Commercial Loan Guarantees

Phil Love  phil.love@pactola.com   

One of the differences I had to get accustomed to when I came to credit union land were requirements for guarantors.  On the banking side of the fence, guarantees were not a regulatory issue.  Oh, we almost always got them and the only way we would look at a deal non-recourse would be if it went to the secondary market or if we received other concessions to entice us to not require a guarantor on a loan.  Another time we would look at non-recourse lending was if we had a project that had very strong cash flow that would exceed the loan term or amortization. 

At that time in my career, guarantees on a loan seemed more common loan sense than a matter of regulation.  Credit union regulations have a clearly defined set of requirements for loan guarantees.  These are required, unless you have other guarantee stipulations with certain government guaranteed loans.  Section 723.7(b) states principals, other than those in a not-for-profit organization as defined by the IRS Code or where the Regional Director grants a waiver, must provide personal liability guarantees for the commercial loan.  Some have read this to mean that any natural person with ownership in a company, no matter how small that ownership portion may be, must provide a personal guarantee.   

But a reading of that one sentence in the regulation and guidance, without an understanding of the whole regulation is “lucky-dipping”.  This is a Missouri term we used to use when someone picks out one sentence or item in a much larger document and bases an opinion on that one item, even though it may contradict the whole.  Whatever you come up by sticking your hand at the bottom of the lake, no matter if it a catfish or a handful of mud, you cannot assume the entire lake consists of whatever you pull up. 

A Supervisory Letter titled, Evaluation Credit Union Requests for Waivers of Provisions in NCUA Rules and Regulations Part 723, Member Busienss Loans (MBLs) provides further clarity on the subject.  In reading on page 10 of that document the definition of who has to guarantee is outlined as “one or more natural persons who have a majority ownership interest in the business organization (borrower) receiving the loan.  For a corporation, this will be one or more shareholders having a majority ownership of the organization.  Natural person partners having a majority ownership in the partnership must each guarantee the full amount of a loan to a partnership.”   

The next key is to define what is a majority?  This is necessary to find out who will have to guarantee.  Majority is a majority of all classes of ownership.  This could be general and limited partners in a partnership, or common and preferred stockholders in a corporation.  So you have to have at least 50.1% of the people in ownership provide a full guarantee on the loan.  This can get more complicated if a part of your ownership group is a company or a series of nested entities.  Then you need to drill down through the different layers of ownership in the company to determine exactly who will need to provide a personal guarantee.  Also you should be getting corporate guarantees for each level of ownership as well.  Page 11 of the document is a wonderful resource and provides an example in a chart of who and what entities need to sign. 

I would add that as a practical matter, even if the controlling partner or stockholder has a minority ownership percentage, the officer should get the guarantee from that person.  It only make sense to have guarantees from those that control the entity.  Another idea is to get a guarantee from anyone who has 20%+ ownership; this follows rules found with the SBA and Rural Development.  A final practical idea here I will advance is to get the guarantee of those strongest financially, even if they have a minority of ownership.  At the end of the day, you want your loan to be paid. 

What does a “guarantee” actually mean?  The guarantor must provide a payment guarantee, meaning they will make the entire payment under the terms of the note.  The guarantee should be full, meaning it applies to all the amount of the borrower’s indebtedness, past, present, and future, to the lender.   It should be joint and several, so the lender can pursue one or all guarantors for the payment or full amount of the loan. 

 With some cases, it is my opinion that you should always require a guarantee on the loan.  An example would be a construction loan.  Construction loans typically have more risk.  If you have a small company that wants to avoid guarantees on this type of loan and have you bear all the risk, you should be extremely careful.  It would be as if the customer is expecting you to bear the risk as a general contractor. 

If you want to deviate from the guidelines, you will need approval from the NCUA.  The reasoning should represent sound credit underwriting and not just, “I have to do it to get the deal.”  The guidance letter lists the following factors that should be in place for all guarantee waivers:

·         Creditworthy borrower

·         Superior DSCR

·         Positive income and profit trends

·         Strong balance sheet and conservative debt-to-worth ratio of borrower

·         Easily marketable collateral

·         Low LTV

·         Long relationship with the customer (5+ years)

Note that often waiving a guarantee will require additional monitoring going forward.  The minimum additional steps you must take are:

·         Well defined financial loan covenants

·         Increased regular financial reporting that include:  annual tax returns, quarterly management-prepared financials, annual GAAP prepared financial.  The frequency can increase if necessary

·         Well defined reporting covenants that outline penalities if the financial reporting is not done promptly

·         Site visits at least yearly and more often if needed

If you are considering waiving a guarantee, consider some alternatives like requiring limited guarantees.  Some deals I have been a part of had pro-rata guarantees that were limited to a certain multiple of a percent of the ownership the individual had.  An example would be with a 150% of ownership guarantee, an owner of 25% of a company would provide a guarantee of 37.5% of the debt.  As an aggregate, you would have total guarantees equal to 150% of the debt, though you would not be able to collect that entire amount from any one guarantor.   

Releasing guarantors should also be done with care.  The lender should make sure that a release does not violate any terms of the loan type, like SBA, and that the release will not produce a violation to any regulations.  In my career, I have only seen releases occur with two different circumstances.  The first occurred to release a spouse of a deceased partner.  The company had buy-sell agreements in place to take care of the estate and the wife transferred any ownership she had to the remaining partners.  The second occurred after a property was built and stabilized that had a long-term credit tenant in the property with a lease term that exceeded the amortization on the loan.

Problem Loan Management

Phil Love  phil.love@pactola.com

The last recession we went through in our country, not counting COVID, was in 2007-08.  That is 15 years ago.  When you look at your financial institution, consider how many of your lenders have been in the industry less than 15 years.  New lenders in the industry (and for that matter old lenders) have focused on generating large loan volume.  Liquidity was everywhere.  Rates were low.  Competition was fierce for loans and concessions were being made in underwriting, lower rates, and looser structure.  Loan officers are hired as how successful of a producer they are and not how well they manage a portfolio.  This is how we have been conditioned as an industry.

Even though we are not technically into a recession, the signs abound for problems ahead.  Some of these are the inverted yield curve, high inflation, increased regulatory burdens, raising vacancies, and lower debt service coverages.  We are bound to begin seeing more loans in 2023 that are will be moved to a watch or problem status as companies will not be able to adequately service their debt obligations. 

If we are going to see more problems in our loan portfolios, is your institution ready to manage this?  Many on your team have no experience with managing loans in these conditions.  What are some practical strategies can you use right now to navigate through these times?

Begin with using each problem loan as a learning experience.  One bank I worked for required that you write a “spilled milk report”.  We had to identify what happened and when.  Was there a problem in underwriting?  Did we cut any corners?  Was there a problem after the loan was closed?  Did the business have a huge downturn after closing?  What caused the business to fall?   Answers to these questions then were used to see if changes needed to be made to loan policies and procedures. There could also be lessons for how to monitor and service the loan. 

Not only is each problem loan a learning experience looking back from the time of the credit became challenged, but it is something to continue to learn from in managing the problem to either improve the credit, remove the credit from the financial institution (FI), or foreclose on the collateral.  Each new problem credit offers new lessons.  Over time, these can be amalgamated to create some best practices that help in managing new problem credits when they arise. 

Next, remember that each problem commercial credit has people that are involved in each business that is your problem borrower.  The best outcome for a problem loan occurs when you have the borrowers and guarantors working with and open to communication with the lender.  Borrowers will go through a wide range of emotions when their business is not doing well.  Your goal is to help them get through the feelings to work for the best outcome that allows you to have the highest probability of recovery.  I have taught about the grief cycle and how this applies to a business or farm that is failing.  The borrower getting to the last stage of this process is the best hope you have to be made whole.

Then, consider the team you have around you in managing these credits.  You may have an individual who is not cut out to work with problem borrowers.  Having them involved may do more harm to the FI than utilizing someone else.  It is why you have certain people involved in consumer collections and others do not touch this. 

Theoretically, the field officer on the account should be the best at identifying problems and working the borrower through them.  There are sometimes that the officer is too close to the borrower to be objective about the lending situation.  What do you do when your borrower coaches your son’s baseball team, is a deacon in your church, and is a member of the same Rotary Club as you are?  Perhaps, you may be too close to the borrower to make hard objective observations and actions to best manage the credit. 

Sometimes we found it more effective to transfer the problem credit to a different loan officer who is not in the community or tied to the borrower.  Sometimes in rural ag banks, they transfer officers to different locations who are not tied to the community to work with the problem borrowers.  In larger institutions, the problem loan is transferred to a special asset group (SAG).  This group is run by experienced people in managing problem credits.  At times, others outside the FI are used such as attorneys, title insurers, appraisers, and auctioneers. 

If your FI does not have experienced team members to manage problem credits, consider bringing in an outside expert.  We have a team of retired banking regulators and senior credit professionals who can help you in identifying and managing through problem credits to minimize any potential losses in your portfolio.  Based on the findings, we can help identify any areas of your policy and procedures that should be revised.

Guarantor Considerations

Rod Werhan  rod.werhan@pactola.com

Do the lenders at your credit union or bank know the common risk management expectations related to obtaining a loan guaranty? Does your loan policy provide appropriate guidance relating to guarantors? The NCUA has a regulation that credit union Member Business Loans (MBLs) generally require the personal liability and guarantee of the principal. In addition, credit unions are required by regulation to have a comprehensive written commercial loan policy and it must address guarantor financial reporting. In this article, I will focus on some of the specific items your loan policy should cover in relation to guarantees, financial information you should obtain, and the type of financial analysis you should do. 

“A guarantor from a financially responsible party can help to ensure a loan is repaid. A guarantor may be able to preclude a loan from being classified or reduce the severity of the classification.” The above statements were made in the Policy Statement on Prudent Commercial Real Estate Loan Workouts put out by the Federal Financial Institutions Examination Council (FFIEC) in 2009. The NCUA is a member of the FFIEC. That policy statement goes on to state the attributes of a financially responsible guarantor include: 

• The guarantor has both the financial capacity and willingness to provide support for the credit through ongoing payments, curtailments, or re-margining. 

• The guarantee is adequate to provide support for repayment of the indebtedness, in whole or in part, during the remaining loan term.  

• The guarantee is written and legally enforceable.

Your credit union’s loan policy should have a section that addresses guarantors including the requirement to get a guarantor or seek a waiver as outlined in 12 CFR Section 723. The loan policy should include a description of authorized guaranty types, requirements for receipt and ongoing analysis of guarantor financial information, policy exceptions standards, and documentation requirements. 

When you initially underwrite a loan that has a guarantor, you should analyze the guarantor’s global financial condition and global cash flow to determine the strength of this secondary source of repayment. To do this analysis, you may need more than a personal financial statement and tax return from a particular guarantor. In some cases, you will also need to obtain statements of liquidity, or obtain information about a guarantor’s other projects by obtaining K-1 schedules or even operating statements on other projects. You will want to make sure you understand a guarantor’s contingent debt obligations as part of the evaluation of the borrower’s global financial condition. Not doing a sufficient analysis of a guarantor could be criticized as a loan administration weakness by credit review or the examiners. 

Some of the items you should consider when performing a guarantor analysis include looking at the legal structure of the borrowing entity and the guarantor's relationship to it; evaluating the guarantors asset valuations; verifying the guarantors liquidity; determining sources and amounts of recurring cash flow; evaluating actual and contingent liabilities; and reviewing any other factors necessary to demonstrate capacity to support the loan.  Some of these other factors may be any contingent liabilities or other businesses the guarantor has which can weaken his ability to support your loan as a guarantor.

Your initial analysis of a guarantor should be done when you first underwrite and approve a loan. As mentioned above, your policy should dictate what type of ongoing analysis is necessary. At subsequent loan renewals or during annual loan approvals you may not need to do a detailed analysis. If the loan is performing well and is of high quality, has good prospects for the ongoing primary repayment source, and sufficient collateral coverage then detailed financial analysis of the guarantor may not be required. In addition, it may not be necessary to do more than a cursory review of a minor guarantor’s financial conditions if they are not a significant part of a loan’s repayment prospects.  

When you obtain a guaranty, you are presuming the guarantor is willing to honor it. If the loan deteriorates and becomes reliant on the guarantor for support, then the guarantor must demonstrate support in some fashion. If that does not happen, then the risk rating on the credit should be determined as if there is no guarantee in place. 

The concepts presented in this article are outlined in various regulatory guidance. 

Rod Werhan was a career National Bank Examiner with the Office of the Comptroller of the Currency who retired in February 2020 after more than 36 years of service. His credit experience includes examining commercial and retail lending in community, mid-size, and large institutions. 

The Upcoming Commercial Real Estate Hurricane

June through November is the Atlantic hurricane season.  This is typically when most hurricanes form in the Atlantic Ocean or Caribbean Sea, and then often wreck terrible destruction on the continent and islands of North America.  Meteorologists are constantly looking at formation of storms, ocean temperatures, winds, and other signs to spot these destructive storms as early as possible to give adequate warning to save lives and property.

As I look at the current temperatures of the commercial real estate market, look at the pressures surrounding it, consider the winds of change, and view the industry from an overall level, I must say that we are on the edge of a possible catastrophic storm in the CRE market.  What we do not know is if this will be a small category 1 tropical storm or a major category 5 hurricane.

There are several signs to look at.  The first is obviously the current interest rate and lending environment.  In 2000, during the throes of COVID, Fed Funds rates were 0.25%.  This rate was also where Fed Funds sat from 2009-2016.  All institutions were overflowing with liquidity as people took government payments and help and stashed these with their local financial institution.  Many of these credit unions and banks invested money into treasuries and agencies, locking rates of 10 years below 2%.  On the CRE side, it was not uncommon to start out with rates below 4% for a period of 5 or even 7 years.  Traditional margins we used in repricing loans were squeezed. 

In February 2023, Lightbox reported that over $1 trillion of CRE loans will come due or be repriced in 2023 and 2024.  2025 has another estimated $425 billion of maturities coming up.  When you consider a simple $1 million CRE loan on a 25-year amortized payment, the difference between an initial 5-year rate at 3.50% and a current rate at 7.00%, results is a payment increase of 34%.  How many of these projects will be able to adequately service their mortgages with the new rate increases?

In some cases, the lender will require the owner to pay down the debt and the borrowers will have the ability and willingness to do so.  Could these paydowns be used by the lenders for new debt?  Probably not.  Emerging Trends in Real Estate Survey reveals that 71% of the investors are reporting “more rigorous” debt underwriting standards in 2022 compared to only 18.6% seeing harder standards in 2021.  Financial institutions (FIs) are more cautious considering new financing opportunities.  Plus, the large amount of excess liquidity in 2020 and 2021 is gone from the banking system.  Consider the Federal Reserve has been taking money out of the system with a $1 trillion reduction in the M2 Money Supply.  Many of these repayments would be used to lower the FIs’ need to borrow to fund their balance sheet. 

Lightbox tracks appraisal volume by county.  This could be a leading indicator of new loan activity.  In the first quarter of 2023, across 587 counties with at least 5 awarded CRE appraisals, 12% saw an average increase of 23% and 83% had an average decline of 47% of appraisal awards compared to the same quarter in the previous year.  This should indicate that we will see lower CRE loan volume in the near future.

The next CRE weather sign to look at is a lack of experience among lenders and regulators.  The last real recession (not including COVID) we experienced was in 2007-2008.  This means that any lender who has been in the industry less than fifteen years, has not experienced the servicing problems associated with an economic downturn.  I believe we sit on the edge of a downturn.  The Federal Reserve’s tightening to manage inflation will continue until prices begin to stabilize.  The higher interest rates, lower liquidity, inverted yield curve, and tougher lending standards, will all be factors in a tougher environment for borrowers to receive the loans they need to expand their business. 

Consider all those in CRE lending with less than 15-year experience with the retirement of the experienced gray heads who have been through multiple recessions and economic cycles.  This is a large mental drain on both the FIs and among the examiner ranks.  Experience is often the best teacher.  Lack of it could be very detrimental in navigating through the winds of problem loans. 

Just like there is typically more damage in some areas where a hurricane strikes compared to others, we will see various impacts on CRE with the current storm.  The impact will vary depending on asset classes and location.  Office buildings face an uncertain future as companies have discovered they can reduce occupancy costs and increase employee satisfaction with work from home arrangements.  I recently looked at a class A office building in California that has a 38% vacancy.  If the leases that expire in the next two years do not renew, this would increase the vacancy to nearly 2/3 of the building.  This level of empty space in a major metropolitan area of Southern California for a Class A building was unheard of prior to Covid.  Some area of retail faces challenges with the continued popularity of on-line shopping.  Multi-family should continue to be strong as we have not built enough housing stock over the past decade to meet the population increase and higher interest rates and construction costs will keep some people out of the housing market.  Self-storage and warehousing should have strength. 

The adage of location, location, location is so true when it comes to the impact on CRE.  Lower regulation and tax states such as Florida, South Dakota, Tennessee, and Texas are attracting more population and strong economic growth.  Of the ten fastest growing counties, by percentage population increase, in the US in 2022, five are in Texas, two in Georgia, and one each in Florida, North Carolina, and Washington.  The area of Texas that I live in still has new construction coming out of the ground and land being cleared for new projects. 

The negative impact of location is in areas with higher taxes, regulation, and crime.  Annamarie Dicola, CEO of Trepp, estimates that $10 billion of CMBS office loans in New York City will mature and have no option to extend.  As I write this, shopping center giant Westfield is turning over their $558 million loan on the San Francisco Centre Mall back to the lender.  After 20 years of operation, they cite the challenging operating conditions in downtown San Francisco that lead to declines in sales, occupancy, and foot traffic.  The final nail in the coffin may have been Nordstroms shutting down both its downtown San Francisco locations.  This announcement comes a week after Park Hotels handed back two prominent hotels in downtown San Francisco back to the bank. 

Kevin O’Leary, a “Shark Tank” entrepreneur, opened up a new fund to invest in North Dakota.  When asked about the location he told CNN, “I don’t put companies here in New York anymore or in Massachusetts or New Jersey or California.  Those states are uninvestable.  The policy is insane; the taxes are too high.”  We will see a disparate impact among different areas of the county and among different real estate types as the storm approaches. 

What do you do if you have a CRE loan in your portfolio that is located in a high-tax, highly-regulated area, that is in an asset class which is challenged, and a loan which you wrote in a rate at 4% which barely made a 1.20 DSCR at the time you closed the loan in 2018?  What happens when this loan reprices in 2023?  You may be in a situation where the upcoming storm may hit you harder.  The impact may be a cataphoric foreclosure and loss.

A colleague of mine who has decades of experience in the industry believes that we are in a summer lull where we are just beginning to hear of the upcoming CRE storm.  He believes that nearly all CRE lending will stop other than high interest rate loans outside of traditional FIs.  He cited a hotel acquisition he financed last week at a 14% rate.  The borrower was just happy to be able to get the loan.  He also believes that this will become one of the biggest stories in the mainstream media this fall. 

Whether he is right or not will only be known by looking back after the hurricane passes.  Only then we will know how much damage this present storm will inflict on your FI.  Today we must keep an eye on the CRE weather and prepare.

The Investment Corner :: YOAI

What is YOAI?  It’s not something that many Credit Unions have given much attention to throughout the years.  This is understandable, primarily because they’re in the business of lending to their members.  Historically, Credit Unions have placed the majority of their business focus on lending-related ratios, such as Loan-To-Share, Delinquencies, Yield on Average Loans.  Thanks to COVID, Credit Unions have had an enormous increase in deposits and liquidity.  This boost in liquidity has far exceeded the demand for loans.  Which leads to the answer to my initial question:  What is YOAI?  Yield On Average Investments, and over the past year, it’s become a much more significant metric for Credit Unions.  The liquidity that’s been ballooning Credit Union balance sheets would normally be looked at as a good thing.  Certainly, we all want to see our Credit Unions grow.  But in the current interest-rate environment, rapid growth comes with a caveat; Net Worth declines.  There are three main ways to support the bottom line and combat the impact from massive deposit growth: 

Fee Income – Ouch.  No one wants to fee their members to death and rely on that type of income to support growth

Loan Income – Generally speaking, Loan volumes nationwide have been pretty anemic since COVID began.  As stated earlier, most Credit Unions have a strong focus on lending.  As a matter of fact, most have everything they need in place to originate loans, manage loans, manage participations, and just, generally, make money from loans.  In some cases, entire buildings are dedicated to lending operations. 

Investment Income – THIS is where most Credit Unions need to focus additional resources.  Even in this historic rate environment, it is possible to generate higher yield than your peer group and enhance overall performance.  It takes some education, some expertise, and, as I said, some focus.

How do we improve performance in YOAI?  There is no ‘secret sauce’ or ‘one size fits all’ answer.  If we all had a crystal ball and knew the direction of rates before they moved, none of us would be working right now!  But the reality is . . . rates change.  The low-rate environment we’ve been experiencing over the past year has created downward pressure on overall margins.  The investment portfolio needs extra work and extra care, putting in overtime to SUPPORT the lending and deposit functions.  To do that requires a critical review of the investment policy first and foremost.  From there, analyzing portfolio structure and securities selection will play a critical role in improving YOAI.  

Tom Campbell is the Co-Founder and Managing Director at Glasgow Partners – an SEC-registered investment adviser specializing in Credit Union investments.  He leads the firm’s portfolio management function and provides guidance for Credit Union clients in the structuring of effective portfolio strategies.  He’s been active in the Credit Union movement for over 15 years, and has given presentations to the NCUA Board, numerous CU Boards of Directors, CUSOs, and several CU associations across the country.  He can be reached in his office at (610)494-1322 or email t.campbell@glasgowpartners.com

Appraisal and Evaluations: Which do I need and when?

When a real estate-related financial transaction is first made, unless it meets one of the exemptions listed in 12 CFR 722.3(a) for credit unions, it requires either an appraisal or a written estimate of market value. An appraisal performed by a state-certified appraiser is required if the transaction value is $1,000,000 or more. A residential real estate transaction of $400,000 or more requires an appraisal from a state-certified appraiser if the transaction is complex, or from a state-licensed appraiser if the transaction is not complex. Complex refers to either atypical properties, market conditions or the form of ownership. Credit unions can assume appraisals of residential properties are not complex unless the credit union has readily available information that a given appraisal will be complex. Transactions that are below these thresholds require written estimates of market value, which is another name for an evaluation.

When you renew or refinance a loan does it need a new appraisal or evaluation?

How does your credit department and lending staff determine if a new appraisal or evaluation is required when an existing loan is renewed or refinanced at your financial institution? Are there policies and processes in place that guide the staff to make the right decision? If there is not a process, your institution may make the wrong decision and be criticized by loan review or the regulators.

To begin, let me state that there are clear instances where you can use an existing appraisal or evaluation to support a loan renewal. The process you take to determine if a new appraisal or evaluation is required should be outlined in your institution’s written appraisal policies. Many lenders would intuitively consider negative changes in market conditions, deterioration in the properties condition, and/or the passage of time as possible reasons to get a new appraisal, but is the criteria clearly outlined and is the conclusion you come to documented in the credit file?

The passage of time by itself is not a reason to obtain a new appraisal. The appraisal regulation does not state the useful life of an appraisal or evaluation. Setting a certain period of time, say every one or two years, as a standalone criteria is not appropriate, although the likelihood that market conditions have changed does increase with the passage of time. Even a recently obtained appraisal may no longer be valid. On that last point, I observed an institution needing to get updated appraisals on a quarterly basis. During the great recession, changing market conditions in some markets like Phoenix required lenders to obtain appraisals as often as quarterly. An institution I was examining in 2009 had a concentration in loans in the Phoenix market and in order to prepare accurate books and records (think ALLL), quarterly appraisals were absolutely necessary.

The interagency appraisal and evaluation guidelines list the following factors to consider in determining whether a new appraisal or evaluation is necessary.

• Passage of time.

• Volatility of the local market.

• Changes in terms and availability of financing.

• Natural disasters.

• Limited or over supply of competing properties.

• Improvements to the subject property or competing properties.

• Lack of maintenance of the subject or competing properties.

• Changes in underlying economic and market assumptions, such as capitalization rates and lease terms.

• Changes in zoning, building materials, or technology.

• Environmental contamination.

Let’s consider how to apply the need for a new appraisal or evaluation on a renewal transaction. After considering the factors detailed above, your lending institution determines there has been an obvious and material change in market conditions (or alternatively the proprieties condition has deteriorated).  The loan does not include an advancement of any new monies (other than reasonable closing costs which are allowed). In this case, the existing appraisal or evaluation is no longer valid. As long as now new monies are advanced your financial institution would need to obtain a new evaluation or alternatively, they could also get an updated appraisal. However, if new money is advanced then the institution is required to obtain an appraisal.

Let’s consider another situation. After performing an assessment based on the factors above, you determine that there has not been a material change in market conditions or physical aspects of the property that would threaten the adequacy of the real estate collateral. Your institution is renewing the loan, and you are not advancing any new money. In this case you would need to support the transaction with an appropriate evaluation. There are some options here. If you can validate an existing evaluation or appraisal, you can use that, or you could obtain a new evaluation, but a new appraisal is not required.

There are other exemptions for not obtaining an appraisal or evaluation in the Interagency Appraisal Guidelines and the above examples assume none of those other exemptions apply. Regardless of the conclusion you come to, you should document in the credit file the facts and analysis used to support the decision to use an existing appraisal or evaluation for a subsequent transaction or obtain a new one.

Pactola offers lender education classes that cover all aspects of evaluations and appraisals. We would also welcome the opportunity to help you set up a sound appraisal and evaluation program or provide training to your credit staff.

Rod Werhan was a career National Bank Examiner with the Office of the Comptroller of the Currency who retired in February 2020 after more than 36 years of service. His credit experience includes examining commercial and retail lending in community, mid-size, and large institutions.

Distressed Loan Servicing - A Sign of the Times

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.

Credit Risk Review (a/k/a Loan Review): A Value or a Burden?

For over 30 years, the regulators have advocated, or required, an independent validation of credit risk.  There is a good business reason for this function if managed well.  Banks spend a lot of money on CRR and internal audit, and in today’s heavy cost, heavily regulated banking world, you need to get optimum value for every dollar spent.  But is the board getting what it needs from it to influence decision making on strategic direction, personnel management and other key lending components?

 *Are you getting a mixed message from your regulator on CRR?

*Do you view CRR as largely necessary to satisfy Regulators and External Auditors?

*What questions does your board or management team ask about the value added?

*And finally: Is it risk based?

 This article identifies common misconceptions and deficiencies in CRR functions that we’ve evaluated in our roles as former regulators, bankers, or as independent consultants.  These reflections hopefully will assist you to proactively manage your CRR function. We routinely (yes, routinely) see such weak performance of CRR that it provides no reliable validation of loan risk ratings, overall portfolio quality or credit administration.  Following are, by order of impact, major observations: 

 1.      Hiring a CRR vendor to perform the function and failing to adequately police its performance or manage the process.  This is far and away the cause of the biggest loss of value.  It is unwise to hand off planning and execution to a vendor and assume it’s handled well.  Deficiencies include:

o   poorly conceived scope coupled with weak or nonexistent risk-based focus.

o   excessive coverage.  Over time, a paradigm has evolved that more coverage is better, and is favored by the regulators.  This is false, and is causing a huge waste of money.  We now commonly see annual CRR file review coverage of 60-80% of outstandings/commitments.  Moreover, the same borrowers and categories are reviewed year after year. While it looks good to show the board, regulators and auditors, the benefit is illusory and here’s why:

§  We have found that such penetration imbues production pressure on the people performing the file work.  This leads to a rush through files and, sometimes, failure to even discuss the credits with loan officers to assure a sound evaluation of the borrower.  Our tests of this work find shallow analysis, unsupported risk ratings, factual errors in calculations leading to incorrect conclusions, missed documentation defects, poor appraisal reviews and weak collateral analyses; all adding up to unreliable systemic findings on your credit world. 

§  To put into perspective, coverage of 60-80% is typically required only when a bank teeters on failure, and the regulators require this level of penetration to verify the extent of loss exposure in the portfolio.  Conversely, a good risk based approach should not target a coverage ratio, but also should not need to exceed 20-40% per year.  This can vary by year depending on how solid your credit function is based on CRR results. 

o   Conclusion oriented observations get lost in the bulk of the thick binder that is delivered to the board by the vendor after each target.  Further, the vendor report is often full of loan portfolio statistics that simply restate what is already in the routine board reports. You are charged for information you already have.  A board member does not have time to sift through this in search of meaningful conclusions.     

o   Overall conclusions are generic statements that provide little insight on validating the bank’s credit risk management.  Worse, these often provide false comfort to the board.  The author of this article has evaluated CRR in dozens of banks over the past 30 years, often after having identified systemic credit quality, underwriting and administration deficiencies in the subject bank.  In no case did CRR ever identify the systemic problems prior to the regulator doing so.   

2.      Inattentive Board/Audit Committee toward managing the process.  While CRR and Internal Audit are designed to be independent validation tools, it is often clear via discussions with board and audit committee members that they are not focused on where the risk is when providing direction on coverage or reviewing results of work performed.  This is usually due to inadequate training of board or committee members on risk based approaches; leading to inordinate participation by lending executives in administering the process, thus diluting independence. 

3.      Using unqualified or unmotivated personnel to perform in house CRR.  This is usually present when the bank is merely showing the regulators and auditors that it has a CRR.  We sometimes find that they are ‘going through the motions’, and committing many of the shortcomings described above.  The tone from the top does not illuminate the importance of the function.  Without a solid commitment from the top and sound execution, value is tepid or absent.

 At Pactola, we would be happy to meet with you to discuss our observations on how to maximize the value of your CRR.  We also have similar observations on internal audit and are qualified to address that as well.  It is very possible that you could cut the costs of these functions while providing more concise, risk based feedback to the board that feeds into good decision making.

Gary Stoley brings over four decades of experience with commercial, agricultural, syndications, asset based lending, leveraged transactions and retail. He has spent over 33 years with the Office of Comptroller of the Currency and then an additional five as a contractor for that agency. More info can be found at: https://pactola.com/credit-risk-advisory-services

Pactola Launches New Services

Listen up!  Pactola announces new services to support your credit administration functions.  These are Credit Risk Advisory (a/k/a Loan Review) and Contracted Problem Loan Management.  Both of these divisions are staffed with a team of seasoned credit veterans with experience in areas of commercial, agricultural, indirect, home equity, and other types of lending.  We also offer various individual services offered on an ala carte basis. 

One big feature is much of this review work can be completed remotely via our secure portals to transport file information safely. Discussions with officers can be made over the phone or using video chat systems like Teams or Zoom.   In today’s world where we deal with remote work environments and limited visits from outsiders, this feature helps limit face-to-face contact. 

Our Credit Risk Advisory Services is designed to help you evaluate the efficacy of your credit risk management function to ensure that the credit risk review mission is clearly set forth and sets objectives as defined by the Board and management.  Credit risk review function is driven by a sound risk assessment tailored to your institution.  Credit risk is evaluated properly, as defined by policy and scope, while values is added via insight and observations of individual lending credit relationships, sectors, portfolios, collateral, purpose, and economic trends.  Reporting includes findings prioritized based upon risk, root causes of systemic deficiencies, practical solutions to address core problems, management corrective plans, and best practice considerations. 

Ultimately, if you are spending lots of money for a third-party loan review report that just checks the box of an examiner requirement, this process is falling quite short of what a good review process can accomplish.  Our approach is to provide you with a study that shows the strengths and weakness of your credit organization and provide you with a path to improve. 

Contracted Problem Loan Management can provide additional support to your credit team to help manage the upcoming problem loans that we will all see from the impact of the economic downturn and lockdown.  Many institutions do not have a seasoned special asset group internally they can send their problem credits to be managed.  This requires either hiring problem credit managers, which can be expensive.  Existing staff can also manage their problem credits.  The challenge here is so much time will be spent on problems that you will lose good credit opportunities that your competitors will be jumping on. 

Another option is to partner with seasoned credit folks to help manage some of your problem credit accounts.  We have a team of professionals who have experience with managing problem credits that can assist your team, thus saving you time to focus on your good clients while saving you labor cost of additional staff. 

Our Credit Risk Advisory Services are led by Gary Stoley.  Gary spent 33 years as a regulator with the OCC before retiring in 2010.  He has experience with all areas of credit from policy framework to collections.  His experience is in many sectors of lending:  small business, oil and gas, agriculture, C&I, asset based lending, secured financing, A/R lending, factoring, home mortgage, equity, indirect auto, and unsecured personal loans.  You can contact Gary at gary.stoley@pactola.com

Our Contracted Problem Loan Management  is led by Randall Pownell.  Randy has over four decades of experience with commercial and agricultural lending with extensive experience with collections and problem loan management with the Farm Credit Services.  You can contact Randy at randall.pownell@pactola.com

A Wave of Defaults Coming?

A Wall Street Journal article from July 14, indicates that the largest U.S. banks of JPMorgan Chase & Co, Citigroup, and Wells Fargo took huge hits to their second quarter profits to stockpile $28 billion to cover losses as consumers and businesses begin to default on their loans.  On June 3, NPR reported that Americans are skipping payments on mortgages, auto, loans and other bills.  Under normal times, this would result in foreclosures, evictions, and repossessions.

Much of this has been put on hold.  Congress and the President have helped with several stimulus packages for businesses and individuals.  Lenders and regulators have been lenient and allowed for modifications, extensions, and deferments of payments.  Many of those modifications will remain until late summer or even toward the end of the year. 

TransUnion is reporting that around three million auto loans and 15 million credit cards are in some forbearance plans.  Black Knight reports that 4.75 million homeowners or 9% of all mortgages are in some deferment plan.  Since lawmakers do not want delayed payments to impact credit scores, Congress mandated that people current on their payments prior to the outbreak should still be reported as current on their payments when they are in a hardship program.  This has the impact of moving credit scores higher at a time when payments are not being made.

The law firm Starfield Smith, PC, in their weekly ezine have a lead article this week titled “Best Practices:  Increasing Loan Defaults Require Prudent SBA Lenders to Pivot Staffing from PPP to Monitoring of their 7(a) Loan Portfolios”.  Again, the message is out.  It is expected a tidal wave of problem deals, defaults, reduced revenues will hit throughout the economy and your portfolio. 

Now is the time to prepare for these.  You really have three options.  First you can move staff you have internally to manage the problem credits.  If you believe that we will see a mountain of problems starting later this year, then existing staff you may have on the consumer side will not have the time, much less to mention they probably do not have the experience in managing problem business deals.  This leaves you with shifting business lenders to manage the problems.  On a positive side, they have the most familiarity with the relationship.  This can also be a negative where they fail to act or act too harsh based upon their knowledge.  This also takes them away from managing their credits and finding good new deals that will be out there as other lenders may not pay attention to their problems.

Your next option is to hire staff to take care of the problems.  If you have a small portfolio, it may not be cost effective to hire experienced folks to manage that.  Also, good workout specialists are also those who are working themselves out of a job.  The demand for the services of problem loan managers will be high.

The third option is to partner with a third party to help you manage your problem loans.  This could consist of attorneys, retired professionals, experts in commercial banking or lender exams that can help you get your arms around the problems and manage them to improve or work to reduce challenged loan balances.  Utilizing a third party provides flexibility to the institution’s leaders.  They can keep existing staff focused on their existing responsibilities and business while working with professionals to help manage the problems. 

Either one of these, or a combination of several options, need to be decided by credit administration now, prior to the problems becoming worse.  The NCUA, in response to the COVID-19 pandemic and subsequent regulatory changes, is changing its emphasis to reviewing actions taken by CUs to assist borrowers during the financial hardships.  Examiners will review CU policies and the use of loan workout strategies, risk management practices, credit union’s controls, reporting, and tracking these programs.  On the examination front, there is a focus of what these pandemic decisions have an impact of their capital position and financial stability.  More emphasis will be placed on loan loss reserves than tracking any progress toward the current expected credit loss (CECL) standards. 

We can provide help in managing your problem loans and if you need a professional third-party review of your lending department.  Contact us for more help.

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PPP Forgiveness

Now that there are only three weeks left in the application process for new PPP loans, there is more of a focus on the forgiveness process.  Some PPP borrowers have completed their original 8-week period and others who have opted for a longer time to use the funds, will exhaust their funds soon.  Most borrowers will want to get through the forgiveness process as quickly as possible. 

The SBA has provided two applications for forgiveness, the Form 3508, and the Form 3508EZ.  The EZ form shortens the application process to three pages and can be used in the event where there has not been a reduction in staff FTEs outside the safe harbor or has reductions in pay rates.  Both forms contain detailed instructions for what must be provided by the borrower.

The challenge is there has been no clear instructions of how the lender is to process these applications for forgiveness.  It does appear there may be some reporting via the Colson report for the PPP loans.  The SBA did announce this week on a national conference call update that there are no clear instructions yet and that they were working with the Amazon Web Services Cloud for a possible solution.   The workload for the lender on forgiveness may change greatly as there has been a bill that would shorten the application and reduce the workload for forgiveness on any PPP loan below $150,000. 

At this time, we just have to collect the application and supporting documents and then wait.  Clear directions will be available soon.

Commercial Real Estate Delinquencies Up and Other News

Commercial Mortgage Backed Securities (CMBS) report an increase of 317 basis points in delinquencies to 10.32% in June.  This is close to the all-time high of 10.34% of delinquency in July 2012.  This number could go even higher in July as another 4.1% of the commercial loans were over 10 days delinquent but were less than 30 days late at the end of June.  Trepp, the leading provider of analytics to the CMBS market is reporting we may have reached the terminal delinquency velocity which means most of the borrowers that needed relief for debt service have requested it.  This points that the delinquency rate may trend smaller as we progress to the later summer and early fall. 

The watchlist of problem loans grew to 20.9% at the end of June.  Hospitality lead the way with 20.5% of all lodging loans on the watch list followed by 14.3% of retail loans.  Percentage of problem loans over 60 days late is up to 6.25% which is up 408 basis points from last month.  Loans from 31 to 60 days late were at 4.07%.  If you were to add in all loans in defeasment state to this, the total in the 31-60-day category would be 10.88%

The best performing sector in terms of lowest delinquency was industrial properties at 1.57%.  Office was next with a 2.66% past due rate and multifamily ended with a 3.29% past due rate.  Retail properties in the CMBS market had a 18.07% delinquency and 24.30% of all hospitality loans were delinquent. 

Clearly, the pressure on commercial real estate is real and still weighs in the market.  This next quarter should be key as PPP loan funds should be spent.  Economic activity should pick up, but growth may be dampened in some areas if local or state authorities shut down portions of their jurisdictions if they see increases in the virus. 

Managing a problem commercial or agricultural loan is a challenge and can be quite stressful.  Many institutions do not have the proper staffing or skill set to work through these issues easily.  If yours is one of those, contact us.  The lending professionals at Pactola in our Problem Loan Management area are here to help.

PPP Reopens

Congress passed and President Trump signed an extension for the PPP program as there is nearly $130 billion that has not been spent.  This may help some institutions which have not been able to gather their funds for these loans, to now be able to find some help with their cash flow.  These loans turn into a grant, if funds are spent according to the program. 

Many of your lenders are now receiving questions about PPP forgiveness.  I would suggest telling your borrowing folks to be patient.  As I write, the reporting structure to the SBA has not been well defined and it is unknown how the lender will request for the loan forgiveness. 

The SBA has shortened their forgiveness form from 5 pages to 3.  There is talk in Congress to shorten the forgiveness app for loans under $150,000 into a one-page application that may not even have the requirement of supporting documents.  This may greatly reduce the workload for the majority of the applications that your institution processed. 

Independence Day

July 4th represented the 244th celebration of the birth of our country.  Here in the Black Hills, we are both proud and thankful to host President Trump and hear his speech at Mount Rushmore.  Our nation is founded on the rights of life, liberty, and the pursuit of happiness which are given to all individuals, not by a government, but by their Creator.  Government exists to rule by the consent of the governed. 

This year, I am sure many of you, like me have found this to be one of the oddest years yet.  This includes some of the events leading up to our Independence Day.  We have not been perfect in our past history, and all people have a selfish streak in them.  This year is not a time to self-righteously condemn the people of the past, but to be thankful of the progress we have made toward a more perfect union today and to realize that the best way we can grow in the future is under our present framework of self-government.

A Time for Courage in Lending

2020 has proven to be a time that we need courage to push through. Some of the definitions of courage in the dictionary are “the ability to do something that frightens one”. Another one is “strength in the face of pain or grief”. Melanie Greenberg, Ph.D. listed six attributes of courage in a Psychology Today article as: Feeling fear yet choosing to act, following your heart, persevering in the face of adversity, standing up for what is right, expanding your horizons by letting go of the familiar, and facing suffering with dignity and faith.

I grew up in Fulton, Missouri, the home of a memorial to Winston Churchill, as he gave his famous “Iron Curtain Speech” in my hometown at Westminster College on March 5, 1946.  Many folks in that area hold Churchill in a place of honor and I thought a quote from the British Bulldog would be appropriate here. “Courage is rightly esteemed the first of human qualities because it has been said, it is the quality which guarantees all others.”

I want to bring some thoughts on courage to you before bringing up the idea that it takes courage, perhaps more now than before, for the lender today. Let’s face it, there is a part in each of us as we attempt to preserve the CU’s assets, we seek to hunker down and let the problems of the world, whether they be COVID, economic shutdowns, riots, or unrest, pass by and allow things to “normalize” before getting back into the full swing of lending.  Staying in the foxhole could have devastating impacts, like we saw when we shut down large sections of the economy.  There are also other devastating impacts that are in a recent meme I saw with a man with his head buried in the sand like an ostrich.  The caption read, “when you have your head in the sand, you expose the rest of your body.”

Borrowers and Portfolio

Courage is needed to understand the current business condition of your borrowers.  Today, this is pretty darn near impossible. How do past risk ratings apply when we have a situation that has impacted the entire world? How do you see what impact a shutdown and possible bounce back will have on your members? What if you make a mistake in your assessment on a borrower? Do not worry about that last one; you will miss seeing some of the risks. But do not let that stop you from the need to take as realistic of a view of your borrowers and portfolio as possible.  It requires looking at more than just historic financials as the first two quarters of 2020 are probably not very valid markers for future performance.

What help do your borrowers need at this point?  As a lender, you are one of their most trusted financial advisors. You may see road signs that they do not see and can help them to preserve their equity and build capital in troubled times. This requires being genuinely interested in their business.  A constant study of the economy and the world around them is also necessary as we look for things that may impact their business.  Remember, your job is to inform and bring up the issues, but the business owner is the one who has to make the decision of what to do.

Lending Infrastructure

Along with your portfolio, it takes courage to look at your present lending infrastructure — staff, technology, training, tools, etc. Here you need to see what the strengths and weaknesses of your department really are. In times of crisis, weaknesses tend to stick out like a sore thumb. Some questions to consider are:

• Do you have an established education or training program for your staff?

• Do you have the right analytical tools to help you assess risk?

• Is your reporting at an accuracy and timeliness level where you need it?

• What experience does your staff have with working through a recession and the problems that come with a paradigm shift in how credit is viewed?

• How will you handle complex problem loan workouts that involve more than good skip tracing and calls and emails?

• How much time will all this new work take?

• What resources can you tap into to help fill in the gaps in your department?–Can you get good new volume with participations? Utilize third parties to help with serious problem loan workouts?  Find outside professional credit folks to help with underwriting?  Have any new classes or training programs for your team?

These are hard questions and it takes courage to find the right answers. Many of them may not be what you really want to hear. It is always easier to enjoy a life of ease, but it is the stresses that help you grow. True leadership requires you face the situation as it is now and chart a course to navigate through the problems. Not answering these questions in these tough times is a form of self-delusion. Many times, the first step of courage is finally being honest with ourselves.

Lending Opportunities

The next area where courage is needed is with your new lending opportunities. Loans are an important source of capital to fund economic growth in your community. If all the faucets are shut off, then pretty soon growth will evaporate like water from a pool that is not constantly filled. As we begin to emerge from the crisis, many of your fellow lenders may elect to stay on the sidelines. There will be tremendous opportunity to expand and establish new relationships that are ignored by the lender who is cowering in fear.

Courage requires action even though you do not have perfect knowledge of the situation. We do this in underwriting every day, but now things are a bit hazier. It takes courage to admit what factors you do not understand that will impact the borrower’s chances of financial success. Perhaps this is a time to help mitigate risk by using more government guarantees on your loans. Maybe sharing the risk through a participation is in order. You must continue to find ways to seek out good loan requests and produce new credits in this time. The borrowers and communities that you serve are depending on you.

Courage is needed as you look in the mirror. As a lender and as a person, you need to understand your own strengths and weaknesses, likes and avoidances, as you understand how to lead and manage the most difficult follower—yourself. Do you tend to see some clients through rose-colored glasses or always see the worst in a borrower? It is time to look realistically. Are there gaps in your knowledge that you have pushed aside?  It is time to begin to set aside time to fill those gaps. Do you avoid the most unpleasant tasks?  It is time to tackle them.

Courage is what we need today to begin to master the impacts that the 2020 worldwide tragedies have had on our portfolio, staff, communities, and ourselves. It is time to take the first step in moving forward, charting a course for future success, and acting upon it.

Searching for Impacts of the Crisis on Your Business Clients

When I was young, I loved reading the detective stores of Encyclopedia Brown and The Hardy Boys.  As I aged this changed to Sir Arthur Conan Doyle’s stories of Sherlock Holmes. I enjoyed trying to find various clues to get to the answer before it was revealed in the story.  Most of the times I did not get it, but I still loved trying to find that out. 

I think this curiosity is essential in credit management and underwriting.  It is naturally needed skill for everyone in your credit department.  Those who love solving puzzles are the ones you want working for you.  The first step in this is to search for the clues.

The clues are essential in determining the risk profile for your commercial customer.  Some institutions may use third parties to do surveys with some of their customers as one of these clues.  Most of these are done directly with the field officer.  What are some of the clues you should be looking for as you visit with your borrower?

The first area is what impact has the crisis had on your revenues?  Some possible clues to look for are:

·         How do current period revenues compare to pre-COVID revenues?  How do the quarters compare to last year?

·         Have the sources of revenues changed?

·         What revenue projections does the company have for the upcoming quarters?  I usually like to see a best case, worse case, and something in the middle.

·         What disruptions have occurred in your client’s business that is impacting yours?  E.g. we have seen hotels lose room revenues as conferences have cancelled. 

·         What other lines of business do you have as a lender that may be impacted by your client’s business changes.  E.g. if you are financing the floor plan for a RV dealer and are also financing their buyers of RVs, how does the changes to their sales impact your RV financing.

·         In some cases, it may be good to shock the projections to see a range of different outcomes.

The next area to look for clues is in the area of cash flow.  Cash is king as cash is what is used to pay the bills.  Here some clues could be:

·         13- and 26-week cash flow projections

·         Watch deposit accounts for cash inflows and outflows (If you do not have the main operating account at your institution and are financing the business, you should!)

·         What are their projected cash budgets on a monthly basis for the next 12 months?

If you have rental real estate as your collateral some clues could be:

·         What does the current rent roll look like compared to the past?

·         Did the owner have to give any rent concessions to the tenants?

·         Projections for rental income, occupancy, expenses, net operating income

·         What regulations have been put in place by local governments that restrict landlord income or limit evictions?

If you are finding clues to the management skills some good questions are:

·         How good is their record keeping and financial reporting?

·         Do they understand their cost of production?

·         Do they have a budget?  Have they tested the sensitivity of the budget?  Do they know break-even revenue and expense levels?

·         Do they understand financial ratios?

·         Do they have a budget for upcoming capital expenses?

·         How do they help manage their loan covenants?

·         Do they have a transition plan for their top leadership?

·         Are they teachable and constantly seeking to learn?

If you have a farm or ranch client, some clues you want to understand are:

·         What is their crop and livestock production?  How does it rank with their neighbors?

·         What is their herd health?

·         Do they have a written marketing plan?  Risk management plan?

·         Do they manage their family spending well?  Do they have a budget?

·         Do they use tools to protect revenues like crop insurance, contracting, hedging?

(By the way, we have a great tool on our website to help rate the management and production skills of your agricultural client.)

Some other clues you want to look at are:

·         Updated guarantor or sponsor information (personal financial statements, liquidity, taxes, contingent liability analysis)

·         Interim financials for most recent 30-45 days

·         Accounts payable and accounts receivable trends, terms with creditors

·         Inventory audit

·         Contingency plans for unforeseen events

·         For hotels: trends in occupancy and rate, comparison to other similar properties in the area

These suggestions are not an exhaustive list of what items you need to look at as you are picking up the clues to understand the impact of the economic downturn on your business client, his present condition, and direction for the future.  Of course, as you study the clues you have been given, this may lead to new items to look at as you peel back the financial onion layers to get to the core.  Today, it is so important, perhaps more than in times of great economic strength and business activity, to have a clear understanding of the financial situation of your borrower. 

Let your curiosity roam as you are looking at the various clues.  Look at this work as reading a good detective story as you use your sleuthing skills to uncover reality.

How in the World Can You Gauge Risk Today?

Lending requires an adequate assessment of risk, understanding of which risks can be managed and which ones cannot, and then having a fair rate of interest paid to the lender from the borrower for that risk.  One key tool that lenders have developed over time to gauge risk is the risk rating model.  These have ranged from a simple “pass-fail” model to a broader scale ranking, say 1-10, to a larger division of looking at the probability of default for a borrower and then the possible loss to the lender if a default occurs.  Models look at many different factors like liquidity, debt service coverage, in ag lending-capital debt repayment capacity, leverage, or loan to value, just to name a few. 

In times of normal economic cycles—growth and recessions—these models have served lenders well in putting a rating on risk.  These ratings can be tested retroactively to see how accurate the model is and what other factors or changes must be done.  But how in the world do you use a risk model to assess risk today?  We have seen changes in the economy that are the equal of a tectonic plate movement and everything has changed.  It is now time to pick up the pieces after the tornado has hit as now basic economic drivers have shifted and it is unsure if they will shift back. 

A few months ago, we would view a hotel located near a major league sporting center as having a huge driver of business from folks attending those games.  Now consider that hotel near stadiums in downtown St. Louis or Minneapolis.  We do not even know if baseball will be played at all this year and it may, like basketball be played somewhere totally different than the cities the teams represent.  It also may be played in relatively empty stadiums.  Essentially, this demand driver for rooms has evaporated. 

In our community, our favorite Mexican food chain has seen record sales as they figured a way to effectively deliver food curbside and take out when some other restaurants did not.  Will these sales continue at this level when other restaurants begin to re-open and people have more alternatives to chose from?  Or what about the face mask manufacturer who cannot make enough masks today to continue with the demand?  Next year, will we see many people walking around with face masks or will it be back to our pre-mask days?  How will this impact demand?  How do you determine where reality lies?

What about office buildings?  Now that companies have successfully been able to utilize remote workers, will they still have the future need for as much office space as what they did going into 2020?  This is just another example of how the new world picture is still a bit fuzzy.

Consider the bounce back in the economy like pulling a rubber band and letting it go.  Retail sales took a huge 8.2% drop in March but then rebounded with a sharp 17.7% spike in May.  How do you figure out what is reality for your retailer who had sales match up with the national averages?  Use the drop, the spike, an average, or something in the middle? 

The current COVID crisis is also different form other past recessions, wars, and other economic shocks, as this current crisis has impacted virtually every human being in the modern world.  How sudden, the scale, and duration of the stay-at-home orders is making the impact on judging credit qualify difficult to measure.   Variations in shelter-in-place will also impact the economic viability and desirability of underlying real estate as areas who have less restrictions will see more growth than areas with stricter lockdown measures or now, destructive riots that destroy communities economically.

The timing of this shutdown that has spanned a calendar quarter end, has made borrowers’ financial information minimally useful as a predictor of future performance.  In lending we often look at past history to mark the future.  This happens as the lending industry depends upon accurate and reliable credit risk ratings. 

This will require the lender to begin to gather and analyze some new information in order to make a sound assessment of credit risk.  It is also important to recognize what impact COVID has had on the standard measures of credit risk we have always looked at and whether to discount or pay closer attention to one factor or another.  As we move forward, mistakes will be made, and no measurement or model will be perfect.  Logic and thought must be present behind each indicator to explain how a certain factor shows or does not show the risk inherent in the credit. 

Other than the general concept that those who have sufficient liquidity to retire the entire debt point to low risk, the picture on the rest of your portfolio may not be as clear.  Now there are several sources of alternative information that can be used to make near term risk ratings to reflect the actual risk.  Some of these may are:

·         Information on the borrower, gathered from the customer, guarantor, or sponsors

·         Lender’s knowledge of the company, industry, management history, customer base, competitors

·         Experience level of the lender’s credit team and other resources available to them

·         Any regulatory guidance

·         Economic information, models, forecasts

·         Publicly available information on the industry

·         Information on the specific area or region the business serves

In some of the upcoming blogs, we will look further at some more of this information and how some alternative methods can help better rate the risk in the credit which should drive the credit management needs.

Prepare for PPP and Economic Changes

On Friday, June 5, President Trump signed the Paycheck Protection Program Flexibility Act of 2020 into law.  By now, most of the readers of this blog will know the changes but it is good to first review what has NOT changed in the law.

·         The application deadline for PPP loans is still June 30, 2020

·         The eligible amount to apply for is still 2.5x monthly payroll expenses

·         The interest rate on the loan is still 1%

·         Amount the government pays financial institutions to do these loans has not changed

·         Forgiven amounts remain taxable

·         Eligible expenses are still wages, retirement and health benefits, state taxes, rents, mortgage interest, and utilities paid by the business

Let us look at a few features that HAVE changed.

·         Borrowers can use a 24-week period to restore their workforce instead of the 8-week period.  If a borrower can achieve full forgiveness in the 8 weeks, they should do so

·         Forgiveness can be calculated on the better of the 24 or 8-week period

·         Only 60% of the loan, as opposed to 75% must be spent on payroll costs

·         If the borrower fails to spend 60% on payroll costs, none of the loan is forgiven

·         Unforgiven amounts are amortized over 5 years instead of 2

·         Now have until December 31 to reach full employment levels compared to the February 15 safe harbor

·         No proportional reduction in forgiveness due to the number of full-time equivalent employees is applicable if the borrower is able to document

o   Inability to rehire individuals who were employees on February 15 and cannot hire similarly qualified employees for the unfilled position before December 31, or

o   The business cannot return to the same level of business activity the business was operating at before February 15 due to compliance from the Secretary of Health and Human Services, CDC, or OSHA

·         Business who received a PPP loan can delay payment of payroll taxes

·         Borrowers can apply for forgiveness of a covered loan up to 10 months after the last day of the covered period

·         Payment deferment period is now extended from the original 6 months to the date the borrow is told the amount of their loan forgiveness

Now that the PPP origination period is coming to an end, we are beginning to wonder what will happen with new business for the remainder of the year.  One thing to look for is a strong economic rebound.  Last week showed a strong increase in employment with 2.5 million jobs, in areas outside of farming, added in May compared to the 7 million losses expected by the analysts.  This comes as large states like California, New York, Illinois, and Michigan were in a period of being largely  shut down.  A surprising majority of those who have lost jobs consider their loss as “temporary”. 

Initial jobless claims are dropping from their peak.  Job growth is coming virtually across the board with more jobs in areas like health, construction, and hospitality.  While we do see improvement, continuous unemployment claims are still at close to 22.5 million.

Other signs are beginning to point to possible economic growth.  New home sales rebounded in April, but existing home sales dropped, while housing prices are still show some growth.  Personal income is up.   On the other hand, consumer spending is down by nearly 17% in April and retail sales dropped showing the negative impact of the coronavirus on the economy.  New orders for durable goods and manufacturers’ new orders have both taken steep dives.

The remaining of 2020 will present tremendous opportunities for some while marking continued struggles for others.  For the lender, this will require great skill and insight to finding the new opportunities while managing the troubled credits in one’s portfolio.

Shifting Gears in Business Lending

As we continue to reel from the pandemic and its fall out, there is good economic news to consider.  Last week’s U.S. Department of Labor’s Unemployment Report showed 2.1 million new jobless claims that were filed over the past week.  This was a decrease of 323,000 from the previous week.  The total of lost jobs due to the coronavirus tops 40 million.

The hidden jewel in the report is that continuing unemployment claims fell by over 3 million to 21 million overall.  This means that over 3 million people who had previously filed for unemployment claims during the shutdown, and who received benefits for more than one weekly period, have returned to work.  This number should increase as more states begin to reopen. 

The coronavirus has probably eliminated most of the long-range goals you began in 2020.  This has required a major shift as new loan production has been replaced with payment modifications and Payment Protection Program (PPP) loans.  Now that the new PPP loans are winding down, there are several shifts you need to consider in your business lending program. 

The first is to continue to watch for changes in the PPP program.  Both the House and Senate passed bills to modify the PPP by expanding areas where the money can be spent and also increasing the time to spend the money.  Nothing is official yet but continue to watch for changes.  Also, now is the time when your borrowers need to be focused on forgiveness, making sure that all expenses are made in according to the program and that records are in order.  We have uploaded some helps on the PPP page on our website. 

Second, make plans on how to handle upcoming problem loans that will crop up later this year.  We all have borrowers in our portfolio who were marginal prior to the economic shutdown.  Many of those may not survive.  Managing problem credits takes tremendous energy and time and will take you away from your financially strong members.  If you do not pay attention to them, someone else will.  If you need help, we are opening up a division to assist in commercial and agricultural problem loan management. 

Third, now is a good time to make plans for an independent third-party risk review of your lending activities.  These reports are desired by the regulators and are often pricy.  A good report should provide you with actionable intelligence to your operational strengths and weaknesses.  The report should point you to ways you can improve and not just validate risk ratings with a spreadsheet.  Contact us as we have seasoned professionals on our team to help.

Fourth, consider using government guaranteed lending moving forward for your loan production this year.   Expansions of the SBA 7a and Express program, along with more options for FSA and USDA loans on the farm side can continue to provide necessary capital for your communities while limiting the credit risk.

Fifth, consider changing your thresholds for lending on various assets.  Some commercial real estate types which were strong prior to the pandemic, show considerable weakness now.  Hospitality, restaurants, and retail are considerably weaker.  Office is now uncertain in the short and longer term as we do not know the full impact of the work from home trends.  Industrial has new strength as more companies will elect to move production back into the U.S.  Multi-family is strong except for student and senior housing.  Remember that there is also differences in area as well.  A mixed-use building located in an area with the economy open will produce more revenue compared to those located in areas with extended shut downs. 

Finally, even though we can get lost in financial performance, spreadsheets, and income statements, remember it is still people that you are working with.  Each business owner has dreams and hopes.  Each farmer has concerns that keep them up at night.  The economy has put undue stress on your members and sometimes they may end up taking it out on you.  It is unfortunate but that is what we all deal with as humans.  Allow them to go through the grieving process so they can reach a point of resolution to move forward.

In many cases, you provide hope for the future for your business members.  You also may be the key that helps them protect their equity and assets in this time.  These are huge responsibilities but also offer tremendous opportunities to make a difference in your communities. 

PPP Loan Forgiveness

Since late February, our work lives have been similar to driving through a whiteout.  All long-term plans have been thrown out the window and you are forced to focus on what is within the next 10 feet in front of you.  The concern for performance in the next quarter has been replaced with wondering if you will get enough work completed to get at least 5-6 hours of sleep.  As I write, snow is falling on Mother’s Day.  I bless the poor weather now as it takes away the desire to be outside in the sunshine!

One question that is popping up regarding the Paycheck Protection Program loan forgiveness is what the borrower should do now that the loan has closed.  After all, isn’t everyone wanting free money?  Wasn’t that the push behind the program?  I would argue that the program is a mere tourniquet on a self-inflected economic wound.  It is hard to imagine how worse this would be without PPP.  We have had over 20.5 million people losing their jobs in the month of April alone and an unemployment rate up to 14.7%.  PPP will help stop the bleeding for a little bit, but we better figure out how to reopen up our economy as any future rounds of PPP will help but will not heal the issue.

So back to the forgiveness issue and I will also reference back to the whiteout analogy.  All you can give folks now is the best information available at this time and they must realize that more clear directions will come out once we drive further down the road.  With that in mind, we tackle the following questions.

What is the time period that the borrower has so spend the PPP money that qualify for loan forgiveness?   An eight-week period starts when the funds are disbursed.  All PPP loan funds are to be disbursed within 10 days of loan approval, unless the borrower has failed to provide necessary information for the lender to prepare closing documents. 

Can the amount of the loan that qualifies for forgiveness be reduced?  Yes, if the borrower reduces staff or reduces payroll during the 8-week period compared to the time of application.  This does not mean that the borrower has to keep the exact employees as at the time of application as replacement workers could be hired.  If a 10-person office obtained a PPP and only rehired 9 employees, then 1/10th of the loan would not be eligible to be forgiven.

Now if a PPP borrower laid off an employee, then gets his PPP loan and offers to rehire the same employee but the employee declines the offer to rehire for the same hours and same rate of pay, the percentage available for loan forgiveness will not be reduced.  The employer should document all the offer and rejection in writing.  The employee should also be aware that any rejection of offer of re-employment may forfeit eligibility for continued unemployment compensation.

Will the SBA review individual PPP files or is this all up to the lender?  SBA states in its FAQ #31, that all loans in excess of $2 million will be reviewed and other loans may be reviewed as appropriate following the lender’s submission of the borrower’s forgiveness application.  The outcome of the SBA’s review of the loan files will not affect the SBA’s guarantee of loan that the lender complied with SBA rules of underwriting requirements for the lender. 

How are payroll taxes counted toward the loan forgiveness?  Eligible payroll is figured on the gross wages paid to employees.  Any payroll taxes withheld from the employee is not considered.  Likewise, any matching funds for the employer’s section of payroll taxes are not considered as eligible forgivable payroll expenses.  State payroll taxes that are charged to the employer may be considered to be forgiven.

Is there a maximum amount of payroll per employee that may be forgiven?  Any portion of an employee’s gross wages which exceed $100,000 annually would not be available to be considered for forgiveness.  When you do the math, this would be any portion that is above $15,385 paid in the 8-week period to any one employee.

Can benefits paid to employees considered to be forgiven?  Yes, employer benefits such as premiums for health, dental, vision, life, disability insurances, retirement contribution matches on the employer’s part, or employer contributions to an HSA may be considered as forgivable payroll expenses.  These do not appear to have any limitations on their forgiveness due to salary level.

Can PPP loan funds be used for other items outside of payroll and still be forgiven?  Up to 25% of the PPP funds could be used in the 8-week period for utilities, rent, lease payments, or interest on mortgage payments made and these can be considered for forgiveness.

What items are required for loan forgiveness?  The borrower must request forgiveness and provide supporting documentation for the qualified expenses during the 8-week period.  This includes items such as Form 941s, state quarterly unemployment tax filings, detailed payroll reports from a third party, bills and cancelled checks or bank statement information for employee benefit expenses, rental and lease expenses.  Detailed mortgage statements are needed to determine the monthly interest expenses if this is part of the forgivable expenses. 

The SBA has issued guidance that a borrower who files a 1040 Schedule C or F can use the 2019 form that was provided at the time of application to determine the net profit allocated to the owner during this period, in addition to, any Form 941 and other payroll information regarding eligible payroll expenses. 

These items are submitted to your lender, who has 60 days after the submission to make a determination on loan forgiveness and submit this to the SBA.  The SBA then has 90 days after the submission to pay the forgiveness along with all accrued interest through the date of payment.  If any portion of the loan is not forgiven, then this will be amortized with monthly payments over the remaining original term of the loan at a 1% interest rate. 

How is PPP loan forgiveness treated on your income taxes?  Treasury Secretary Mnuchin stated in an interview with Fox News, that the amount forgiven would not be treated as income, but the expenses paid for the forgiven amount could not be treated as business expenses; i.e. you cannot double dip to receive PPP forgiveness and take the business expense deductions. 

Again, this is what I understand as I write this.  Be on the lookout for new guidance as we progress toward the end of the first 8-week period and forgiveness requests roll in.

No Man Left Behind

I am sure that we all are familiar with this phrase.  We may have seen this in a war movie where heroic soldiers crash through bullets and bombshells in order to save a wounded comrade.   When these are based on true stories, they mean so much more.  Some of my recent favorites are Hacksaw Ridge, the true story of Pfc. Desmond Doss who won the Congressional Medal of Honor in saving 75 men in the Battle of Okinawa, despite refusing to bear arms on religious grounds.  Another is Dunkirk, the true story of the successful evacuation of 330,000 British, French, Belgian, and Dutch soldiers from France to Great Britain using every serviceable naval and civilian boat that could be found. 

The concept of “no man left behind” is very American, and dates back before the Revolution.  In 1758, during the French and Indian war, a group of American soldiers known as Rogers’ Rangers fought the British against the French using a combination of pioneer techniques and native-American tactics to outsmart enemy soldiers in deep woods where traditional militias struggles.  According to Paul Springer, a professor of comparative military studies at the Air Command and Staff College, they were known for holding a certain standard, which was to leave no fellow soldier behind. 

So now you know this concept is built in the American bloodstream.  Life is precious and none of our fellow men or women, should be left behind. 

Fast forward to a few weeks ago.  It has been less than 7 weeks since we first began to see signs of strain among small businesses and our economy with the COVID-19 virus.  Truly this has now changed how we live, work, and conduct our day.  We have seen solid businesses that are prohibited from opening their doors, the new weekly unemployment numbers that are worse than our nightmares, and solid financial customers shaken to their core. 

It is at this time that many of you in the credit union movement ran toward the crisis in an act of first response, instead of running away from it.  Your actions have been to leave no business behind in attempts to modify loans, extend maturities, and continue to extend credit through resources like the Small Business Administration’s Paycheck Protection Program. 

Sadly, last Thursday, the original allocation of $349 billion ran out.  Our team is still working to draft closing document sets to help CUs close these loans.  The tragedy is that many small businesses were left on the sidelines without the ability to pay their employees.  But while the PPP funding is currently out, it is not necessarily over.  There is strong support among Republicans in both the House and Senate and President Trump to support more funding.  Democrats such as Karen Mills, the SBA Administrator under President Obama, have called on Congress to act as soon as possible to replenish the funding.

When this happens, will you be prepared?  Are you ready to run toward the disaster, ready to help your members?  Ready for another round of long work hours, seven days a week, skipping meals just to help your fellow man.  Remember, no eligible small business left behind.  Why should we have this attitude?  Because these loans provide cash that will make it to the hands of employees. 

I suggest the following action steps.

1.        If you are not signed up with the SBA to do these and other SBA loans, do it NOW.   Government guaranteed lending, even that outside the PPP, can be a big part of your loan portfolio growth strategy this year and in future years.  If you need help, contact us.  We help institutions underwrite and package these loans.

2.       Triage the PPP applications that you have now which you could not get approved.  We have hundreds of these which were not able to be approved due to incorrect applications or poor supporting documentation.  Reviewing these is an easy two step process.  We have a checklist to make sure the request is complete.

3.       Contact small businesses that can qualify for this program who may have not obtained a loan yet.  Have the get ready so you can rush in with an application when the funding opens back up.

As always, we at Pactola are here to help.  Contact us with any questions or assistance in processing these applications.  We have worked with over 500 of these so far and look forward to helping more.  Each one that I have reviewed, I note the number of jobs that are impacted.  Some are only one job.  Some hundreds.  Each one makes a difference.

No eligible small business left behind!

Time for SBA Lending

Most of my days this week are filled with calls from lenders and borrowers who do not know what to do about their business and what help is available.  I am sure this is common thing that takes up most of the time throughout your days now.  One borrower I spoke with today said that a few months ago, if you would have said what we were facing in the world today, he would have said it was a good science fiction story!  I am sure we can all relate to this.

Today in your credit union you are probably facing the following:  new auto requests are going away as no one is looking at cars today,  Mortgage refinances may dry up as many people who could qualify now have no job.  You have multiple businesses and individuals who need help as they cannot make their payments with no job or a closed business.  The good loans you have on the books now, want a lower interest rate since all the rates have fallen so far.  Your net interest margin is squeezed, and your overall income is slashed from what you expected this at the beginning of the year.

Now is the time, for the betterment of your shop and also to help your communities with the new options in government guaranteed lending that have opened up with the new CARES Act.  Much of this lies with the options with the SBA.  First, the SBA Express loans have increased from $350,000 as a top to $1,000,000 till the end of this year.  This is a relatively easy way to provide important lending capital for your borrowers.

The SBA 7a loan has increased its ceiling from $5,000,000 to $10,000,000 until the end of the year.  Also, the size requirements of all affiliated businesses have been stopped, this increases the number of businesses that you can do loans for with borrowers who have ownership in other entities. 

The guarantee on SBA loans has risen to 100% this year, then drops to 85% for loans up to $350,000 and 75% for loans over that amount in 2021.

A new loan that will be backed by the SBA is the Paycheck Protection Program (PPP).  This was just created last Friday and Treasury Secretary Steven Mnuchin, is indicating the rules for implementation should be ready this Friday.  This program also waives the business affiliation rule that was in place with SBA qualification.  The PPP applies to small businesses (under 501 employees), sole proprietors, independent contractors, and self-employed individuals,  which have been operational as of 2/15/20.

The PPP is designed to pay for payroll expenses, utilities, rent and leases, and the interest portion of business loans.  To figure out how much a business can qualify for uses the following formula:

Included Costs:  Sum of all wages, salaries, commissions, tips, vacation pay, sick leave, payment for group health benefits, payment for retirement benefits, payment of state or local taxes on the employee compensation.  Now if there are some guidelines for businesses that are seasonal or those which had no payroll in 2019 but have payroll starting January 1, 2020.

Excluded Costs:  Take out any compensation for employees with over $100,000 of income annually, payroll taxes, income taxes, compensation for employees living outside the U.S. and any qualified sick leave wages which you have received a credit under the Families First Coronavirus Response Act. 

Maximum loan is lesser of (included costs – excluded costs) divided by 12 multiplied by 2.5 or $10MM

The part that is very interesting is that a portion or all of the loan may be forgiven.  The amount spent on payroll using the same definition to determine loan eligibility, interest on mortgage obligations, rent, leases, payments on utilities that are spent over the 8 weeks after the loan has closed may be forgiven and the business owner will have not have to declare the loan forgiveness as income.  Some of the loan forgiveness will be reduced if there is a reduction in employees or payroll of 25% of more.  Any part that is not forgiven is amortized over up to 10 years at a rate of 4%.

Why go through all this trouble to do these loans?  Other than the fact that you are helping your membership, which should be enough, the SBA is also going to pay you for it.  Loans up to $350K will be paid 5%, $350K to $2MM is 3%, over $2MM is 1%.  Not a bad rate of return for having money mostly outstanding for two months. 

We can help you with providing you support on your SBA lending needs.  Let us know how we can help.  Also check out the video blog we did on Strategies to Manage Through the Current Credit Crisis.  In it we discuss the current economic condition, business climate, impact on borrowers, lenders, ideas on modifying loans, impact of SBA, USDA B&I loans and the new CARES Act.  You can find it at https://pactola.com/informational-videos

Credit Administration Leadership in Uncertain Times

We are hosting a free Webinar on Credit Management in the COVID-19 Virus.  We will hold this on Thursday, March 26, 2020 at 10:30 CDT, 9:30 MDT.  Our goal is to provide some ideas as you reach out to your borrowers in this challenging time.  To attend, go at https://www.anymeeting.com/671-071-642  The dial in number is 863-208-0120 and the attendee pin is 243 7669#.

The COVID-19 virus situation has created a huge challenge for us, but this has also presented an opportunity we would not see in normal times for true leadership in our communities.  I imagine by now you are beginning to see the large impact this virus is having on your membership and it is probable that this impact will only be compounded within a few weeks.  It is important to realize that there are also the additional issues of low oil and a bear market in most commodities which are creating additional stress to your communities. 

The tendency for many of us whenever such large negative events are hitting unexpectedly, is to hunker down and hide.  But this does not provide your communities what is needed.  Now is the time to rise up and lead.  The folks you serve in your financial institution are looking for help and a crisis provides a wonderful opportunity to deepen your relationship with them.  You must lead even though you don’t know the true condition of the crisis (no one does), you don’t have 100% certainty of what the proper action is to ease your member’s pain (no one does), or you don’t understand how long the crisis will continue (again, no one does). 

The COVID-19 crisis is serious, and I write this not to diminish the seriousness.  But think of what we have gone through in the past twenty years:  first we had Y2K, then 9/11, next Anthrax, West Nile Virus, SARS, E-coli, Ebola, the 2008 financial crisis, Swine-flu, the 2012 end of the world from the Mayan Calendar, Isis, the Zinka Virus, just to mention a few.  Then I would throw in the various hurricanes, droughts, blizzards, and tornadoes.  Crisis is part of our human condition. 

It is important at this time to create traction during the crisis, instead of being distracted and going into a hole.  To create some positive action in you shop I would suggest the following.

First, divide up your business and ag portfolio into thirds or fourths by those that you think are most severely impacted down to those least influenced.  Consider Tier 1 entities which could be a hotel, restaurant, or non-essential retail.  But also think about entities which are not directly impacted but those which will have their revenues impacted from a Tier 1 customer.  An example here is the owner of the retail strip center which has had some stores and restaurants close from the virus.  Also, consider geography in your list.  If you have a community or area that has had an outbreak, there should be more negative impact among businesses in those places. 

Then contact those on the most critical list and ask how they are getting along during this crisis.  Once you find out who needs help, you can provide real help for them.  Some of these actions could be:

·         Pointing them to disaster loans with the SBA for up to $2MM of low interest loans for cash flow needs.  Send them to DisasterLoan.SBA.gov

·         Update financials from the company and guarantors.  Have them put together a revised operational budget that lines up with the new paradigm.  If you are making payment concessions, consider going to monthly reporting where necessary.

·         Consider payment relief on their loans.  If you have loans with a government guarantee on it, then make sure you follow the guidelines of that program.  Some options may be to go to interest only, forbear payments for up to 6 months, require the borrower seek out and provide proof they are looking for relief in various federal and state programs.

·         Keep updated with what is happening with the news and any changes to relief from the government that could help your borrower. 

·         Encourage them to rethink their plans for the current economy  but remember this must be their plan.  We are seeing distilleries change to make hand sanitizer, auto companies working on respirator production, and businesses who required workers to be in the office, learn to function remotely at home. 

Today is a time for you to exercise leadership in helping your membership through the present situation.  A crisis is the time the real leaders show up.  You were made for this!  I hope that several of you will have time to attend our webinar on Thursday and will find it useful.  If you need help, contact us.