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Businesses mull refinancing loans in changing climate

Rochester Business Journal
March 7, 2014

See correction and amplification below.

As interest rates begin to climb out of a prolonged period of economic stimulus, it is a good time to refinance commercial loans, experts say.

David Halladay, chief lending officer at Genesee Regional Bank, says many businesses have recovered from the economic downturn and there are fewer commercial loan delinquencies these days. He sees service providers and manufacturing businesses improving. While sectors such as homebuilding still lag, there is steady commercial loan activity.

“Two years ago (the Fed) said they’d keep floating-rate interest rates low through 2015,” says James Barger, president of the Rochester district for Key Bank N.A. “Now we’re getting close to 2015, so what we’re seeing are companies with floating-rate loans starting to look more closely at refinancing them as a fixed-rate loan. You can’t wait forever.”

Commercial loans’ floating rates typically are lower than fixed rates at closing but are subject to increase over time. It is hard to go wrong in refinancing a home mortgage when savings are available with a lower interest rate, but interest rates are not the only consideration with a commercial loan or mortgage. Commercial borrowers should make sure a new loan will really save them money, experts say. Commercial loans have a lot more terms and variations than home loans do.

Typically, residential mortgages do not have prepayment penalties associated with refinancing, but most fixed-rate commercial loans and mortgages do. Prepayment penalties are greater near the beginning of a loan than at the end.

Borrowers should also consider closing costs to determine if refinancing is worth it. Standard closing costs may include recording fees, attorney fees and title insurance, but others vary by lender.

Maturity is another factor for businesses to consider in refinancing. Commercial loans and mortgages typically are for much shorter terms than a traditional 30-year residential mortgage. Stretching out payments over a longer period of time helps cash flow and is something banks help their business customers with.

“Most commercial mortgages only have a 10-year term,” says Robert Jackson, senior business lender at Reliant Community Federal Credit Union. 

Refinancing commercial loans is a core competency for Reliant, which offers business members a 15-year commercial mortgage loan.

“Most commercial mortgages are going to be refinanced down the road at some point if they have a balloon payment due,” Jackson says. “Most borrowers are surprised to see how much they owe after 10 years on a 15-year repayment schedule.” 

Balloon payments are common in commercial lending, but Jackson says Reliant tries to avoid having its business members end up with one.

“We often give options to the borrower and let them decide what rate structure works best for their needs,” he says.  

How long a lender will lock in a commercial loan interest rate is an important consideration in selecting a financial institution.

“It might make sense for the borrower to pay more and have the peace of mind to know that his rate is fixed for a longer period of time,” Jackson says.

If a business is not doing well, it is going to be tougher to refinance, since the amount the business can borrow is based on revenue and profit margin. Lenders know their clients’ bottom line. They know their assets, cash flow, business plan and budget. They want to know how business is going on a regular basis.

The relationship between lender and borrower is closer and longer-lasting in commercial lending than it is in home refinancing, for which it is unlikely the borrower will have contact with a lending officer after closing. Commercial loans are aligned to fit the unique capital needs of a business.

“We’re really interested in finding out what’s going on in the business and in making sure we get repaid. We want to make sure they are generating enough revenue to service the debt,” Halladay says. “We’re more ingrained with connecting with the borrowers on a regular basis.” 

Although commercial banking is very much banker-borrower focused, ultimately, underwriting a commercial loan depends a lot on accounting. It is an area of expertise a commercial banker needs to have, since underwriting a loan is largely a matter of financial analysis.

“A certain component of (refinancing) is interest-rate-driven, but it really comes down to what’s going on in an individual business and where they are in the business cycle,” Halladay says.

Having lender accountants and representatives keep an eye on business profit and revenue can also be an asset for businesses trying to figure out how much they need to borrow to sustain growth and profitability with a new loan.

“One of the principal things we do with our clients is to help them determine their optimal capital structure,” Barger notes.

For example, if a company wanted to expand capacity at a manufacturing plant, it might want to buy equipment as well. The bank works with customers to identify what’s needed, what the goals of the business are and how to finance the expansion.

If a company is in growth mode, then it’s probably less about the interest rate and more about sustaining growth—more customers, increased sales, new products, vehicles or equipment. If a business is growing, it is likely to need more working capital to finance that growth. Anything that is critical to operating the business can be financed.

Financing a company’s capital needs with a floating-rate line of credit is common and can also be refinanced with lower closing and transaction costs than are associated with commercial mortgages. Halladay notes that a line of credit is typically used as a safety net for buying inventory or paying vendors, but it does not come with fixed-rate safety and predictability.

There will always be a market to refinance business debt, Jackson says, as business needs change and grow.

Todd Etshman is a Rochester-area freelance writer.

3/7/14 (c) 2014 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email
Correction: An article in the March 7 Special Report on Commercial Lending contained an error. Canandaigua National Bank & Trust Co.’s outstanding commercial loans grew 5.6 percent to nearly $770 million in 2013.

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