Bank Workout Departments: 6 Reviews When a Loan Moves to Special Assets

A Loan in Trouble Goes Through Six Reviews

When a loan gets into trouble, the bank’s Special Assets group takes it over to handle it. The bank is no longer a relationship banker; it’s collecting and protecting itself. And it goes through six reviews. It has to be analyzed for:

• what defaulted and why;
• new risk grade;
• accrual status;
• your and guarantors’ finances;
• collateral value, and;
• workout plan and exit.

Each day that you delay costs you more leverage.

You might expect your friendly lender relationship managers, even senior officers, to help you steer the bank through its bureaucratic labyrinth. But often once your relationship bank puts your loan in workout, your officers get walled off. They may be polite when you reach them, but they won’t be making decisions anymore. And remember: it’s not personal; at many banks, workout bankers are paid and measured by how quickly they get delinquent loans straightened out.

Take a minute now to read the default section of your loan agreement. Lots of borrowers expect a missed payment to be the only thing that matters. Often that’s not so. A financial covenant default, like missing a coverage ratio in the agreement, can do the trick. So can failure to give the bank timely quarterly or annual financials, or certify the collateral is insured, or that there are no other liens on the collateral. Asset-based credit usually carries a heavy monitoring burden.

The bank will define your loan as either pass (fine), special mention (the next review level below pass), substandard, doubtful or loss. Special mention is the level your loan is moved to when there’s potential for default, even when nothing serious has happened yet. It means you have potential weaknesses: maybe falling revenues or margins, management problems or pending litigation. Further down, doubtful is when they don’t even think they’ll collect in full.

The next thing Special Assets checks is accrual status. This just means they’ll no longer record your interest income (generally when it’s 90 days in default) unless the loan is secured by enough collateral and in the process of collection. And they probably won’t put you back on accrual status till they’ve seen at least six consecutive months of repayment.

The bank looks hard at you and your guarantors. They want to know how much you’re worth and whether you have the liquidity to cover the bank should you default. It wants full information on you, and probably every guarantor on your loan. As part of that, it’ll scrutinize each one’s income, liquidity, cash flow, and contingent liabilities, to see if there’s any chance of recovery. Get your records updated.

The bank will do a collateral valuation by new appraisal, or at least a new evaluation. Smaller commercial real estate loans ($500,000 or less) often get an evaluation. If it finds your business or real estate collateral worth less than the outstanding loan, that’s not enough for the bank to move you to the next classification. It’ll weigh that with the debt service coverage, from the cash flow.

The final thing Special Assets is interested in is your exit plan and follow-up. They want a conservative business plan from you, with data to back up each forecast. They’ll grade your company (and you) against that plan, and favor borrowers who report frequently and follow up quickly. The next job is to make sure you avoid any surprises. That’s the worst thing Special Assets can hear, the borrower’s lurching from crisis to crisis. If you see something about to happen, let the bank in on it. It helps to remember: these workout lenders have heard every broken promise in the book. Be totally honest with them about what’s coming. Manage expectations: tell them where you think you can be and when. Under-promise and over-deliver.

Ultimately, that exit generally means refinancing elsewhere. The bank expects to know the exit plan, and your refinance options before agreeing to a long forbearance. The bank is serious when it says it expects you to leave; few borrowers ever do return to regular banking there. Make sure you work that part of your plan out first.

The Bank’s Little Negotiations

At this stage, it’s important to see through the bank’s little negotiations. Too often, it’ll try to get new personal guarantees or put additional collateral up without giving you anything in return. As a rule of thumb, don’t give up anything new until you and the bank restructure the loan. If the forbearance the bank is offering is only a month or two, think hard before giving up more collateral for it. So what do you get for the added security it wants? It may waive your default for a period; cut your interest rate; commit to keep all or part of your credit line available; agree to a slower amortization; and it should agree to a forbearance of six months or longer, not a rolling 30-day thing. Short extensions, where the bank says every 30 days whether or not you can go another 30, only create uncertainty.

Expect your costs to rise. Some banks will boost your rate and add fees to loans, partly to encourage you to refinance elsewhere. And be prepared to pay all, or part, of the cost of your loan restructuring: that can easily mean any consultants or accountants it hires, and their lawyers’ bills. You should monitor them and make the bank justify them when they seem out of line.

Cash Is King

Throughout this process, cash is king. This is the time to actively manage your company. Tighten credit to customers who aren’t paying on time; collect slow accounts; do whatever it takes to collect. Cut nonessential costs and sell unneeded assets. And don’t count on the bank extending your credit line.

Filing a Chapter 11 can act as a backstop, since the bank must fear you’ll do it. What you’d like to do is use it as a way to put pressure on the bank. That’s because the bank wants to avoid a Chapter 11, which shifts the leverage to the borrower. A Chapter 11 bankruptcy stops a foreclosure automatically.

Get help from experienced lawyers; maybe a financial advisor. But don’t let the law and finance push you off track: Keep your focus on customers, vendors and employees. That’s where the solutions are. And if your results start to turn, new lenders will open doors.