Oil Prices Tumble; South Louisiana Businesses Should Be Prepared

Source: AAA

GAS PRICES BELOW $2.OO PER GALLON!!!!!!! Consumers are celebrating…… but there is a cloud on the horizon. For South Louisiana businesses and residents, the future could be very challenging.

Let’s review a bit of history, flash back to the mid 80’s. Massive layoffs, declining real estate values, businesses folding, and a mass exodus of people leaving the state for employment. And then the BP Disaster that shut down oil production that really didn’t devastate the economy. Some might say, well the state’s economy isn’t as dependent on the oil industry as it was in the 80’s. WRONG, don’t forget that BP paid out Billions in claims, Billions in clean-up activity, and post Katrina spending by Federal, State, and local governments were all supporting the Louisiana economy. Think about that, take away the BP money, take away post Katrina spending, and take away the payments by BP to Louisiana businesses for damages….. Hmmmm, maybe we should count our blessings.

And now, the Oil Industry cycles again. Almost anyone associated with the oil industry knows about the huge swings in production. Prosperity for a few years, poverty for a while, and then back to living large. The Oil industry is notorious for huge sudden shifts in spending; mostly driven by the price of oil.

And I pose a simple question, “Are you prepared?” Those of us that suffered thru the 80’s localized recession in South Louisiana will remember many common sayings amongst business owners, in particular, “Oh Lord, just give me one more chance, I won’t squander it this time”. Well, for the most part, their prayers were answered, but did they prepare for the next downturn. We’re about to find out.

OIL PRICES PREDICTIONS AND RUMORS ABOUT THE NEXT TWO YEARS

As we listen to the commentaries on television and hear the “insider gossip” from the oil field, they all seem to be echoing each other. Oil prices will remain unstable and could fall to $30 a barrel or lower. In due course, the price will stabilize around $75 a barrel, if we’re lucky. All followed by, the most famous of all words “I Hope”.

And what might that mean to Louisiana Businesses and residents? It’s really simple, Tighten Your Belt. Businesses are already beginning to review their financial positions and in some cases, employees are polishing their resumes. There are no studies to support these statements, but trust me, in my conversations with people and business owners, their financial futures are at the top of their priority lists. Anyone who has been around the oil industry knows what could happen in the next 24 months.

Is anyone optimistic? Absolutely, bankruptcy attorneys and CPA’s. In hard times, these professionals are very busy. Businesses file for Chapter 11 reorganization and CPA’s are inundated with work associated with restructuring of debt and providing financial guidance to their clients. Now I do lots of work with bankruptcy attorneys and CPA’s, that statement is not intended in anyway to be negative towards them or their profession. These guys do a great job when helping a company or individual reorganize their financial affairs. The bankruptcy laws are very complicated and require focused experience by professionals. CPA’s advice to clients is often the critical difference between survival and failure. While these professionals may be optimistic about their financial future, they are also concerned about their clients’ future; with good reason.

Now many folks might say, well these businesses should have been better prepared. And in many cases that is a correct statement. But there are forces that impact businesses that are outside of their control; like banks and banking regulations. You might say, what does that have to do with the price of oil and the impact on Louisiana’s economy? How about almost Everything.

BANKS AND LENDING PRACTICES

Remember the 1980’s Savings & Loan crisis? Remember the 2008 nationwide recession? Remember the “Bail Out” of “Banks too large to fail”? Yep, those are important things to remember.

Prior to the S&L crisis, lending institutions placed great importance on the “Character” of their borrowers when making loans. That proved to be disastrous. And the Federal Government responded by tightening regulations requiring lenders to be more diligent in examining financial indicators associated with borrowers financial statements. And after the 2008 banking crisis, the Fed’s tightened the regulations even more. Most people have no idea of how detailed bank underwriting departments are when it comes to reviewing loan applications. I’ve seen some of the spreadsheets. Every ratio is calculated, cash flow is predicted, assets are valued, and on and on and on. And a potential borrower better have his house in order in order to get approved.

You might say, so what, that needed to be done. No doubt. And as we look forward to 2015/16 what will be the challenge of almost every business? CASH. And where will they get it? Most likely it won’t be from increased sales, they’ll be calling their loan officer. And with sales tanking, overhead expenses constant, accounts receivable diminishing, those loan officers and their banks will be saying “NO”; primarily due to the very strict rules of the FDIC and the constant auditing by the regulators that has been going on since 2008.

And I’m confident that the FDIC pays attention to potential industries that are in decline. There will most likely be direction given to auditors and regulators to step up their reviews of banks that are in “Targeted Industries” that may be in decline. And that means, the bank boards will scrutinize loans more carefully and be less likely to approve loans that are marginal and the bank underwriters will most likely redefine a “marginal loan application”; taking into consideration all the “doom and gloom” predictions in the media.

It is already happening, one of my clients had a loan application pending over the holidays. The loan was approved by the underwriters, the loan was approved by the banks credit committee, but the board delayed its loan approval meeting due to the holidays. Then 30 days after all of the internal bank reviews approving the loan, the bank board after reading all the predictions makes the decision that regardless of the strength of the borrowers financial statements, they turn down the loan citing the instability of the oil industry.

And there is more. Generally speaking, banks make loans for short periods of time; even if the loan is amortized over a longer period of time. For the most part, if business conditions remain similar to when the loan was originally approved, the loan is renewed or extended. But things are changing.

Over the next 24 months, bank boards will be reviewing many loans for renewal and will be required to enforce the regulatory requirements of the FDIC. If the bank renews what has now become a “troubled loan” (due to financial indicators in the financial statements), that loan becomes “classified”; which means more scrutiny on that loan by the FDIC. If the bank develops too many classified loans, the bank may be identified by the FDIC as a potential problem and be placed on the FDIC watch list; which means more auditors more frequently or worse, a demand by the FDIC for the bank to raise more capital.

All of this means that borrowing money will be more difficult for businesses at a time that “Cash becomes King”. So what is a business to do? Let’s talk about that.

DOING BUSINESS IN THE NEXT 24 MONTHS

Almost anyone can manage a prosperous business. Even if they manage poorly, or neglect their management duties, if the business is highly profitable, it will get along okay; just not make as much profit as possible.

The next 24 months will most likely test the management skills of every business negatively impacted by lower oil prices. Sales may be scarce, new business will be gained in a very competitive environment (everyone will be looking for work), and some tough decisions may be needed; like layoffs or sale of unproductive assets.

The first order of business should be a thorough assessment of your businesses financial condition, a realistic prediction of future sales, and a thorough analysis of your cash flow over the next two years. And of course, you must look at your pricing structure. With increased competition, other businesses will be trying to steal your customers with lower pricing, will your margins remain stable or do you need to recast your projected budget taking into consideration lower margins on sales? Do you have loans renewing in the next two years? And the Bottom Line, how confident are you that you will have enough cash to pay your bills?

Those are tough questions, but those questions form the tip of the iceberg as it pertains to management decisions your business is facing over the next couple of years; perhaps longer. You need to drill down and start getting some answers.

IS THERE HOPE?

ABSOLUTELY !!!

There is always hope, but the reality boils down to your ability to stay focused, plan ahead, and deal with any potential problems before they reach the “Crisis” stage. In my experiences with financially stressed companies, often those in bankruptcy, I see a common thread. Due to the stress, the owners become paralyzed by the stress and stop making decisions. I had one client who literally did not show up at his company for 5 months. He is a good guy, a good businessman, the stress got to him and he couldn’t deal with it; so he tried to bury his head in the sand. We worked with his company and in his absence, got his reorganization plan approved by the bankruptcy court and he is now back at work with a smile on his face. He’s not as profitable as he once was, bankruptcy does have an impact, but his company does have a future and he saved his home as well.

Not all businesses will be faced with the prospect of bankruptcy; in fact, most will not ever consider that option. That said, I am predicting a surge in bankruptcy filings simply because it is often the only way to put creditors on hold and give a company enough time to reorganize and put together a plan to pay its creditors. Otherwise, without the protection of bankruptcy laws, the banks are forced by the FDIC to foreclose on delinquent loans, and those businesses would be liquidated.

Hope is a motivator; opportunity is the driving force of every entrepreneur. The coming months will certainly test the resolve of many business owners but those who focus and remain diligent will survive. As is often said “This too shall pass”.

WHAT SHOULD YOU DO?

I’ll keep this simple:

Assess your risk over the coming months
Review your financial condition
Focus on sales & marketing
Reduce costs
Stabilize your banking relationships
Look for opportunities to acquire or merge with other businesses

Of course there’s more, but these suggestions are a start. My main advice is to stop talking about what might happen, identify what is within your control, and take action. For those of us in South Louisiana, we know how to prepare for hurricanes and weather the storm. The same principles apply, pay attention, prepare, and take shelter from the storm.