Business forecasting done with meaningful data? One might call that good business practice. Forecasting done with data from the last 36 months? One might call that junk science. Seems it is hard for a business owner to make a predictive model anymore.
Are we at the beginning of a Japanese decade of malaise? Are we halfway through cleaning out the economic wreckage? Or has the deleveraging finally taken the slack from the line and we are all approaching a new day?
If you are in the stock market, particularly some areas of foreign stocks, you are probably feeling good. Many smart companies have shed debt, hoarded cash, and streamlined operations which have positioned them well for profit harvesting. Just don’t confuse this with a healthy economy.
If you are a small business owner, even in a hot area of innovation, it may be wise to conduct your business forecasting with these 4 points. Maybe its predictive power will be more than junk science…
1. At 2007 levels, the book value of commercial real estate was more than $6 trillion with around $3.6 trillion of debt. $1.4 trillion comes due between now and mid-2014. The delinquency rate on commercial mortgage backed securities topped 9% for the first time in history. The number of loans in the “bad bucket” is now approaching 1 in 5. At 2010 levels, the value of that same commercial real estate is less than $3.5 trillion with the same amount of debt. The lesson? Give your pro forma a few years of room to breathe! Investors and shareholders don’t like missed numbers anymore than we do as individuals.
2. The same banks that loaned money on these deals are the same banks that give small businesses their revolvers for cash flow fluctuations. They are also the same banks that are dedicating massive resources to modify the failing loans in a way that will hide them from regulators and push the problems from their desks to the desks of successors 2 or 3 years hence. Don’t expect them to renew your loan each year. More and more banks are using this annual renewal as the catalytic mechanism to invite you and your other big term loan out of their bank. And they will do it using completely legal means embedded in that note you did not read. In fact, in the loans we restructure or look to buy, nearly every one of them is in some form of technical default. Even most healthy loans are in some form of non-monetary technical default. The only difference is the bank has no reason to push them out of the bank so they never care to notice. The lesson? Plan your budget on retiring company debt or building your own war chest of cash so you won’t need a revolver to survive. Otherwise, you are giving your bank an excuse to invite you down the street on your big term loans too.
3. Earlier this year (January) The Economist magazine reported a fantastic study of 32 periods of sustained deleveraging. Sometimes we just inflated the problem away. Sometimes we just defaulted our way back to normalcy–which of course the American consumer has been doing a fine job of statistically. But in more than half the cases, it took 6 or 7 years beyond the end of the financial crisis for business deleveraging to correct. When credit grows more slowly than output, the only thing that can budge is the waistline of the consumer and of the businesses that rely on them to eat. The lesson? Nothing wrong with being bearish when you are trying to read the tea leaves. This data suggests that on the corporate or business side, we still have several more years of slack in the line.
4. Certain types of loans are still off the radar screen of Fed officials, regulators, and economists. The only reason we see them is because we are actually working on them before they hit a trigger for regulatory disclosure or some other mechanism of transparency. The commercial land developer who escrowed a year’s worth of payments at his bank in order to get the 5 million dollar loan? Those accounts are almost drained, and yet the bank is still able to claim they are good loans even though the properties are non income producing and have no chance to survive in a market where nothing is selling. Or what about the business owners who have taken additional loans out on their homes, or borrowed against their stock portfolio, or received cash from relatives and friends to prop their businesses up? No one actually sees that they are in trouble until the crash is well underway. The lesson? You may have business customers who buy from you who are nearer to the end than you think. You may have a landlord or a vendor that has a problem that could quickly become your problem. Build your business projections assuming stability, assuming expense shaving, assuming a protective stance. This is not about hiding in a bunker, it is about making sure you can look past the hood ornament and see the horizon.
These are not reasons to fear the future or to hide in a cellar. The next few years present challenges to those who expect too much, protect too little, and plan too late. The rest of us should do just fine!