Commercial loan workouts seem like old news, but the COVID-19 crisis and its aftermath are likely to result in old news becoming news again.
The good news is that many lessons have been learned from the Great Recession of 2008 and those lessons have led, among other things, to enhance internal systems and controls.
Here are a few lessons that I’ve learned from a decade of legal work inside a community bank that started with being dedicated to special assets during the Great Recession.
- Review loan portfolios with internal and external resources to determine if any gaps that need to be filled. This includes having up-to-date and properly filed UCC-1 financing statements with complete collateral descriptions (which may have changed if, e.g., the borrower has an account on deposit that was not in place at loan origination, the borrower has gone through an entity conversion or has changed its principal place of business, or if the borrower is entitled to a loss carryback resulting in an assignable tax refund payment), financial covenant updates, whether there is a need for additional real or personal property collateral or guarantees, whether a loan requires modification or forbearance.
- Put together an internal, special assets team and have them ready to go if loans start to show weakness after payment deferrals burn off and PPP loans have been forgiven.
- Pull together a problem loan committee that can meet regularly to review graded credits, particularly the ones that are in danger of falling out of one classification and being downgraded.
- Ensure that the head of loan administration communicates well with their chief credit officer, internal legal and the line and special assets bankers so that loan grades are kept current and up to date. Institute monthly meetings comprise all the above, where all graded loans can be reviewed and analyzed as to proper grade.
- Ensure that loan review is properly staffed and able to work through loan collateral and documentation issues without a backlog.
- Consider sending confirmation letters to a borrower’s account debtors to establish a liquidation value for the debt and determine collectability.
- Hire professionals — legal, accounting, engineering, environmental, asset search and entitlement experts, as applicable, help make sense of the collateral position if foreclosure becomes necessary. Do this before there is an actual crisis so that there is time to strategize and maximize recovery.
Loan workouts take many forms, from the simplest of loan modifications or loan extensions to a more complex forbearance if there is a basis for rehabilitating the credit. The borrower needs a little more time to get its house in order. Repeated extensions and forbearances may be “kicking the can down the road.” While easier to swallow for a borrower, it could be potentially lethal to the bank and its capital position. A good, neutral special assets team can be an invaluable check on a relationship that may have been solid for a very long time but is weakening due to events unforeseen at loan origination, from which the credit and the borrower may be unable to recover. Consider the prospect of effecting a settlement with a borrower or a guarantor since the first loss may be the best, and “letting your money get mad” may feel good for a moment but may be disastrous in the long term.
Foreclosure of real or personal property or deed in lieu of foreclosure for real property may be a last resort. Other measures may work more effectively, such as having the borrower appoint a chief restructuring officer or agree to receivership or a sale of the underlying asset or business. There is a risk of being dead right by moving too quickly to enforce against the individuals or the collateral and possibly winding up with a marketing nightmare.
Try to be patient while being vigilant and proactive. As I often said in mediations, both sides will feel lost to come to a resolution. The loss tolerance for each party is unique and needs to be understood to reach an acceptable resolution.
To learn more, please consider registering for the upcoming CBA webinar, “Hindsight is 2020 — Looking Ahead to Loan Workouts, Financial Litigation Trends and More” to be presented by Snell and Wilmer on Wednesday, Dec. 16th from 9-10:00 a.m. MST. We will provide a variety of perspectives from a team of transactional and litigation attorneys, including myself. Among other topics, we will provide a bank examiner’s bird’s eye view of the banking industry in 2020, the ins and outs of SEC receiverships and spotting account fraud, and an update on eviction and foreclosure in the shadow of the FHFA moratorium. Information about the webinar will be available shortly from the CBA.
This article is for educational purposes and does not constitute legal advice. It represents the current, general opinions of the author and not of her law firm or colleagues.
Judith Lajoie is a transactional attorney at Snell and Wilmer with more than 30 years of commercial finance and real estate finance and acquisition experience. She previously served as general counsel to a large state-chartered bank and financial services company where she supervised complex commercial litigation, served as counsel to the line and special assets bankers, and provided oversight with respect to bank policies, procedures and account and loan operations.