight consumer market have contributed to lethargic business activity, including dramatically lower vehicle sales by all OEMs. This slowdown has directly led to a greatly accelerated cash burn rate by the Detroit 3 and many manufacturers. At the same time, frozen credit markets have restricted the Detroit 3’s access to normally available capital from traditional debt and equity markets and have thwarted planned sales of various business assets.

What does this mean for suppliers and other manufacturers? Accelerated business consolidation, both within and for other manufacturers over the next three years. This consolidation will result in bigger, financially stronger, and operationally excellent manufacturers and suppliers. They will have better costs and improved pricing power. This consolidation will result in dramatically improved capacity utilization rates and much improved average operating margins approaching a sustainable level of 7-10 percent of sales. The next few years, while difficult for suppliers and manufacturers throughout the Midwest, will provide the cleansing necessary to build a solid foundation for future growth, profits, and prosperity for all.

TD: So, in light of that, Tim, how have you seen the banks responding to these current economic conditions?

TW: Well, banks are feeling squeezed by the losses they’re sustaining in their portfolio and the increased cost of their borrowing and they’ve been reacting accordingly. They’ve been taking a direct impact on their commercial customers by, when available, increasing the pricing on loans.

We’re also seeing a shift from pricing based on prime rate to libel rate. This has a direct impact on prices and it typically has resulted in increased pricing to their customers. When a customer violates, or what we call trips a covenant, a bank usually has the right to make changes to their agreements that also end up increasing costs to the customer. We’ve seen banks become more aggressive in enforcing covenants more strictly and consequently increasing prices when they can.

Banks are also looking to reduce lending on receivables and inventory when their customer’s customer looks distressed or is tied to rumors of bankruptcy. In the past, such behaviors may have resulted in a customer deciding to shop for a new bank. Today, however, it is significantly less likely they’re going to be able to find a new bank due to more credit constriction at the bank level, and there’s no guarantee that a new bank will come on to provide better terms, let alone be willing to take on a new lending relationship today. Consequently, the best thing to do is to have a good working relationship with your banker. You need to be able to share your plans, both your current plans and what your contingency plans may be, try to avoid surprises, and deal with the increased pricing in the credit markets accordingly. That’s usually the best outcome for most companies.

DP: To add to Tim’s comments, it’s not that the banks aren’t making any new commercial loans at all, many of them are, but now it’s only to the best credits. In recent weeks, in talking to some banks, they’ve told us that some of them are avoiding new automotive loans where the collateral is Detroit 3 receivables. Some of them have said that they’re avoiding new automotive loans entirely. It really depends on what they have in their portfolio. Some of them are avoiding new loans with a high portion in real estate, and also avoiding new syndicated loans where the loan is big enough that they have to bring in another bank. Some finance companies, that’s the subprime folks that are not banks, some of them are still lending. Just like the banks, though, there’s much less availability today, tighter terms and higher costs than previously was the case.

Now, the ironic twist to the credit crunch: because refinancing and liquidations are more limited for troubled loans, it’s harder for banks to force their troubled credits out. So what we’re finding is that if a borrower is communicating well and is managing to keep the bank’s position from deteriorating, there’s a good chance that the bank will ride out the situation, at least for a while. Finally, if a borrower is concerned about personal guarantees, they should make sure they understand their bank’s position in case of a sale or liquidation. Some banks are being lenient with owners who, in good faith, sell or liquidate their businesses and get the best possible recovery for the bank.

TD: Tim, we’re seeing an increasing number of companies across a broad range of industry sectors dealing with customers facing bankruptcy in light of this current situation. What is your advice to companies that are in this position?

TW: Well, Tom, there are a number of things that people can do. The first thing that I would do is check on your receivables. Take a look at your listing, verify that all the payments that are being made are being done so timely and according to the terms you have agreed to. If you find any slippage, you need to immediately make inquiries and get customers’ commitments for payments.

The other thing you need to do is evaluate the kinds of capital you’re tying up for a customer who appears to be distressed, whether that’s inventory, capital expenditures, or other costs. You need to determine whether it’s feasible to begin limiting these investments if possible. If you have any other outstanding commercial issues with a distressed customer who may owe you money, you need to try to expedite any negotiations and receive a payment of cash hopefully before any possible bankruptcy filing.

Have an attorney experienced with bankruptcy examine your customer agreements or contracts to determine what kind of rights you have within those agreements or in lieu of bankruptcy of a customer. If a significant risk of bankruptcy exists, re-examining how much credit you extend to that customer is likely going to be the most critical and the most difficult action you are going to have to implement. Your attorney can assist with this. He or she will likely advise you on your rights to demand assurance of future performance from your customer.

If you provide goods to your customer, then reducing your payment terms to net 20 days or less will increase the likelihood of receiving full payment for your shipments in event of their bankruptcy. If you’re a provider of services, or you just want to eliminate or minimize your credit risk, then going to cash in advance or cash on delivery is your best option. This distressed customer is a small enough portion of your business, so you may decide to be very aggressive with your negotiations to the point of trying to force the customer to pay you off and move their business elsewhere. If the customer ends up filing bankruptcy, then immediately move into cash in advance as a typical option to take. Also look to seek classification at what is called a “critical vendor status.” These are vendors that typically keep getting paid as if the Chapter 11 didn’t occur. Finally, call that attorney to find out if there are any other actions you might need to take immediately.

TD: So, Craig, what are some key indicators that we would recommend a company look at to evaluate their options in light of this situation?

CF: There are various attributes that are well used for identifying viable future business options. These include financial considerations focusing on financial liquidity and leverage, relationships with the bank including covenance status, business model strength and sustainability, which really speaks to profitability, and the number of competitors the supplier or manufacturer has, market attractiveness, are they in commodity markets or niche markets, and miscellaneous considerations, such as customer concentration, the manufacturing footprint, and ease of work transfer to a new supplier.

TW: Let me add another couple things on that, Craig, as it relates to cash and liquidity. Companies need to assess how much cash they have today, and what credit they will be able to tap into in the future. From a cash perspective, it’s really how much money do I have in the business today, and if you’re forecasting a burn or cash burn ratio from operations in the near term. From a credit perspective, you need to understand where you’re at with the bank: how strong is your relationship, is the bank hinting that the loans are mispriced in today’s marketplace, and when does your loan agreement expire.
Is the bank asking what plans you have for finding additional financing elsewhere, or asking you to put in more capital? Have you or will you be violating any loan covenants? Do you need to finance any new capital expenditures, and is the bank willing to provide lending for this? If the answers to these questions are mostly in the negative, you need to figure out what to do to find new capital or a new lender. The answers to the cash and credit questions will significantly impact your ability to survive in the short term until the economy recovers.

CF: I’d like to add that we’ve developed a simple financial health diagnostic template that uses commonly available information to profile key data that can help an enterprise identify and evaluate feasible strategic options for their business. This template, which we posted on plantemoran.com, includes items such as revenue trends, margin trends, income trends, depreciation and interest costs, and some common balance sheet data.

TD: Once you and your advisors have performed the assessment and determined the right course of action,
we encourage you to execute quickly while you are still in control.

This concludes our program. I would like to thank Craig, Tim, and David for their insights and advice, and I hope that each listener can take away at least one idea to apply to their company. This has been Plante & Moran Perspectives, an audio series dedicated to examining the issues that affect our clients most. If you have questions, I would encourage you to contact your Plante & Moran partner who can get the right people involved to assist you. Thanks for listening and join us again as we continue to find new ways to help you thrive.

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