What are the challenges in lending to a seasonal business?
Lending to a seasonal business brings with it challenges that a borrower that operates all year long doesn’t face. Whether lending to a hotel in a coastal summer hotspot or an ice cream stand in North Dakota, one question that always comes up is how will a seasonal business support debt service in the off-months?
Recently we were asked to underwrite a loan to a river boat cruise company in the Mid-Atlantic region. The tours operated from late May until the end of October. How did we mitigate the obvious issue: how will the loan payment be made for the 7 months each year the company was closed for the cold weather season?
In-season operations: No room for error
When we sat down to underwrite this loan, we knew straight away that we had to nail the analysis of the in-season operations. If we couldn’t adequately understand and opine upon the in-season operations, there was no chance we could mitigate the off-season cash flow issues.
Here is how we ensured we understood the in-season operations of this seasonal business:
- We’ve covered how to analyze income statement projections before but a seasonal business adds another layer to analyze. While analyzing cruise ticket prices and forecasted guest volume in order to sensitize revenues was obvious, we knew other factors could impact revenues. How could we assess the impact of these factors? As with any seasonal business weather plays a huge role in the success of the busy season. We wanted to know what impact weather had historically had on this business. To answer this question, we turned to a source with over 200 years of data: the Farmers’ Almanac. Using this source, we were able to understand the impact the weather in the region impacted the revenues of the Borrower both historically and for the upcoming summer and fall season. We were able to provide sensitized projections based upon differing weather conditions that were supported with quantitative data.
- What about expenses? The projections revealed a decrease in operating expenses during the busy season. The expense line items we were most concerned about were fuel expenses and payroll. These two expenses combined to account for the projected decrease in expenses compared to the prior year. We were able to get comfortable with the projected expenses for two reasons. First, the Borrower had locked in its fuel costs for the upcoming season with a hedging agreement with a local fuel supplier. Second, payroll was forecasted lower because of a reduction in staff on each cruise. The Borrower had trialed operating with one less deckhand per cruise in the last month of the prior season. There was no meaningful impact on customer experience and, most importantly, the cruise operator was still in compliance with Coast Guard regulations. The decrease in expenses was justified and adequately supported.
So…..what about those pesky off-season loan payments?
We were able to demonstrate through sensitizing the projections a series of outcomes that would result in a range of debt service coverage ratios. But we hadn’t addressed the mechanics of how the seasonal business would make its off-season loan payments. Several options were considered. These options included:
- P&I payments “in-season” and interest only payments “off-season”
- Double P&I payments “in season” and no payments in the “off-season” and
- Regular P&I payments all year long.
While each payment option had its own strengths and weaknesses, we recommended a blended solution to the Lender. We recommended that the Borrower make double payments during the busy season. However, the “extra” payment was placed into a deposit account and off-season payments would be auto-debited from this account. The Borrower did not want to be accruing interest in the offseason on its loan. The Bank was happy to have the “extra” payment already in hand before the off-season arrived. Also, the loan would be fully repaid within loan policy limits- another plus for the Lender. Finally, the Lender would have several months of warning if cash flow was less than projected and the off-season payments were possibly in jeopardy. This would allow the Lender to adjust its risk rating on the loan well before a payment was missed and provided runway to find alternate sources of cash to fund the off-season loan payments.
What was the end result?
We recommended the loan for approval. The extra analysis we completed was a key component of our recommendation. We were able to support the extra analysis with quantitative data and qualitative data. The loan repayment was structured to meet the needs of both the Borrower and Lender with a full understanding of the seasonality of the Borrower’s cash flow.