Preparing For The End Game When Underwriting New Credits – Finance and Banking

Most financial institutions we have represented over the years
make a fine-line distinction between loan officers and asset
recovery officers. In many instances, this distinction makes sense.
If a loan officer considers too openly the risk for failure of a
new loan, he or she may attract less new lending relationships and
cut off the life-blood of that institution.  

That said, the problem with complete isolation of those two
functions is this: if a loan officers fails to consider how the end
game looks short of a full and timely pay-off, loan recovery
efforts can easily (and often do) fall well short of the ideal
recovery. Therefore, we offer some items for consideration at the
earliest stage of lending. Here are some critical ways a loan
officer might protect his institution if the borrower falls flat.
These tips, we hope, help the loan officer, the underwriters, and
the recovery officer alike. They definitely help our creditors’
rights team answer important the questions (that we outlined in
part one of this series) early. 

The first thing a lender needs to do is to get a detailed
financial statement from any obligors in the new credit
relationship. Those obligors include all named borrowers and all
parties asked to either pledge collateral or sign guaranty
agreements. For any related parties not asked to sign guaranty
agreements, the lender should understand why. If, for example, a
small business borrower offers the guaranty of one member but
specifically asks that another member not sign a guaranty, this
should raise some flags. If the small business borrower has several
affiliates that it does not offer as guarantors, the lender might
review bank records to determine whether the affiliates receive
transfers from the borrower on a regular basis. If so, making the
affiliates guarantors could prevent recoverable assets from leaving
the lender’s reach. 

In the collection endgame, one axiom remains sacrosanct. The
more knowledge the institution possesses when it comes time to
collect, the greater the institution’s advantage. If a borrower
threatens bankruptcy, the recovery team can review the initial
financial statement and determine what assets should be
there. If the assets justified underwriting in the first instance,
then, absent cataclysmic events in the interim (which we will
discuss later in this series), the borrower should still have
assets to recover in a threatened bankruptcy. If the borrower
claims a completely different financial picture in the default and
recovery phase than in the underwriting phase, this discrepancy can
be used to the institution’s advantage in numerous ways. If the
lender fails to get detailed financial statements during
underwriting, however, the recovery team has no basis for
comparison. 

Next, a lender needs to draw particular attention to financial
covenants in the governing loan agreement. For example, most loan
agreements require borrowers to provide detailed financial
reporting on an interim basis throughout the life of the loan. If
this is not part of your institution’s regular
practice already, it should be. The lender needs to make a borrower
aware that the lender expects that borrower to provide balance
sheets, tax returns, and financial statements, at the bare
minimum.  

During the collection endgame, the recovery team often suffers
from a lack of meaningful data to review. Sometimes, the missing
data can be as simple as being unable to answer the question:
“how do I contact the borrower?” Did the borrower
relocate during the life of the loan? Did the borrower disconnect
its phone line? Being unable to track down the borrower to its
current number, officer in charge, and address puts recovery behind
the eight ball immediately.  

Beyond that, if a loan default occurs several years into its
life cycle, then the financial statement obtained during
underwriting would be stale. The picture of assets and debts
carries less weight. Having more points of data against which to
compare the financial picture at default affords the recovery team
numerous advantages. Creating early expectations that the
institution plans to collect financial data at regular intervals
helps the entire team do its job effectively. 

Finally, a loan officer should work to understand as well as
possible the nature of the underlying business if working with a
corporate borrower. This holds especially true if the institution
takes accounts receivable, inventory, or equipment as collateral.
The loan officer should take detailed notes about everything he or
she learns during the diligence process. For example, does the
borrower collect the bulk of its receivables at time of delivery or
at set times during the month? Does the borrower have peak seasons
in its business cycle? Who are the borrower’s primary
customers? The answers to each of the questions greatly help
recovery understand its most viable paths to collection. If Atoms,
Inc., represents the borrower’s largest customer, and Atoms,
Inc., always pays between the first and fifth day of each month,
then the informed recovery officer knows to send account demand
letters to intercept those payments from Atoms, Inc., fourteen days
before the payments would be made.  

While these two things seem simple enough, we have worked too
many loan files missing this critical data. Recovery has
never complained of having too much information, but
recovery officers often lament just the opposite.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.