Loan Workouts: Most commercial borrowers, and even some loan officers, rarely expect to have a business face structural difficulties such that the prospect of full contractual repayment becomes a concern. When a borrower does face difficulty, their banking relationship is often transferred to a special banking officer to “workout” the problem loan. At smaller banks, the originating lender or chief credit officer might assume such a role. In either case both borrower and lender need to quickly create a strategy to maximize the chances of a successful outcome. Drawing from personal experience doing loan workouts I put together a few basic points to consider when entering this new territory.
Cash is king. Understand what drives the business’ cash flow. Regardless of what the accrual financial statements say, a business in distress is a cash based business. What is the operating cycle and how long does it take to convert a sale into cash. Is the business seasonal, like an agricultural trucking company or a resort hotel? Ask for a 13-week or seasonal rolling cash flow forecast. This will be your short-term roadmap of how you will get repaid.
Size up the borrower. Meet with the key executives as soon as possible and walk the entire business and ask lots of questions about how the business operates. Don’t be afraid to ask to look inside buildings, open boxes, make sure the equipment runs, and generally size up the inventory to see if it matches what appears on paper. This is a critical time to assess the management to determine their strengths and weaknesses, honesty, and most importantly, character. This meeting will be formative to the future strategy.
Size up the collateral and unencumbered assets. Immediately engage appraisers to value the fixed assets and conduct environmental reviews if the operations or the walk thru warrant further investigation. Obtain detailed accounts receivable aging reports with contact information for each account. Audit the accounts and inventory to determine collateral sufficiency. Find out if there is more collateral that you may be able to get during negotiations.
Prepare a liquidation analysis. If all collateral were to be liquidated, how much cash would it bring? Identify all possible sources of repayment, including those unrelated to the primary business. Use this analysis as a guidepost for progress and decision making.
Evaluate the downside risks. Do the borrowers have any legitimate issues with the Bank? Should you prepare pre-negation agreements? Preform a careful and thorough document review to look for any deficiencies, such as unperfected liens or missing guaranties. Retain qualified counsel to review all documentation and be on retainer for future documentation preparation, consultation and litigation needs. Make demand and limit access to credit facilities or other bank products with credit exposure such as treasury management, international trade products or derivatives.
Understand the borrower’s business inside and out. Read all the original credit and underwriting files. Determine what has changed or if there were issues overlooked at origination. Do the problems stem from market forces (low milk prices coupled with high feed costs) or are they a result of operational errors (overcapacity, careless administration) and keep an eye out for fraud or money laundering.
Finally, once you have a handle on the situation and critical issues have been resolved, meet again with the borrowers and their trusted advisors to set expectations that you expect to be repaid in full and to hear their plan to do so. Be inquisitive, upfront and set hard deadlines. Failure by borrowers to follow through with agreed upon deadlines and objectives is a sign to change course.
Come to the table. Chances are borrowers have never been in this situation, so understand the rules of engagement and do not act out with hostility or silence. Your relationship with the Bank has changed and how you present yourself is going to play a significant role in developing character and the chances of a successful workout. The lender is in control now and likely has very robust and comprehensive default remedies. The bank is your new best friend and they want to get to know you better than ever.
Be an open book. The bank is going to ask lots of information that you have never provided before. Be prepared with cash flow projections and annual operating budgets. Be ready to have auditors spending a week counting inventory and checking your books and records. Can you produce monthly financial and collateral statements? Any delay in producing documents, especially financial records, will be viewed with suspicion or as incompetence, either of which will greatly diminish your credibility and ability to negotiate.
Do not be afraid to ask for help. Sometimes hiring a consultant approved by the lender will help you identify the operational issues causing the business to underperform or can aid in proactively presenting a workout plan to the lender. This demonstrates a commitment to fix problems and shows strong character. Also, if you are struggling, ask for help early, long before you are introduced to a workout officer at the bank. Your chances of survival will be much greater.
Be willing to compromise. The bank will only be willing to give if they get something in return. Most often borrowers need more time to turn the business around. If so, are you willing to provide additional collateral, shorten loan tenor, inject additional capital or sell equity to raise liquidity? At the same time, carefully review the loan documents and find deficiencies that you can use against the bank to negotiate time or even additional funds.
Every workout is different. Sometimes the problems are just too great to overcome and the asset values or cash flow just do not warrant a turnaround. If this is the case, you can decrease potential deficiencies by being proactive and self-liquidating. An orderly sale of assets will garner significantly higher prices than a bank auction or a foreclosed property. If you have any personal assets, the bank will likely pursue the deficiency through legal action. Bankruptcy is expensive, and many times, preferred by the bank since it is orderly and forces action. However, you are responsible for all expenses incurred by the bank, including legal fees, consultant fees, inspections, and repossession and auctioneering fees. Obstruction and delays will only cost you money.
I am happy to discuss more specific strategy or field any questions you may have regarding debt collection.