Workout: Making the Best of a Bad Loan Situation

By Maureen McCarthy

Like a high tide rolling in, or flood waters pouring over the banks of a river, liquidity flowed abundantly during the early days of the COVID-19 Pandemic. We were awash in cash. Paycheck Protection Loans and other stimulus cascaded through banks filling the deposit accounts of businesses desperate to stay afloat. In those early days, as the nation abruptly shut down, many lenders readily modified loans, granting short term (90- or 180-day deferrals) and looked past the pandemic, ahead to recovery and conditions returning to what everyone hoped would be the “old normal”, or at least a benign “new normal”.  Many businesses that otherwise may have failed survived, at least for the time being.    

But as those initial frenzied days of pandemic responses fade into the past, instead of making PPP loans bankers are focusing on forgiveness (or perhaps “unforgiveness” or “some forgiveness”), and unwinding “panda” deferrals that are already maturing.  As the liquidity subsides the question now is, what will portfolios look like as the tide goes out and floodwaters crest and subside? If shipwrecks, or those foundering and struggling to stay afloat, reveal themselves, then what? And, how will it all work out?

Loan workout can be tricky, challenging, stressful, and rewarding all at the same time.  Some say it is also an incredible opportunity to gain a lifetime of experience in a compressed timeframe, ultimately making one a better lender. Those who have done it will tell you there is no substitute for the learning and insight one gains from navigating problem loans and finding the best course of action for an optimal outcome. For this reason I interviewed loan workout professionals and asked them to share their perspective and expertise on how to make the best of a bad loan situation.    

Meghan Breuer is a highly experienced Senior Workout Specialist at Brookline Bancorp who has also served as a commercial lender and Loan Review Officer. Meghan currently concentrates on the resolution of problem C&I loans, having previously focused on loans secured by commercial real estate (CRE).

Senior Credit Risk Manager Richard Dunn is a seasoned workout expert (a veteran of the ’08-’09 financial crisis) heading the Managed Assets Group at Bank Rhode Island. Rich was previously a commercial lender specializing in SBA and C&I lending.

McCarthy: What is a loan workout? How would you describe its purpose and nature?

Dunn: I think of a loan workout professional as loan officer whose primary focus is on loss mitigation in the face of a problem loan.  Ideally the workout officer will be successful in preventing a loss to the lending institution, but in some cases that may not be possible. So I would say that for a workout officer success is measured by whether the outcome is the best it could possibly be. This can be accomplished in a variety of ways, depending on the circumstances. Sometimes it involves working with the borrower to restructure the debt so that it better matches the needs of the borrower; other times it could be managing through exiting a relationship or by a transition to another lender or perhaps the sale of the business; and in a more extreme case it can require legal action, such as insolvency strategies or foreclosure to liquidate. 

Breuer: I would add that problem loan workout officers provide valuable support to the front line lending groups.  Workout situations can be (usually are) very time consuming and protracted, something that could consume a lender and distract them from business development or managing the rest of their portfolio. Problem loans often require a lot of energy and attention, much more than a healthy account. For example in the case of a C&I loan to an operating company this typically includes close monitoring of cash flow projections and deposit balances (especially if there are overdrafts); borrowing base certificates for inventory and receivables; and frequent discussions with or visits to with the borrower. And that’s not even counting time spent with attorneys; appraisers; field examiners or other 3rd parties.

So as not to risk liability, a lender can never make operating decisions for the borrower or direct them in the running of the company. However, discussions, focused on the borrower’s obligations to the lender can sometimes be a catalyst for improvement and preclude the need for more serious legal remedies.  Workout specialists are not miracle workers, but their experience, specialized technical skills, and role as a dedicated resource, can make a big difference in minimizing losses and achieving a positive outcome.

McCarthy: When should a loan be transferred from a front-line lending division to a workout specialist? What triggers this decision? When is a loan considered a “problem”?

Breuer and Dunn: The simple answer is, when the loan has become a problem, which would generally be when the risk rating becomes OAEM (Other Assets Especially Mentioned) or worse. However, when a credit begins to show signs of weakness (for example frequent delinquent payments, chronic overdrafts etc.) the loan officer might want to consult a workout specialist. Early attention and problem loan workout skills can help to prevent (or at least reduce) diminution of collateral or other deterioration of the lender’s position, and ultimately determine whether there will be a loss given default. Timely action can potentially make the difference between a charge-off and a loan paid in full. We encourage lenders to reach out to a workout specialist sooner rather than later if they have a concern.

McCarthy: As we begin to face the fallout of the COVID-19 pandemic, what would you want to tell your younger self, or lending professional who just getting into a problem loan workout role?

Breuer: Always start with the legal documents, as soon as you take responsibility for a problem loan.  These documents establish obligations of the borrower and rights of the lender.

  • Confirm that the loan was closed as approved. If not, review any adjustments or change memos that detail differences between the credit approval document and the closing documents.
  • Identify any documents that are missing or have deficiencies. Seek to cure any problems with the documents during discussions with the borrower – as early as possible. Borrowers will often be most cooperative early on when everyone has something to gain, especially if the borrower is asking for understanding and relief from the lender.  
  • Look at the Guarantees. If there is recourse is it full and unconditional or limited? Are the guarantors strong with healthy assets and ready access to liquidity?
  • Understand the details of any covenants, for example get to know requirements for submission of financial reports, and (if applicable) the nuances of requirements for borrowing base certificates.   

Dunn: In addition to the legal documentation, perform an overall review.  Take stock of where things stand.

  • If the account was transferred to you, start with a discussion with the previous relationship manager. Front line lenders typically know their customers really well, sometimes and can provide valuable background about the business; principals, and management. Gain insight into what’s important to them, how they conduct their business and communicate, and the unvarnished story of what is actually going on. But also remain independent, some loan officers have worked with their borrowers so long it may sometimes be difficult for them to be objective.
  • Review the financial statements. Request updated financials, especially if the ones in the file are stale or not representative of current circumstances.   
  • Evaluate the borrower’s liquidity. Consider requesting a 13 week cash flow analysis to determine whether the borrower can continue to operate in the short term without additional help. Review their overdraft history. Determine whether the lender would be in a better position by making additional funds available.
  • If the loan is secured by real estate, check property tax records. Have municipal liens compromised the lender’s position and diminished available collateral?

Breuer: Have a plan, a clear strategy.  Some loan officers tend to immediately execute a forbearance agreement. Don’t move too fast or rush into anything unless there is no other option. Take time, if you can, to get the facts (verify everything), understand the situation and map out a path to an optimal outcome. Remember this is a negotiation between the borrower and the lender. There may be an opportunity to strengthen the bank’s position and mitigate risk of loss – consider requesting more collateral, additional and/or stronger guarantees, or perhaps covenants (for both the business and guarantors). The lender has the most leverage when the borrower is requesting a concession or other help.

McCarthy: What is it like working with a troubled borrower? What do you find works best in communicating with them?

Dunn and Breuer: Every situation is different.  There is no single playbook. People are different as are circumstances. Some borrowers are extremely cooperative and helpful, others can be uncooperative and even uncommunicative (yet interestingly this doesn’t necessarily determine the ultimate outcome or loss). We have found the following helpful:

  • Communicate what the bank is thinking and maintain open lines of communication. If the account was recently transferred to the workout officer it provides a great opportunity to change the tone (if needed) and establish a more positive dynamic.
  • Clearly establish what is acceptable or not acceptable, and establish boundaries.
  • Provide an honest assessment.
  • Your message might not always be what the borrower wants to hear, it is important to remain professional, and don’t take anything personally – do your job. Sometimes a borrower may be seeing their entire livelihood and life’s work at risk and it may be extremely difficult for them. Some may be not able to fully acknowledge or accept the reality of the situation.  Others may react emotionally and express frustration or even anger, don’t be drawn in or distracted by drama – keep calm.
  • Discuss solutions and potential alternatives, for example is the bank willing to stay with them and work through the problems, or might it be better for the borrower to go elsewhere to another lender.
  • Be careful of oral communication, so there is no misunderstanding.  I like to have borrowers sign a document up front confirming they understand that any agreements will be in writing, this prevents any “but you said….” argument later. 
  • Don’t ever (ever) make promises you can’t keep.
  • Keep good records of communication and correspondence. Document everything.
  • If someone is uncooperative (and that can happen) sometimes it is easier to work through a 3rd party, such as an attorney. Often a letter from an attorney (rather than a discussion with a workout officer) can be helpful. 

McCarthy: You have mentioned legal counsel, at what point do you bring in an attorney?

Dunn and Breuer: At risk of being repetitious, every situation is unique and it really depends on the circumstances, however, some trigger points could include the following:

  • The borrower has filed for bankruptcy protection.
  • The borrower is uncommunicative, uncooperative or adversarial.
  • The initial assessment indicates things are very serious, for example the borrower can’t or won’t provide financial statements or comply with covenants such as submitting timely borrowing base certificates.
  • If there is evidence of fraud, theft, inappropriate conveyance of collateral, or other activities of a suspicious or potentially criminal nature – these may also require law enforcement involvement.
  • When modifications to the original loan terms are needed, typically the original closing attorney would be asked to assist given their familiarity with the legal documents.
  • In cases of foreclosure or where the lender seeks to take physical possession of records, collateral, etc.

McCarthy: What do you like about workout? What keeps you doing this? Is there a favorite experience or success you could share?

Dunn: I especially appreciate the opportunity for creativity and the sense of accomplishment from preventing or minimizing losses and maximizing recoveries. Interestingly one of the cases I am most proud of was not one where a loss was completely avoided (there was a loss) but I knew that we had gotten the absolute best result possible for the bank – nothing was left on the table, we got it all and maximized the return on assets - I was confident that no one could have done better.  

Breuer: I enjoy the creativity as well.  It is very satisfying to get through a difficult period and see a positive outcome. For example I think back to a situation where we worked through a restructure with the borrower and they turned the corner and improved to the point where the risk rating could be upgraded and the credit was returned to the line. The borrower is still happy with the bank despite having to go through a very difficult time. They viewed the bank as an ally who stood by them.  I did what I had to do to protect the bank’s interests but also preserved a relationship with a good customer.

McCarthy: Any parting words?

Breuer: Having the chance to serve as a loan workout officer provides a great opportunity for growth. Every aspiring or rising loan officer could benefit from the experience. It makes you a better loan officer, more careful, attentive to the details of loan structure and appreciative of the importance and value of well-written legal documents.  You start to look at it from the end, just in case some day you need to make the best of a bad loan situation.

Maureen R. McCarthy is an SVP and Director of Corporate Credit Policy at Brookline Bancorp, a multi-bank holding company headquartered in Boston, Massachusetts. She is also a member of the RMA Journal Editorial Board. She can be reached at MMcCarthy@brkl.com

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