Tip of the Week
Tracking a Loan Default - Then what?
A loan default usually evolves through many stages. At each stage both the borrower and lender are trying to figure out what their next action or inaction will be and what is likely to happen as a result - "Then what?"
Often, the first signs of a loan default will not be apparent in a financial statement or tax return. Those reports are like "looking in the rearview mirror". They only show where the borrower has been - often way in the past as in the case of a tax return that may have been filed many months after the close of the fiscal year (due to an extension).
The first signs that the lender may see of an impending default are usually more pragmatic:
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Late payments
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Borrower won't return phone calls or respond to other attempts to contact
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NSF checks and overdrafts
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COD on trade credit
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Inquiries from landlord and/or trade creditors or trade bureaus
So, if the lender sees these telltale signs, "Then what?"
From the borrowers' perspective, they often do not even realize the degree of trouble they are in until someone or something "confronts" them. These could be things such as:
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Checks get returned NSF
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Unable to meet payroll on time
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Supplier invokes COD terms
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Landlord initiates eviction proceedings
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Borrower receives notice of a tax lien
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Bank account is levied by state or IRS
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Borrower is forced to decide who to pay and who not to pay
At this point, the borrower may not fully comprehend the consequences of their decisions but has to be thinking, "Then what?"
If possible, the lender and borrower need to communicate, discuss the facts and circumstances and decide whether there is potential for a workout or not. See the Tip titled "WORKOUT OR LIQUIDATE" from November 2009. Which ever conclusion is reached, it will still lead to a "Then what?" for both the borrower and the lender.
If the conclusion is to try to work through the problems, there should be benchmarks established for borrower performance. The circumstances of each situation differ and will determine how specific or general such benchmarks should be. The circumstances may only call for short-term verbal agreements about certain aspects, or the situation may call for a detailed forbearance agreement. (Regardless of how general or specific the arrangements with the borrower may be, the lender should ALWAYS document discussions and agreements thoroughly in a credit memo or a chronological log.) As each benchmark is either completed successfully or failed, the outcome should lead to another "Then what?"
On the other hand, if the conclusion is that the business - and continuation of loan payments - is not sustainable, plans must be made for how the business will be concluded - including whether it will be done cooperatively or forcefully. Each step involves a decision-tree with the outcome of each decision leading to another "Then what?" If the borrower is not communicative and cooperative, the lender is left with the options provided by the loan documents and local statutes, such as replevin or foreclosure actions. Filing a legal action by the lender might prompt the borrower to reevaluate their position and possibly take steps to reinstate the loan. "Then what?" Or, legal action might cause the borrower to hide or damage collateral. "Then what?"
Perhaps the underlying point here is that the lender needs to "Begin with the end in mind" but be nimble as twists and turns come up along the way. It is primarily the responsibility of the lender to be prepared to respond to circumstances that will arise along the path of trying to resolve a loan default - whether through remediation of the default or by protecting and liquidating collateral, pursuing guarantors, etc. Such actions must be timely, reasonable, and consistent with prudent banking practices to protect the SBA guaranty and protect against the potential of lender liability claims.
sbaAccess specializes in helping lenders take the "curves out of the road" by providing timely, relevant advice based on many years of experience of lending "The SBA Way". Call us to arrange a free consultation or email us with the issues that might cause you to say "Then what?"
Take the Right Approach
John Cumbey, Brian Burke and Karen McHugh
SBA Access ©2009 - All Rights Reserved
All content is copyrighted and unauthorized use is strictly prohibited. If you would like to quote any part of this text, email bburke@sbaaccess.com or kmchugh@sbaaccess.com for permission.
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