While the market remains soft and some businesses continue to struggle, recognizing the value of a trustworthy alliance with your bank is crucial. Consider a banker to be a member of one’s business management team and utilize their expertise to help address a downturn in business operations as soon as the trend emerges. Your bank may be willing to modify existing commercial loans to restructure debt and improve cash flow. Early recognition of financial trouble and communication between the borrower and the bank is the first step in navigating the process. A bank’s preferred solution on a problem loan is to negotiate a plan of action to try to protect both parties from possible loss. This partnership is vital to reach a favorable solution.
Loan personnel are responsible for continuously monitoring business loans to discover and manage potential complications. Loan review is important in early discovery of troubled loans however, lenders also rely on their personal relationship with the borrower to predetermine hardship. When communication with a borrower deteriorates, so often does the performance of the loan. Loan personnel are trained to detect any unexplained change in the borrower’s attitude and decreased communications, which are often interpreted as an indicator of financial difficulties and potential loss.
Additional signals that reveal problems to a banker include late or missed loan payments, overdrafts on deposit accounts, cancellation of insurance on collateral, management turnover and reluctance to provide timely financial statements. Other, more obvious, signs include deteriorating trends in financial condition, worsening accounts receivable or accounts payable timelines and tax levies.
Larger banks typically assign problem loans to a separate department to manage — often in a different state — but community banks place a higher value on their relationships with their customers and generally allow the banker who originated and maintained the loan to spearhead modification recommendations. Therefore it benefits a business to build a partnership with their banker before problems arise by maintaining frequent and frank contact in good and bad times.
A loan restructure plan must be approved by the bank and legally documented as a modification or forbearance agreement. This sets forth a new repayment program with loan covenants and establishes requirements for the borrower to provide frequent financial reports for the bank to review. A written business turnaround plan may be required, along with updated collateral appraisals.
It is important to note that providing timely and accurate financial statements to the bank is essential to any modification request, as banks have regulatory guidelines to obtain consistent updated financials on modified loans. Without current financials the bank could be required by regulators to downgrade a loan relationship to a “substandard” classification — even when the borrower can pay on time — which may hamper negotiations. The best practice is to provide the bank full financial disclosure, along with all requested information, although a borrower’s instinct may be to avoid providing unfavorable financial data to the bank. This could be a costly mistake.
Problems with secured loans may arise from inadequate collateral. When the market value of certain types of collateral declines it may create an inadequate loan-to-value ratio. Banks may require a new appraisal or collateral evaluation, and may also require additional security if it is deemed the value of the primary collateral has declined since the inception of the loan. Another remedy may be to provide the addition of personal guarantees to improve the bank’s exposure to loss.
The earlier the bank is aware of a problem loan, the more likely a modification agreement can be reached. Communication with the bank is key. Loan modifications focus on the borrower’s ability and willingness to repay, and analyze their economic incentive and use of other assets to provide ongoing support in the relationship. If a borrower is reluctant to communicate with their banker, the problem can be unnecessarily escalated as the bank may deem itself insecure and a modification program may not be an option.
Get to know your banker and keep them apprised of your business. Above all, treat your commercial banking relationship as a valued partner in your business life and turn to your banker for advice and guidance when difficulties arise.
Contact Teresa M. Nowak, senior vice president for Commerce Bank of Arizona, at email@example.com or (520) 325-5200. Commerce Bank is a locally-owned community bank specializing in serving small- to mid-size businesses in Arizona.