Posted by Ed O'Leary in Talking Credit
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The news in recent weeks on the problems that Borders Books is having in paying (and negotiating with) its book publishers is an unpleasant reminder that some significant segments of our economy are getting worse rather than better.
That some degree of the problem is "structural," as opposed to "frictional," is undisputed. But what we don't really know is how severe the technological changes stalking some of our everyday patterns of activity (such as reading) will be. Let's remember too that Borders is a business that employs almost 20,000 people and has large retail outlets in shopping malls in virtually every one of our major metropolitan markets. Borders is a very visible victim of some fundamental technological shifts going on all around us.
Reflections on the news
My first reaction on reading the stories in The Wall Street Journal was, "How many people will instinctively blame the banks?" In other words, would they think banks were refusing to lend to a large, creditworthy company? Were our terms and conditions so onerous that we priced Borders out of our market for credit?
My second reaction was to once more be reminded that in balance sheet terms, liquidity surfaces as a problem ahead of solvency.
It's not that solvency isn't an issue in these situations but it's seldom first. The leading edge of the problem hits lenders first with the concern that the customer may be unable to meet its short-term obligations. In the Borders situation, it looks like the problems have been simmering for a few months-out of the public consciousness, but not necessarily out of public view. Publicly traded companies are reasonably transparent. (I suppose one could cite Enron and others of that troubling time nearly ten years ago when public disclosures weren't any guaranty of authenticity or usefulness of available information. )
Lender's-eye look at Borders' conundrum
Borders is hardly unique in wrestling with profound technological change. The drama currently unfolding around the book business has been its the method of delivery of and access to content. This is a problem shared by media channels such as newspapers as the consuming public of the written word has had what in historical terms must be viewed as a "sea change" in what it reads and how it accesses it. (Personally, I find it a bit unnerving to realize that a book per se is not a very technologically sophisticated item and in terms of appearance and function, it's little changed since the days of Gutenberg. )
As lenders we extend credit on a variety of maturities ranging from very short (and even demand) to very long maturities. One important point is that no matter what the contractual maturity is of a promissory note, it's seldom the equivalent of the useful or economic life of the asset or series of assets it finances.
To think that our average maturity or "average life" of our loan portfolio is, say, two years, we should recall at the same time that the purpose of the original borrowing often has a useful life of many more years. What we seem to ignore is these assets or uses of funds by our customers usually need to remain in service for considerably longer than the maturity of the note to repay us in full. ALCO discipline is one thing but economic life of an asset is quite another.
Last year my wife and I visited my sister and her husband in Forsyth, Ga. They showed us some of the beautiful, old residential areas built up in the late nineteenth century. Many houses and the old town center are well preserved. But the economic base, originally cotton farming, has long since gone away.
There's a lesson in that for all lenders. What we are engaged in financing (the infrastructure) will often outlast the technology and practices that spawned it in the first place.
How do we spot those "inflection points" in technological obsolescence?
How do we train our current and future lenders to be vigilant and watchful for these things?
How do we stay short enough with our repayment sources to be retire the debt within the economic cycle of assets?
Putting everything together that you read, hear, and see
Two of the major components of any lender's DNA should be vigilance and common sense. Vigilance today means spotting the trends that can render whole industries obsolete quickly-months or a very few years. Common sense is putting together the various seemingly disparate observations and converting such data into useful and actionable information.
Maybe there's no reasonable way that lenders should have anticipated the problems that now beset Borders and, to a degree, Barnes and Noble, B. Dalton, and others.
Yet haven't all of these observations been in the public domain?
The New York Times, for example, will later this year convert the digital version of the newspaper into an informational source that will no longer be completely free. What about the printing presses? What about the human component of the company's fixed costs? Journalism, a facet of the printed word, has been undergoing a very visible transition for quite a while. What are the special risks in such changes for creditors?
Maybe another way to understand vigilance is to think of it as intellectual curiosity. How do things work? Is there change on the horizon that can create significant dysfunction for a particular industry or for certain industry participants?
The Borders story is in its early phases of resolution. How painful this may be for creditors will be interesting to watch. But it's one more lesson that change is not just an abstraction. This relates back to the very basic credit proposition that liquidity problems precede most all credit crises. The problems may first surface with eroding profit margins, but the fundamental consequences of the ability of the borrower to continue to manage its debt and fund itself is fundamental to any long-term survival strategy.
A question to ponder
How proactive are we in helping our customers manage their liquidity?
After all, that's in both our best interests and their own.
But what more can we do? How do we stimulate those creative juices within our lending staffs to think in more discriminating terms?
There's not much we can do to alter fundamental technological forces that will powerfully impact our economy. But we can be watchful, anticipatory, and deliberately defensive as we approach liquidity management both for our banks and for our customers.
About Ed O'Leary:
Veteran lender and workout expert O'Leary spent more than 40 years in bank commercial credit and related functions, working with both major banks as well as community banking institutions. He earned his workout spurs in the dark days of the 1980s and early 1990s in both oil patch and commercial real estate lending.
O'Leary began his banking career at The Bank of New York in 1964, and worked at banks in Florida, Texas, Oklahoma, and New Mexico. He served as a faculty member and thesis advisor at ABA's Stonier Graduate School of Banking for more than two decades, and served as long as a faculty member for ABA's undergraduate and graduate commercial lending schools.
Today he works as a consultant and expert witness, and serves as instructor for ABA e-learning courses and a frequent speaker in ABA's Bank Director Telephone Briefing series. You can hear free audio interviews with Ed about workouts here. You can e-mail him at email@example.com. O'Leary's website can be found at www.etoleary.com.