Business Loan Workouts: What You Should Know

When you search the Internet for the term "commercial business loan workouts" you find the first 30 or so entries are job postings for commercial loan workout specialists. That may give you a sense of how many banks are ramping up their loan workout department right now. Over my 15-year banking career, I have seen two or three periods of time when there were a high number of loans being worked out. Given the number of job postings for financial specialists who handle these cases, I suspect that in today's marketplace we are in short supply of qualified workout professionals.

For any small business today, it is helpful to understand what happens when your loan is "classified" and subsequently placed in the workout department of your bank. When a bank believes your business has a substantial chance of defaulting on the loan, it has a duty to its shareholders and its regulating agency to protect its interest in your loan. Signs of possible loan default initiate the procedures for a loan workout.

A classified loan is one in which the bank has a shortfall of available collateral, and for which the loan repayment history has not been stellar. The bank moves the outstanding total of all classified loans to a special place on their balance sheet. They are required to maintain reserves of 100 percent of the loan in anticipation of the bank suffering losses on that loan. Essentially, the bank must tie up 100 percent of your loan balance in a reserve for losses. Because reserving for loan losses negatively affects the bank's balance sheet, this is something the bank does not want to do unless it believes it has no alternative -- or in the case where banking regulators require the loan to be classified.

Another occasion that may trigger a workout process for a loan is a bank acquisition. When banks acquire other banks, one of the first things they do is examine the loan portfolio of the acquired bank. Sometimes your loan can be "unclassified" in the first bank and then change to being classified in the second. The acquiring bank is quicker than first bank to classify a loan because 1) it didn't originate it so it doesn't suffer the stigma related to having a high percentage of classified loans; 2) the originating bank didn't use underwriting standards that were as tough as the acquiring bank in evaluating loans; 3) you failed to comply with all the loan covenants such as providing the bank regular financial reporting; 4) you are showing a significant loss and the bank cannot see how you are going to turn a profit in your business.

The first thing you should know about loan workouts is that it's important to stay out of the loan workout department if you can do it. Make sure you are complying with all the loan covenants you can accommodate. If your loan covenants require you to submit your interim financials monthly, get them to the bank by the specified date each month. Know your financial ratio covenants, and calculate them yourself each time you prepare interim financial statements. If you fail to meet a certain key ratio, prepare a memo to the bank explaining why you missed the ratio and your plan for getting your ratios back where they should be. Seeing an improving picture of your business makes bankers feel more comfortable. They will work with you much more easily than when your business circumstances continue to change for the worse, without explanation or commentary from you.

There are other measures you can take to help your circumstances when times are tough for your business:

• Communicate regularly with your banker. Don't give them too much detail, but make sure they know you are working very hard to improve your financial picture. Provide them concrete examples of your actions and plans to turn around.

• Do everything you can to speed up your accounts receivable collections to improve cash flow.

• Try to never miss a payment to the bank. The fastest route to foreclosure is to get 60 days past due on your loan. If you are going to be late on a payment, let your banker know in advance and tell them when the payment will get there. Make sure you get it there when you promise.

• If your total debt service is too high, first try converting accounts payable into notes payable. Many trade vendors will do this if they think it is in their best interest. They will rarely wait over 12 months to be repaid the current A/P you owe them, but this negotiation helps. Make sure you show the A/P as being current, on your balance sheet, according to the new arrangements.

• Consider employing a contract turn-around specialist. The best organization of turn-around specialists is the Turnaround Management Association. (TMA). They have a comprehensive list of members sorted by location. Turnaround specialists won't be cheap, but if your situation is complex and may require loan restructuring, turnaround people can help move quickly to assist you in getting your business back on track.

• If you need to consult a bankruptcy attorney, don't announce it to the bank or anyone else (other than your CPA or corporate attorney). It is important that the bankruptcy filing occur before the bank moves to foreclose.

• Trim your owner's draw or distributions to the lowest level you can. Don't take long vacations or buy expensive luxury items while your company is having trouble. Nothing will irritate a banker more than seeing you spend personal money on non-essentials while your business is in trouble.

The good news is that banks do not want your loan to be classified any more than you do. They completely understand that the best way to get their entire loan repaid is for you to stay in business and work through your company's problems. They also know that if they have to foreclose on and liquidate their collateral (other than real estate), they are not likely to be fully repaid.

A successful loan workout is one where both the bank and the business win. The bank receives full repayment for their loan and your business pushes through the tough times to open its doors for another day, stronger and more experienced.

You may contact Sam directly at: sam@lesliethacker.com

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 EXTRA: If you have questions for Sam regarding business financing, the credit market, and similar issues, please send an e-mail. Your questions will be recorded and Sam will answer the best ones in his Ask the Expert podcast show.