Problem loans. The last step in the loan process is monitoring the loan. However, that does not mean that it is the end of the road, as the bank still has much work to do to ensure the loan is serviced and repaid on time. Once the loan has been made is in syndication, the banker has work to do. The borrower, according to the terms of the loan, will be submitting quarterly financials to the admin agent for distribution. We always hope that the company is meeting projections and expectations, but occasionally, this is not the case. Once covenants are tripped, the bankers will work to restructure the loan if possible so as not to jeopardize the entire loan. This might mean lightening the amortization schedule or forgiving a covenant breach in exchange for another concession. This will hopefully get the loan back on track. However, sometimes there is nothing a banker can do to help turn around a downward trend and in that case, the loan goes to workout and may eventually have to get written off. In the first module, we discussed what happens when banks have to write off loans. As a loan continues to underperform, the riskier it gets. This increased riskiness will require the bank to hold more capital against it to protect against loss. As capital requirements increase, so does the cost of the loan to the bank. The only way to offset this is by increasing fees or interest income. Once the workout team is taken responsibility for the loan, raising interest rates is usually high on the agenda, even though that may seem counterintuitive to a credit already having trouble making payments. The workout specialist is not a relationship manager or a client banker. The wining and dining of the client days are over at this point. The chief responsibility is to protect the bank's balance sheet. The borrower will not always understand why the loan is in workout and will often ask the banker for more time or money, both of which has become very expensive from the banker's perspective as the risk has gone way up. Nevertheless, there will be an attempted negotiation. Banks will have to consider designating the loan non-performing, causing a double whammy to the bank's bottom line. Once the loan is non-performing, the bank can no longer recognize interest revenue, as all of the payment from the borrowers go to reducing the capital. The loan then moves to the highest risk spectrum, requiring more capital and attention, which is more expensive to the bank. In general, for a loan to become non-productive, non-performing, it has to be in arrears for 90 days. Regulators are also putting pressure on the banks to identify risky loans, so as not to have capital shortfalls when loans ultimately go bad and have to be written off. These workouts are challenging, but they can be productive and they do not necessarily have to be adversarial. Occasionally, due to the changing outlook on an industry or sector, a loan can get moved to workout without a payment being missed or a covenant being breached. This can be hard for a client to understand, but the bank must take all necessary steps to protect its capital.
