03 Jul Credit Crunch: Experts Broker Loan Settlements
When Banks Call Loans, More Businesses Are Hire Negotiators
Article Reprint From the Banker & Tradesman
By Michael M. Ciaburri
Special To Banker & Tradesman
Since 2008, the small business community has been under siege as a result of the banking crisis that forced all banks to tighten standards in extending new credit to small businesses.
Not only has it become more difficult for small businesses to obtain new commercial loans, but banks have also become very aggressive in collecting the small business loans that are already on their books and in their loan portfolios. Thus, small businesses have the added concern of making sure that their bank does not call the loan that is already outstanding. Even if the small business borrower never misses a loan payment on its loan, the bank can call the loan if it deems itself “insecure” with a particular credit or borrowing relationship.
Most banks force small business borrowers to sign a loan agreement that is part of the loan documents when a new loan closes. Included in these loan agreements is language that protects the lender and allows the bank to call a loan if the borrower does not meet certain negative covenants that are imbedded in the loan agreement. The most common negative covenants that are enforced by the banks are the company’s current ratio, quick ratio and debt/worth ratio.
The borrower must maintain a certain minimum number with each ratio; otherwise, the bank has the legal right to ask the borrower to pay off the bank’s loan immediately. Hence, even if the small business has made all of the monthly payments on its loan as agreed, the bank can still exercise its right to seek immediate full payment of the loan.
What that happens most of these small businesses do not have enough ready cash to pay off the loan. That means they must either sell off personal assets to pay off the loan or liquidate the company to pay off the loan. In either instance, the small business is placed at the mercy of the bank and is typically forced to hire an attorney to defend itself against the bank at a considerable cost to that business.
At A Crossroads
Banks are trying to shed small business loans from their loan portfolios and are forcing small businesses to seek alternative financing from other lending sources to pay off the bank loans. In many cases, small businesses are unable to secure replacement financing for their bank loans and subsequently end up in both lengthy and costly litigation with their bank. By not being able to comply with a financial ratio in their loan agreement, the business is in “technical” default and their loan is placed in the bank’s classified asset category. At that juncture, it becomes the mission of that bank to seek full payment of that loan as soon as possible no matter what negative impact that it may have for that particular small business.
These loans are sometimes referred to by the banks as Performing/Non-Preforming (PNP) loans. PNP basically means that although the borrower is making the monthly loan payments in a timely manner, the company’s underlying financial condition has deteriorated from the time that the loan was initially made – creating a concern for the bank about the future viability of their borrower.
In essence, the bank is now at a crossroads with the borrower in which they are deeming themselves “insecure” with this borrowing relationship.
Instead of seeking out the services of an attorney to negotiate with the bank on their behalf, the borrower whose loan relationship with their bank has now been relegated to “classified” status, can retain the services of a loan workout specialist to protect their interests.
A loan workout specialist is typically an ex-commercial banker who has experience in working with small businesses and has specific knowledge as to how banks deal with their classified assets and the methods by which they restructure these assets. Much like a prosecuting attorney who then becomes a criminal defense attorney, a loan workout specialist has spent time working for a bank as a loan review or loan workout officer for that bank. That individual is very familiar with how bank regulators interact with the bank’s loan committee and the bank’s impaired loans and how a bank reserves its capital against these classified or nonperforming assets.
Since many banks are already saddled with a high percentage of non-performing or classified assets, it is in the bank’s best interests to negotiate a workout settlement with the small business representative so that the bank can avoid adding another loan to its classified or NPA portfolio.
The primary goal of the loan workout specialist is to either negotiate a settlement for the borrower in which the bank agrees to accept a discounted payoff to the outstanding principal balance of the loan or to negotiate a debt restructuring for the borrower in which the bank agrees to lower the loan rate; reduce the monthly loan payment; extend the maturity of the loan; release a portion of the collateral that is securing the loan; and to either reduce or totally eliminate the financial covenants that the borrower must comply with in the loan agreement.
If a small business does not qualify for alternative financing that can be used by the loan workout specialist to negotiate a discounted payoff on an existing loan, then the specialist will be forced to seek a restructuring of that loan and make sure that the borrower’s relationship with the bank remains cordial and viable going forward for as long as possible.
Unlike attorneys who typically bill for their services on an hourly basis, most loan workout specialists charge a one-time upfront retainer from their client and are then paid additional fees from the client based on their performance. Thus, the loan workout specialist has tremendous incentive to produce a successful outcome for the small business borrower in order to earn additional fees from the transaction.
Michael M. Ciaburri is a principal of Worth Avenue Capital LLC in Guilford, Conn. Email: firstname.lastname@example.org