News | Best Practices for Problem Loan Management
January, 2011
Recovery Ahead - News from Crossroads Credit & Portfolio Management LLC
Best Practices for Problem Loan Management
Since the start of the financial crisis, the number of problem loans has increased as real estate values declined, credit markets tightened, and various companies struggled to survive and stay in business during this recession. For bankers who made loans secured by real estate, these banks are now being faced with loan defaults and deciding how to best handle their current situation.
1. Review Your Loan Documents
Before any workout scenario can be successful the bank must verify that the loan documents which the loan is based upon are properly executed and provide for proper perfection of the banks lien. What lies within the four corners of the documents will make or break any possible workout scenario.
2. Review Your Collateral
The lender will want to update its evaluation of repayment sources, including available collateral for the loan and the borrowers cash flow.
3. Correct Any Deficiencies in UCC-1 Financing Statements
A common mistake on a UCC-1 financing statement is including the wrong debtor name! The lender should verify the formal legal name of the borrower. If the borrower is an entity, the UCC-1 should have the name shown on the Articles of Incorporation, Certificate of Formation, or Certificate of Partnership, as may be applicable, on file with the appropriate filing office designated by the state of the borrower's organization. (Also remember no P.O. Boxes).
4. Review the Administration of the Loan
The asset manager handling the problem loan should confer with any relationship manager or prior asset managers to flush out potential lender liability claims. For example, is there any evidence of oral agreements modifying the written loan documents, or course of conduct that may suggest implied waiver of the terms of the written loan documents?
5. Review Your Borrower and Guarantors
The lender also may want to update its review of the borrower and any guarantors of the loan, including taking one or more of the following steps: (a) obtain current financial information on the borrower and guarantors, (b) evaluate the current management (c) evaluate current operations, (d) evaluate external factors (e) identify the causes of the borrower's problems. (are your guarantee agreements loan specific or provide for guarantee limits). If your customer is an LLC, verify that all of the signers on the note are approved to do so on behalf of the LLC and were members at the time of loan origination.
6. Determine Your Strategic Position
The lender should identify defaults and potential defaults under the loan documents, checking notice and/or cure requirements and possible waiver issues. Then, the lender should evaluate the materiality of the defaults. Is there a material breach of a material obligation?
7. Select a Strategy
Subject to the loan structure and any documentation or collateral limitations, the lender may have various options in dealing with a problem loan, such as the following:
(a) Do nothing,(b) Gather more information,(c) Grant a temporary or permanent waiver of default,(d) Extend time to cure defaults,(e) Encourage the borrower to address its problems, (f) Conduct a least cost analysis to determine the best course of action for the bank. Workout resolution strategies vs. legal remedies, (g) Obtain additional collateral, (h) Restructure the terms of the loan, (i) Seek legal remedies.
8. Check for Suretyship Waivers
Depending on the applicable governing law, a guarantor of a loan may be entitled to numerous statutory defenses, which may undermine the purpose of the guaranty unless such rights and defenses are effectively waived. Guaranties typically include suretyship waivers. However, such waivers are often missing in other loan documents when the loan involves co-borrowers or third-party pledges of collateral. Suretyship rights and defenses also may arise indirectly if one loan is cross-defaulted and cross-collateralized with another loan, and the loans are made to distinct entities.
9. Put it all in writing
It is absolutely critical that the bank document everything about this workout scenario. The asset manager must maintain a detailed accounting of all communications, discussions, agreements, modifications and commitments. This element is critical to document your actions for the bank's management, board, regulators and bank's counsel in the event of default. Document through official correspondence with customers, (watch the e-mails) lax e-mails have killed many of the best laid workout plans.
10. Centralize Lines of Communication
We saved the most important practice for the last in our listing of best practices. To avoid the "end-run" around asset management, the Bank and its lenders must speak with "one voice." Whether the banks representative is an officer in the special assets department or a third party special assets manger responsible for the loan, all parties must speak with one voice.
Conclusion
The handling of a problem loan portfolio is an exercise in loss mitigation. Banks and lenders are well served to approach it as such and remember these decisions are not credit decisions but loss mitigation decisions.
At Crossroads Credit and Portfolio Management, we refer to it as "keeping the customer in the game". If you can keep your customers performing at some level for an extended period of time the customer and the relationship may have a chance to survive and possibly even improve their internal risk grade.
Source: Richard Burleson, Crossroads Credit and Portfolio Management LLC
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