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Negotiate a line of credit before terms get tougher

Article

With business loans becoming harder to obtain, many DVMs are turning to community banks.

Among the most basic types of credit used by veterinary practices and other small businesses is the line of credit, or revolving loan — simply a loan agreement with the paper work and approval process already completed. Many veterinarians rely on such financing to help bridge inevitable slow periods or cash shortfalls.

A recent study by the Government Accountability Office (GAO), Congress' watchdog, showed that banks currently have made more than $1 trillion in credit available nationwide to businesses through lines of credit.

But the cost of such credit soon may rise, as the effects of an international banking accord kick in.

Just how important is revolving credit to your veterinary practice? Why would an international banking accord have an effect on the availability and cost of such an arrangement with a local bank?

Here is some basic information to help answer both questions:

A line of credit

A line of credit is an agreement between a commercial bank and a veterinary practice, stating the amount of unsecured, short-term credit the bank will make available to the borrower should it be needed. It is not a guaranteed loan. It typically is a one-year contract under which the bank — if sufficient funds are available — agrees to lend the veterinarian, or his or her practice, up to a stated maximum amount of money.

A line of credit helps speed the borrowing process for all concerned because the bank does not have to examine the creditworthiness of the veterinary practice each time it borrows.

For guaranteeing availability, the bank usually charges a commitment fee based on the unused balance. Interest is charged for the time the money is in use.

Line-of-credit loans

A line-of-credit loan probably is the one permanent loan arrangement every veterinary practice should have with its bank, because it protects borrowers from emergencies and stalled cash flow. Such loans usually flow into a practice's checking account to cover checks written to purchase supplies, cover operating costs, for working capital and other business-cycle needs.

They are not intended for purchases of equipment or real estate.

Line-of-credit loans often carry the lowest interest rate a bank offers because they are viewed as fairly low-risk. Some banks include a clause that gives them the right to cancel the loan if they think a borrower is in jeopardy.

Interest payments are made monthly and the principal is paid off at the practice's convenience.

Many experts say it is prudent to make frequent payments on the principal, as an indication that the veterinarian or his or her practice is earning a reasonable income.

Many line-of-credit loans are renewed automatically for an annual fee. Some banks require that credit lines be paid off for at least seven, or up to 30, days during each contract year.

International impact on borrowing

Anyone considering setting up a credit line should act soon, because a recent international banking accord may affect the fees charged for these loans and other transactions.

For years, regulations allowed banks — even encouraged them — to offer short-term credit products such as so-called "364-day lines."

Because banks did not have to maintain capital reserves against such loans, they usually were offered at attractive rates. Some banks even used them as loss leaders to attract new customers. But the adoption of a new international banking accord, called Basel II, and its requirement that banks must start setting aside capital against short-term loans in 2007, the glory days of this short-term financing may be limited.

Some banks already are implementing the required changes. Experts warn that every veterinarian should think about the consequences now, because banks may seek to pass on costs through "increased expenses" clauses that most loan agreements contain.

There is increasing evidence that in some cases — particularly if you happen to be a small or mid-size business or your credit rating is either non-existent or has seen better days — the bottom-line for Basel II could be tighter credit and higher rates.

In the United States, banking regulators decided to adopt Basel II's advanced approach and apply it on a mandatory basis only to the country's largest, internationally active banks.

Other financial institutions likely will decide to opt in to Basel II because they fear being at a competitive disadvantage. However, it is estimated that only the 20 largest U.S. banks will switch to the new system, leaving many banks free to use current capital requirements.

Apart from the impact on the cost to borrowers, Basel II will alter the way the cost of capital is calculated for virtually every kind of risk encountered by a bank, including fraud and consumer risks such as mortgages, credit cards and personal lending.

The accord will affect some banks' ability to lend.

Every veterinarian should be aware of this and negotiate with Basel II in mind. Or, perhaps, find a bank that has chosen not to comply with Basel II, or at least not yet.

Going local

With business borrowing becoming more difficult and expensive, many veterinarians are turning to community banks.

That is not to say that financing is always easier there. A veterinarian still must meet the same credit and collateral requirements, but community banks can be more flexible and are more apt to make so-called "character" loans, where the banker already knows the veterinarian and his or her practice.

In fact, in light of Basel II and the meltdown among home-mortgage lenders, every veterinarian is well advised to shop for financing and to negotiate.

Even if a line of credit is not needed immediately, it might be wise to talk to a banker now about how to obtain one. Usually, to negotiate a credit line, a banker will ask for current financial statements, the practice's latest tax returns and a projected cash-flow statement.

As Basel II fully kicks in, all types of credit may soon become more difficult to find and afford.

Through negotiation, however, most veterinarians should be able to find a line of credit, for which the peace of mind and flexibility are well worth the cost.

Mark E. Battersby is a financial consultant in Ardmore, Pa.

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