Financial Lending Notes
May 26, 2009

How to Manage Problem Loans

With the industry-wide financial crisis continuing to take its toll on small businesses, many banks are facing rising levels of delinquencies in their commercial loan portfolios. The best way to stem the rising tide of bad loans is to identify problem loans in your portfolio as early as possible.

Maximize Your Options

Recognizing troubled loans early is critical to maximize your options for dealing with them. The sooner they are spotted, the more likely it is that there will still be a viable core business, a cooperative borrower, an adequate collateral position or, perhaps, an opportunity to move the borrower out of the bank before it’s too late to salvage the credit.

To this end, it’s a good idea to constantly “mine” your past due list, since this is usually where problem loans are born. This mining can be done as often as daily, with weekly summaries shared among all lenders.

Get to the Core

Start with the premise that the core of every problem loan lies in one or more of these three areas:

  • Cash flow: What’s causing the cash flow shortfall? Can the problem be addressed?
  • Management: Can the owner/managers who got the business into financial trouble get it out? Are they even willing to acknowledge that a problem exists and they need help?
  • Debt: Is there a high debt-to-equity ratio and/or excessive short-term debt?

As you comb your portfolio, first concentrate on industries that are historically weak during economic downturns. Residential builders and developers and commercial real estate are the two most obvious, but don’t forget the industries that support them, which include lumberyards, metal fabricators, plumbers and electricians.

How To Deal With Them

Once identified, there are three steps to dealing with problem loans:

1. Make sure the borrower recognizes that there is a problem.

2. Help the borrower understand what caused the problem (cash flow, management and/or debt).

3. Assess management’s ability to turn the problem around.

Based on this analysis, you’ll likely have three remediation options: Devise a workout solution with the borrower, liquidate the business, or sell the loan into the secondary market (for example, via http://DebtX.com).

Remember that the final decision about how to deal with problem loans is first and foremost a business decision. Which option will result in the most money for the bank (present valued) and require the least time, least risk and lowest cost? Conducting a detailed decision-tree analysis that compares the financial impact of each option side by side is the best way to objectively analyze your choices.

Important: If you decide to pursue a workout solution with the borrower, you should assign this task to a chief credit officer or workout specialist, not the customer’s normal relationship manager. This will free up your relationship managers to concentrate on making new loans to higher-quality businesses and ensure that someone who is objective, trained and experienced in problem loan workouts is focusing on this task.

For additional information on how to manage problem loans please contact Patrick A. Tuley, CPA with Porter Keadle Moore LLP, at ptuley@pkm.com.

 

  

Compliments of:

Porter Keadle Moore, LLP (PKM) is a full service accounting firm based in Atlanta, Georgia. PKM offers audit, tax and systems services to clients throughout the country. The firm focuses its efforts on companies registered with the Securities and Exchange Commission (SEC), community banks, the insurance industry, technology and life sciences companies and the real estate/construction industry.
 

To discuss this article contact Pat Tuley, CPA with Porter Keadle Moore, LLP at ptuley@pkm.com.

Pat has over 23 years of experience in public accounting. He has worked with clients ranging from individuals to international Fortune 50 companies in a variety of tax consulting and compliance areas. He is most active in the real estate and banking industries, serving numerous clients across the Southeast. Pat has led PKM’s tax practice since 2003. Prior to joining PKM he was a partner with KPMG, where he spent 17 years of his professional career.

 
What About Participation Loans?

If your bank owns participation loans that have become problem loans, you’ll want to do whatever you can to protect your interest in these credits. The key is carefully structuring the participation agreement between banks. This agreement should spell out all the details of the loan and each party’s rights and responsibilities in the event that a loan becomes troubled. So start by going back and taking a close look at what your specific rights are with regard to problem loans. For example, is the selling bank required to provide you with comprehensive financial information, a copy of the loan workout strategy and regular updates on the workout? Do you have the right to be involved in major decisions relating to the loan workout, liquidation of the business or sale of the debt? The selling bank may or may not cooperate with you — if not, be as aggressive as you can within the limits specified in the participation agreement. And remember to structure future agreements in a way that gives you as much input and flexibility as possible to protect your interest in the credit.

 

Tim provides accounting and auditing services to financial institutions as well as clients in the construction, service, technology/life sciences and manufacturing/distribution industries. He routinely works with companies registered with the Securities and Exchange Commission; privately-owned companies and S Corporations. He has experience with Initial Public Offerings (IPOs), Mergers and Acquisitions, Sarbanes-Oxley compliance and internal control consulting. You can contact Tim at tmessman@pkm.com.