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.