With a rising number of COVID-19 cases as we move into the winter months, there is concern about more lock downs and the economic fallout that has impacted many small (and large) businesses. Will institutions be facing a larger number of loan workouts? If so, who is trained in strategies to deal with borrowers who are experiencing financial difficulties? After a prolonged period of profitable growth since the Great Recession, many institutions have reduced or eliminated their workout departments.
Here is some guidance for getting back into the workout business.
Who Should Be Involved with Workouts?
Selecting persons to handle loan workouts depends on the severity of the borrower's financial difficulties and willingness to cooperate. If the borrower is in the early stages of having financial troubles, it should remain with the loan officer assigned to the account. This officer knows the credit best, and this officer will learn valuable lessons during the workout. However, if the loan is deteriorating quickly, transfer the loan to a workout loan officer or provide workout skill training to a seasoned lender.
When a seasoned and trained lender is assigned to the credit, this action sends a definite signal to the borrower that they have a severe problem. And this message quickly becomes, "Maybe I should find another funding source to work with," which is precisely the intended message. The message also creates a psychological advantage for the institution when a loan moves from its original loan officer to a workout loan officer. If the credit is in default, an experienced workout officer needs to oversee the credit. There is too much at stake to let a novice handle the problem.
Once the appropriate person is assigned to the workout, there are four steps that should follow with a sense of urgency.
Step 1: Gather Loan Information
The first step in the workout is for the assigned officer to do his or her homework:
Review the credit file.
Re-assess the borrower's character.
Analyze the borrower's current financial statements.
Check all loan documentation.
Perform a public records verification.
Analyze the institution's collateral and guarantor positions.
Step 2: Arrange for an Initial Meeting with the Borrower
After the workout loan officer has finished gathering loan information, it is time to meet with the borrower and get their perspective on the emerging workout situation.
Consider having two loan officers attend this meeting – the loan officer assigned to the account and a loan officer with workout experience, if possible.
Establish the meeting purpose.
Do not negotiate a workout at this meeting.
Use the meeting to determine the stage of credit deterioration.
Try to identify as many facts as the borrower will disclose.
Evaluate the borrower's attitude toward the problem loan situation.
Ask questions and listen to the borrower.
Step 3: Evaluate the Institution's Exposure
After meeting with the borrower, use the information gathered to answer these questions:
What is the borrower’s financial situation?
Will this be a simple workout, or is the borrower’s problem serious?
Does the institution have loss exposure?
If so, what must be done to minimize future losses?
Is the loan relationship salvageable, or has it already reached the point where a loan modification may not work?
Your approach to the borrower’s financial problems will be different, depending on the seriousness of the situation.
However, no matter what the assessment is, the institution must move quickly, but not so soon that it increases its exposure to a lender liability suit. In short, it is time to develop a workout plan for this credit.
Step 4: Develop a Workout Plan
The workout plan will be based on a decision to:
Negotiate a workout
Move the loan to another institution, or
Liquidate the collateral and pursue guarantors.
Here are some examples of alternative strategies:
Do Nothing. Too often the choice is to do nothing. This choice avoids a confrontation with the borrower, and there is at least a chance that the situation is not as bad as it appears. "Do nothing" is the null decision. If the loan officer does not consciously develop a workout plan, try to get the loan moved, or begin to liquidate the collateral, he or she has chosen the do-nothing option.
Correct Documentation Deficiencies, Renew and Refinance . No matter what the choice, if there are documentation deficiencies, it will be necessary for a workout plan to be initiated that includes redocumentation of the loan and a new note. Even when this is the case, it may still be possible to get the loan moved after the new documentation is in place. The plan should be to renew the loan and, at the same time, put enough pressure on the borrower to cause a refinance elsewhere.
Proceed with Liquidation. The bank obviously wants to catch the problem in the salvageable stage and start a workout. If the problem was detected too late, however, or if the workout fails, then the loan must be moved, or the collateral must be liquidated. If liquidation is advised, it is in the borrower's best interest to admit the futility of the situation and assume responsibility for the liquidation. Only when the loan is beyond saving should the institution be responsible for collateral liquidation.
Click here to learn more about workout strategies that can protect the institution from lender liability while minimizing loss exposure.