Roger Elliot, vice president and loan officer of the First National Bank of Cincinnati, was recently alerted
Question:
Roger Elliot, vice president and loan officer of the First National Bank of Cincinnati, was recently alerted to the deteriorating financial position of one of his clients, Seal-best, Inc., by his bank's newly instituted computer loan-analysis program. The bank requires quarterly financial statements - balance sheets and income statements - from each of its major loan customers. This information is fed into the computer, which then calculates the key ratios for each customer, charts trends in these ratios, and compares the statistics of each company with the average ratios and trends of other firms in the same industry. If any ratio of any company is significantly poorer than the industry average, the computer output makes note of this fact. If the terms of a loan require that certain ratios be maintained at specified minimum levels and these minimums are not being met by a company, the computer output notes the deficiency.
When an analysis was run on Seal-best three months earlier, Elliot noticed that some of the company's ratios were showing downward trends, dipping below the averages for the dairy products industry. Elliot sent a copy of the computer output, together with a note voicing his concern, to Eric Swenson, president of Seal-best. Although Swenson acknowledged receipt of the material, he took no action to correct the situation.
The first financial analysis indicated that some problems were developing, but no ratio was below the level specified in the loan agreement between the bank and Seal-best. However, the second analysis, which was based on the data given in Figures 1, 2, and 3, showed that the current ratio was below the 2.0 times specified in the loan agreement. According to the loan agreement, the Cincinnati Bank could legally call upon the dairy for immediate payment of the entire bank loan, and if payment was not forthcoming within 10 days, the bank could force Seal-best into bankruptcy. Elliot had no intention ofactually enforcingthe contract to the full extent that he legally could, but he did intend to use the loan agreement provision to prompt Seal-best to take some decisive action to improve its financial picture.
Seal-best is a company that handles a full line of dairy products in central and southern Ohio. It produces both fresh dairy products and such storable products as powdered milk and cheese. Seasonal working capital needs have been financed primarily by loans from the Cincinnati Bank, and the current line of credit permits the dairy to borrow up to $240,000. In accordance with standard banking practices, however, the loan agreement requires that the bank loan be repaid in full at some time during the year, in this case by February 2021.
A limitation on dairy products prices, coupled with higher costs, caused a decline in Seal-best's profit margin and net income during the last half of 2019 as well as during most of 2020. Sales increased during both of these years, however, due to the dairy's aggressive marketing program.
When Swenson received a copy of Elliot's latest computer analysis and the blunt statement that the bank would insist on immediate repayment of the entire loan unless the firm presented a program showing how the poor current financial picture could be improved, he began trying to determine what could be done. He rapidly concluded that the present level of sales could not be continued without anincreasein the bank loan from $240,000 to $340,000, since payments of $100,000 for construction of a plant addition would have to be made in February 2021. Even though the dairy has been a good customer of the Cincinnati Bank for over 50 years, Swenson began to question whether the bank would continue to supply the present line of credit, let alone increase the loan outstanding. Swenson was especially troubled by the fact that the Federal Reserve recently tightened bank credit, forcing the Cincinnati Bank to ration credit even to its best customers.
Andersons Business Law and the Legal Environment
ISBN: 978-1133587583
22nd edition
Authors: David P. Twomey, Marianne M. Jennings