As the result of the corona virus and resulting economic fall-out, a number of commercial/agricultural borrowers may struggle to perform on their obligations and thus require loan restructuring to continue in business. This article is thus intended to provide advice and guidance to lenders who may not have faced these challenges to date.
While distressed loan servicing may pose significant new challenges, if addressed on a structured approach, it can significantly reduce risk, facilitate timely correction of borrower loan defaults and may ultimately contribute to strong customer loyalty.
To begin, distressed loan servicing should be approached as a new credit decision to an existing borrower with significant credit weaknesses. Thus lender due diligence needs to be as thorough, if not more so than due diligence for a new loan to a new borrower. Thorough due diligence is required to ensure the full extent of borrower credit weaknesses are identified and credit risk is reduced through appropriate loan restructuring. This will also help ensure debt restructuring does not contribute to delayed collection action and compounded credit risk. As a result, updated and verified credit information should include the following as applicable:
- Updated and verified borrower income and financial information,
- Verification of all borrower debt obligations, not limited to in-house obligations,
- Updated verification and valuation of all chattel collateral,
- Updated RE collateral appraisals as needed.
Updated information would thus form the basis for any proposed restructuring or collection action as needed.
In addition, a “Loan Restructuring Policy” is recommended to help ensure distressed loan servicing is consistently addressed by applicable lending staff and results in timely restructuring and/or collection action. Loan restructuring policy should include the following:
- Designated lending staff to handle distressed loan restructuring,
- Specific delinquent loan contact requirements, to include borrower personal and/or phone contacts,
- Required timelines for obtaining updated borrower credit information,
- Defined timelines for credit classification changes, accrual status changes and allowance for loan loss adjustments,
- A distressed borrower letter template, which includes the following;
· Specific notice to the borrower that they are distressed and required to respond to the notice within a specified and reasonable timeframe, i.e. 45 days,
· A detailed list of information the borrower is required to submit with their response, i.e. current income and/or financial information, etc.
· Borrower’s proposed loan restructuring/servicing action to address correction of existing credit weaknesses,
· Specific contact information identifying the credit officer responsible for serving their account.
This distressed loan letter will help ensure distressed borrowers are dealt with timely and consistently, thereby helping to restore borrower viability whenever possible and instituting collection action when required.
Additional distressed loan servicing procedures are recommended to include the following:
- Review of existing loan legal documentation, to identify potential deficiencies and ensure correction through any restructuring action,
- Identify local legal counsel with collection experience to be consulted for legal advice on collection actions involving bankruptcy or foreclosure.
While legal collection action (bankruptcy and foreclosure) is considered the last alternative for collecting defaulted loans and may be expensive, legal advice for these actions may significantly reduce ultimate collection costs.
Bottom line, a well-structured distressed loan servicing process will help restore borrower viability on a timely basis, significantly reduce credit risk and contribute to significant borrower loyalty.
Randall Pownell is a semi-retired agricultural banker and credit examiner. He has over seven years of managing high risk agricultural accounts with Farm Credit Services. He has over 32 years experience as a credit examiner and financial regulator.