September/October 2008
High commodity prices and billion-dollar mergers have heightened banks' interest in the scrap industry. To create strong and lasting banking relationships, however, scrap companies must rely on their long-term strengths, not the short-term buzz.
By Ann C. Logue
Scrap companies need banks. Companies in all segments of the industry need funds to cover short-term gaps in cash flow. Processing facilities need funds for new equipment or expansion. Brokers need funds to pay for stock they purchase before the consumer pays. Scrap consumers need funds to purchase inventory when commodities prices spike. Some scrap companies need access to credit for the first time, others want to expand their borrowing, and others seem to be purchasing scrap companies as much as scrap, such as the recent billion-dollar-plus purchases of OmniSource Corp. by Steel Dynamics and the David J. Joseph Co. by Nucor Corp.
Unfortunately, banks have become cautious about lending in today's economy. Many banks are in disarray because of bad real estate loans. Even if they survived the subprime crisis, it has resulted in a "credit crunch" that's affecting businesses both big and small. "There is a tightening in the credit market right now," says Robert Marino, senior vice president of Center Capital Corp./Webster Bank in Farmington, Conn. Banks have less money to lend, so they're being choosier about to whom they lend and under what terms. In a June 27 Forbes article, entrepreneurs report that banks are revoking or cutting their lines of credit, charging more for loans, asking for more collateral, and scrutinizing their financials, even if they've been with the bank for years. One CEO said he's resorted to using credit cards for some large purchases.
One concern for banks, Marino says, is the arcane but important spread between the prime rate—the rate that banks charge their best customers—and the London interbank offered rate, or LIBOR, which is the rate at which banks borrow from each other. In the long run these rates tend to move in parallel, but in recent months the two have become decoupled because of many banks' financial problems, making it harder for banks to set their lending rates.
Banks need to lend money to make money, though, and the scrap industry is one bright spot in today's gloomy economy. When bankers' knowledge of recycling is limited to what they separate and put out at the curb, scrap companies have to work to make them comfortable with the dynamics of the industry. That effort can result in a mutually beneficial relationship that leads to a larger and more profitable scrap business.
What Banks Offer
It's not enough to find a bank that wants to work with you; it needs to have the services your company needs. Most commercial banks offer fee-based services beyond basic checking and savings accounts that can help a scrap company better manage its finances. These might include online funds transfer, electronic bill payment, payroll processing, credit card processing, and lockbox services for accounts receivable.
Commercial banks also offer loans and lines of credit to help companies manage their cash flow. As a scrap broker, "for many of my customers, I am the bank," explains Michael Kirk, manager of Golden Metals Trading in Denver. He usually accepts 30-day terms from metal consumers but pays 15-day terms to scrap suppliers. To manage his own cash flow, he relies on a line of credit.
Kripke Enterprises (Toledo, Ohio) uses a similar arrangement. "Our consumers pay in 30-, 45-, or 60-day terms, and many of our dealers prefer to be paid net 5, 10, or 15, and the line of credit allows us to do so," says Matt Kripke, vice president. "If you want to continue to grow your business, then you pay your bills to the terms you tell people you'll use," he says, and "the only way to do that is with a line of credit."
Companies that need global banking services or that plan to merge, expand, acquire other companies, or go public might turn to an investment bank. (Since 1999, the same company can offer both commercial banking and investment banking services, though not all banks do both.) City Carton Recycling (Iowa City, Iowa) uses a local commercial bank, Hills Bank and Trust Co. (Hills, Iowa), for most of its needs, but it financed two facility expansions in the last five years with industrial revenue bonds issued through GE Capital Public Finance (Minneapolis). The rates available through the bonds were simply too good for the local bank to match, says Tom Rowland, the company's chief financial officer.
"I don't think people really understand what investment banks do," says Rudy Scarito, managing director of one such bank, Canaccord Adams (Boston). "We can help you raise money to keep your business funded or help you buy other companies" or entertain buyout offers. Investment banks often work on spec, providing information and analysis free before the deal takes place. Most bankers understand that entrepreneurs will take their time to make a decision, so they're willing to show off their stuff with no obligation. And almost all investment bankers will sign nondisclosure agreements, Scarito says, in which they promise to keep information out of the hands of competitors even if you don't end up hiring them. "We want our corporate clients to know that we keep their information secret," she says. In return for their assistance, the banks typically earn a fee that's a percentage of the transaction price.
Not all scrap companies will need the services of investment banks, but "if you have any interest at all in selling your company, now is a good time," Scarito says. At a minimum, she says, companies should start talking to bankers early on to see just how different people and firms behave, allowing them to make better decisions when they are ready. And Scarito suggests that family-owned companies work with a tax and estate attorney to prepare their internal structure for external investors. (For more on preparing a company for sale, see "To Sell or Not to Sell")
Selling Banks on Scrap
The low profile of the scrap industry can work against companies when they approach banks for financing or other help. If anything, bankers are hearing about high scrap commodity prices and the many mergers and acquisitions the industry has seen in the past few years. Acquisition activity is one sign of how good the market is, and it's drawing the attention of a lot of financiers, says Eric Klenz, director of industrial corporate investing banking with KeyBanc Capital Markets (Cleveland). And high commodity prices might have inexperienced bankers confusing business value with inventory value, even though the latter can fluctuate dramatically. Further, Golden Metals' Kirk says, many bankers tend to lump all commodity businesses together. They assume that the dynamics of trading aluminum cans are the same as the dynamics of trading pork bellies, and they're not. "But when they understand the commodity and the industry," he says, "they get excited."
In other words, bankers may be attracted by inventory valuations and merger opportunities, but they'll stay for the consistent profits. "Most of the people in the recycling business are really fat and happy right now," says Center Capital's Marino, benefiting from higher margins and higher demand (especially export demand) for most commodities. "What makes them attractive to lenders," however, "is their character and their credit."
The scrap business is very much about value-added service. At heart, profits come from collecting materials from suppliers who have no use for them and preparing them for consumers who do. Some scrap commodities have a high intrinsic value, but others, like paper or rubber, are valuable to only a few end users. "You normally don't hear about anyone stealing a bale of cardboard," says City Carton's Rowland. "Lending decisions with paper recycling companies are based more on performance." It's not as glamorous as, say, real estate development, but the cash flow is more predictable, he says, making the company a good credit risk—and banks are beginning to realize it. Rowland says City Carton has been inundated with phone calls from different financial institutions looking to lend the company money.
So how can a company demonstrate that it's credit-worthy? Lewis J. Hart III of Brown Brothers Harriman & Co., a private New York-based bank, says he isn't interested in clients with too much commodity exposure. "I'd want to know what percentage of profit is coming from higher commodity prices versus increased volume in the yard," he says. Excessive profit from price appreciation indicates speculation, he says, which can hurt a scrapyard if prices change. On the other hand, good profits from the basic operations indicate that the business is run efficiently, with a good stream of sellers and steady demand from consumers. Hart also looks for a mix of customers, he says, because that protects the business if any one customer stops buying.
Marino looks for prospective clients with a minimum 650 credit score, all outstanding bills paid as agreed, and a business plan that shows how the firm will move to the next level. "You don't have to go out and hire a big-four accounting firm," he says, as several online templates and basic books can help entrepreneurs create a simple but thorough plan. Likewise, he finds audited financial statements helpful but not necessary; a financial compilation in conjunction with income tax returns often are enough for him to make decisions.
Banks lend money to see companies grow, and they want assurance that the business will do just that. No matter what the commodity, Rowland says, prices fluctuate over time, so companies have to understand their five-year trends and then make them clear to their financial institutions. "Markets can change dramatically on a year-to-year basis, but they are very stable on a rolling five-year basis," he says.
Finding Financial Harmony
Banks can be big or small, they can be based locally, regionally, or all over the world—what really matters is whether they're interested in metals and recycling. Some, like Brown Brothers Harriman, tout their lengthy expertise in commodities trading financing. "We believe we're more willing to lend a higher percentage of the asset value," Hart says. "We appreciate how liquid and deep the market for scrap is." But newer entrants into the industry can offer excellent service as well.
Though bank officers talk a lot about the products they have for sale, banking is a service business. No matter what a scrap business needs, the company executives should get to know their bankers and be able to discuss business matters with them. Kripke says he makes a point of calling his bankers monthly with an update so that there are no surprises—good or bad—on either price trends or operations. Not all scrap companies are set up to actively manage their financial relationships. Hart suggests they start by hiring an experienced financial officer who has worked with outside institutions.
At the same time, some banks manage relationships better than others. And a good relationship can turn sour (or vice versa) when the bank's ownership changes. Between 2000 and 2007, 2,423 commercial bank mergers took place, according to the American Bankers Association (Washington, D.C.)—282 mergers occurred in 2007 alone. From the megamerger of J.P. Morgan Chase and Bank One (2,300 combined branches) to Watertown Savings Bank's acquisition of Redwood Bank in Northern New York (seven combined branches), there's a good chance a company will involuntarily find itself with a new bank sooner or later.
Bruce Blue, president and CEO of Freedom Metals (Louisville, Ky.), says he was very unhappy with his treatment by the officers of the company that acquired his regional bank. "They honestly didn't want to deal with small companies," he said. So he moved his business to a local bank, Stock Yards Bank & Trust Co. "Right away, we saved a couple thousand dollars a month" from faster check clearing and lower fees, he says. He has since arranged for a line of credit for working capital, taken out a mortgage for a second yard, and arranged financing for the purchase of a new horizontal baler through Stock Yards. "Their rates might not be the cheapest," Blue says, "but I know that when the market turns around, they'll still be with us."
Working with a small, local bank gives him access, Blue says—he can call the bank's chairman and discuss how the company is doing and what other services the bank can provide. Bankers "want to make money, and they are going to make money," Blue says. Still, he's worried Stock Yards, too, will get gobbled up by a larger bank, and once again he'll lose a valued financial partner to an acquiring bank that doesn't care about his business. "If this bank were sold, our job would be a lot tougher," he says. •
Anne Logue is a writer based in Chicago.
High commodity prices and billion-dollar mergers have heightened banks' interest in the scrap industry. To create strong and lasting banking relationships, however, scrap companies must rely on their long-term strengths, not the short-term buzz.