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November 14, 2018

Best Practices: Diligence In Collecting Financials Can Save A Lender Headaches Down The Road

by Lyndsay E. Rowland

Once a loan has closed, it moves into the lender’s portfolio to be serviced in accordance with that lender’s policies. That servicing continues until the loan is paid in full or until the loan defaults and ends up in a lender’s workout department. Typically, loan documents for commercial loans, including SBA loans, require a borrower and guarantors to supply financial information to the lender over the course of the loan. The financial documents that borrowers and guarantors are required to provide will vary depending on the specific terms of the loan, and can include federal tax returns, internally prepared financial statements, balance sheets, accounts receivable aging and/or inventory lists, among others.

Lenders should ensure that they are following up with borrowers on these requirements in their loan documents and should collect and analyze the financial information borrowers are submitting on a regular basis. A review of the financial information of a borrower can provide a lender significant insight into the health of the subject business. These financials can provide an early warning sign to lenders when a business is taking a turn for the worse and give the lender an opportunity to proactively sit down with a cooperative borrower to chart a path to change the course of the business.

In some cases, the business may be too far gone to recover from a financial downturn. The financials may help a lender outline and assist a borrower with an orderly liquidation of the business and its assets. Sales of a business as a going concern will likely maximize the return on the liquidation and may, in the best cases, result in a payoff of the loan. In the event a liquidation of the business assets does not result in a payoff, the financials can also reveal to the lender what avenues the guarantors may have available to them to address any remaining deficiency balance after a liquidation.

Additionally, the financial documents may alert a lender to issues with a borrower who has improperly transferred collateral securing the loan. If the loan to the borrower is secured by equipment and the borrower is not showing the equipment as an asset or accounting for depreciation of the equipment on the prepared financial statements, the lender may want to conduct a site visit or otherwise investigate where the equipment has gone.

Although it is typically an event of default under most commercial loan documents, it is not unheard of to find a borrower who has transferred assets to another company for one reason or another. A transfer of the lender’s collateral to another entity can be a significant problem as it can put the collateral outside the reach of the lender’s UCC lien without the lender having any idea. If a lender spots these types of issues on a borrower’s balance sheet, the lender should immediately reach out to the borrower or conduct a site visit to determine what the status of the equipment is. Whether malicious or not, if the lender determines the equipment has been transferred to another company, lender should proactively work with the borrower to take the necessary steps to ensure that the lender’s lien in the collateral remains perfected and of the required priority. If the borrower is uncooperative, the loan can be placed in default.

A lender that is regularly obtaining and analyzing its borrower’s financial information can feel confident that it is being a “prudent” lender should the need arise to submit a guaranty purchase package to the SBA. If you are a lender who has a borrower that is having financial trouble or has transferred collateral assets, contact Lyndsay at 267.470.1154 or lrowland@starfieldsmith.com to see how we can assist.