By Theodore J. Hamilton, Esq
Have you ever thought it would be nice never to have to hire an attorney to collect on a bad loan? Never to have to deal with collection issues at all. Well, this might be possible, if you never made a loan. Otherwise, no matter what you do, you face a certain percentage of your loan portfolio going bad and heading to collections. There are, however, a few steps you can take to ensure most of your loans stay on the positive side of your balance sheet.
The first step is a basic one. Make sure you document your loans properly. Make sure you file the UCC-1 or a mortgage to perfect your security interest. If the loan involves other types of collateral such as a liquor license or automobile, make sure you either hold the title or record the lien as required in the state where you operate. If it is a construction loan, make sure that all subcontractors are paid before you disburse. Finally, make sure you get the correct corporation to sign the loan. Ensure the name of the borrower matches with the corporate records filed with the secretary of state and obtain an affidavit to this effect. Finally, get guarantees. A loan without guarantees, especially to a small business, will not be paid when things go bad with the company.
Secondly, know who you are dealing with. Our firm receives so many bad loans where the lender has no personal relationship with the borrowers. Knowing who you are dealing with at the outset is very helpful. Go see the location where they operate. How long have they been in operation? If it is a short period of time, find out the prior business of the principals. If they rent, talk to their landlord. Ensure they are current on their rent and have not been late. Before you make the loan, get a chance to learn about the borrower’s business. Ensure you have up to date financials. This includes completed balance sheets and income statements. If you are relying on receivables, review monthly receivables reports and compare them month to month. Review the financials for at least a 2 year period prior to the current date. Ask questions of the owners and the CFO relating to the balance sheet, income statement and receivables report. This type of question and answer period can be very helpful in determining the potential success or failure of the business. You also need to check the public records. Search the Secretary of State for other corporations owned by the borrower. Check the clerk of the court where the borrower resides for any filings. Check bankruptcy filings as well as a precaution. As President Reagan said of the Russians; “Trust but Verify”. With this mantra, you will ensure that the statements made on the application and by the borrower are accurate.
Third, go with your gut. How many times have you said, I could see this one coming. Closing the loan may not be worth the hassle, if in 6 months it goes bad and you have to spend your time dealing with a bad loan.
Finally, don’t wait to get the file to your attorney if it is going bad. If the loan documents were not created by an attorney, get them to your attorney to review when it does go bad. The attorney can ensure your documents are in order so when you sue, everything is ready. The attorney can also assist in creating loan forbearance documents that deal with many of the defenses raised and eliminate them should suit be necessary.
Good luck and may your loans all be paid in full. Theodore (Ted) J. Hamilton is a principal with Wetherington, Hamilton & Harrison, P.A. in Tampa, Florida. He has been practicing law for 20 years and is a member of the Commercial Law League of America, The American Bar Association, The Florida Bar, the Hillsborough County Bar, the National Funding Association and the Tampa Interbay Rotary Club. He has extensive leasing, litigation and bankruptcy experience. Ted can be contacted at firstname.lastname@example.org. (813) 225-1918 ext.14
Commercial Credit Reports
Commercial credit reporting has changed dramatically over the last 35 years. Gone are the days of relying on credit references provided by the company in question or waiting days or weeks for a response. (Besides, who would provide a vendor that wasn’t paid promptly as a reference?). Using standard credit applications is always recommended to obtain the proper billing address, contact person and phone number of the new customer; however, to make a truly informed decision more efficient options are necessary and readily available. Computer databases now gather, compile, classify and present pertinent credit data, allowing businesses to anticipate future payment behavior of their customers based on historical information.
Thousands of companies across the country in a wide variety of industries contribute accounts receivable information monthly to various credit bureaus, including terms, recent high credit, current balance and aging. This accounts receivable data is typically broken down by industry and credit activity level so only the most current data is used in calculating the current days beyond terms. By reviewing this past payment behavior, identifying trends and cycles, future behavior may be anticipated.
Many commercial collection agencies submit information to commercial credit bureaus about debtors placed, commonly the first step taken by a business in seeking outside help with outstanding accounts. The presence of recent collection activity can indicate that a company is experiencing cash flow problems. Multiple placements for collections over a longer period of time can be a key indicator of a business that is in the habit of defaulting on financial obligations, certainly not a good candidate for open terms. It is important to review the details on collection accounts to determine if the dollar amount, response time and payments justify excluding the extension of open terms. Legal filings and records are gathered on a daily basis for judgments, liens, bankruptcies and UCC filings. Whether a company had a dispute with a vendor or was sued for negligence, an open judgment is a financial liability and the seizure of funds by a plaintiff could create a serious cash flow problem. Tax liens at the local, state or federal level can be enforced at any time and also put a financial burden on a company, resulting in vendors not being paid. Stressed or failed businesses that have sought bankruptcy protection in the past may have done so as the result of poor business models or decisions and may be doomed to repeat this type of action. UCC (Uniform Commercial Code) filings allow leasing and financial institutions to secure movable equipment, vehicles and business loans. While the filing of UCC’s is a normal business practice, a multitude of filings may represent a business that has little or no assets of their own. Insolvent businesses with many UCC filings leave little to nothing for unsecured creditors to claim. All commercial credit decisions should be made based on factual, impartial information so that further concerns and complications can be minimized. Consumer Credit Reports
While commercial credit reports may be requested for any business entity without the knowledge or consent of the business, consumer credit information is protected by the Fair Credit Reporting Act (FCRA) and requires a signed authorization by the individual. Consumer credit reports provide a complete history of an individual’s credit activity including mortgage, automotive, medical, credit card and revolving accounts, as well as personal judgments, tax liens, bankruptcies and collection activity. All the information is used to generate a score between 350 and 850 with relative risks outlined below: Score Range Score Description
700-719 Very Good
619 and below Bad to Very Bad
Consideration must be applied to all scores for the relative size, activity levels and end results for the reported details. A collection issue from years past may have been the result of a dispute or medical insurance issue that should not be used as the basis for denying open terms. Using credit reports to gain valuable insight on the history of a potential new customer (or on existing customers requesting higher credit limits) leads to more informed decision-making. Access to past payment, legal and collection information will help increase confidence in extending open terms to those companies that add more to the bottom line. Combining the speed and accuracy of 3rd party verified information with the minimal costs of the reports; the credit inquiry process is now fast and affordable. Excerpt from original article titled “How Far Out on a Limb are You Willing To Go ? By Richard Bostwick, Senior Investigative Consultant for NCO Financial Investigative Services. NCO Financial Investigative Services (FIS) is a worldwide commercial due diligence firm, providing in-depth background investigations, public record research and detailed analysis to the global business community. Special thanks to Christina Grenga, Vice President - Business Development Ph: 914.213.1698, Christina.Grenga@ncogroup.comwww.ncofis.com
Any commercial loan request must address satisfy the Five “C”s of credit:
1. Capacity- can they demonstrably repay the loan? If they are an existing business, do they have a debt service coverage ratio(DSCR) in excess of 1.25x calculated by dividing EBITDA by total annual debt service requirements. Some lenders calculate the Fixed Charge Coverage Ratio (FCCR), which is EBITDA plus rents and leases divided by total debt annual debt service plus rents and leases. This more conservative approach is appropriate when the borrower has significant leased equipment or real estate rental obligations. If the business is a start-up, how bad does it have to get before the ability to repay is jeopardized?
2. Collateral- Every loan needs 2 ways to get your money back. First is the repayment in the normal course of business. If that doesn’t work, liquidation of collateral pledged to secure the debt is pursued. What is it? What is it worth, and how did you determine it? How quickly can it be sold and converted to cash? Are there any senior liens that would impair your ability to convert the collateral to cash?
3. Capital- How much money does the borrower have in the deal? On real estate purchases, SBA allows the lender to lend up to 75-90% depending on the loan purpose. Project costs include closing costs, moving costs and any fix up costs. It is good practice to have the borrower show they have three to six months of operating expenses in the bank after the loan closes. You don’t want to use up all of their cash to buy the property and then call you when the first payment is due and tell you they have no money.
4. Conditions- Can the local economy support the business? Are national trends favorable for this type of business? What are they using the loan for: expansion, acquisition, working capital? Does the borrower have the management skills or support to pull this off? You have to put aside your subjective biases and objectively look at the request in the context of where(location), what(operations), who(management) and why will this succeed or fail? Demographic data is available from the US Census Bureau and local or regional chambers of commerce to help you make your case- pro or con.
5. Character- Personal credit reports and scores can tell you their historic payment performance, from which we infer a propensity to pay us. Talking to their customers and suppliers gives us a good picture of their business acumen and reputation. But, after paying their bills, what have they done with the leftover cash? Have they reinvested in the business, or saved for retirement or gone out and lived a lavish lifestyle that now requires them to withdraw all available funds to maintain? If they have a significant personal debt load, you need to calculate their personal withdrawals into your DSCR. Every lender can tell a story or three about a good loan that went bad because of a flaw that was apparent from the beginning, such as the owner who relied on the bookkeeper/ office manager to make deposits and write checks and never checked the bank statements until it was too late.
An original article for InsideBanking.net by Frank Murray.
The most important part of any loan request, and the one most commercial lenders pay the least attention to, is the purpose of the loan. Why do they want or need the money? If a borrower can’t articulate in a succinct and simple way why they need to borrow from you, then you can’t get to the important decision of whether or not the loan makes sense.
I always carry a pad and pen so that I can write down and recite back what I understand the loan request to be. It saves a lot of anguish down the road because you can’t make assumptions that turn out to be erroneous. It also helps frame the loan request in terms of appropriateness and conformity with your bank’s loan policy. This can save time by weeding out the loan requests that would never be approved by your management. Potential borrowers appreciate honesty and while they may not like a quick “No”, they sure as heck don’t like a drawn out “Maybe” that turns into a no.
A well thought out purpose leads you to ask for the information you will need to make a good decision. If the borrower wants working capital, why did the need suddenly arise? Have receivables collections slowed, or are their bad debts not being recognized? Have they gotten a slew of orders they need to fill, or has business permanently increased? Does the borrower know why they need money, aside from the fact they are overdrawn? Often, your investigations into the cause will be different from your borrowers and result in a different solution than the one initially requested. If the need is seasonal or temporary, a short term loan is appropriate, or an SBA CAP line might fit the need. If the need is permanent, a term loan they repay from operations might be more appropriate.
As you firm up the loan purpose, you’ll naturally fill in the sources and uses of funds. Often, borrowers will ask for only what they think they need, ignoring transaction costs, moving costs and working capital needs during the transition. Say your borrower wants to buy a local gas station convenience store for $1,000,000 and has $300,000 to put down. Your bank will lend 75% on a purchase like this with an SBA guaranty. But is there enough to close? Simple T-accounting tells us the following:
Sources $ Uses $
SBA Loan $ 700,000 Purchase 1,000,000
Cash from Borrower 300,000 Legal, appraisal, environmental & SBA fees 75,000
Shortfall 225,000 Working cap 6 mos. pmts + 3 months expenses 150,000
Total $1,225,000 Total $ 1,225,000
Your project costs are $1,225,000 and SBA would allow a 75% loan against costs, or $918,750, which requires the borrower come up with an additional $6,250 to close. If you can’t get beyond 75% of purchase price, the seller could be asked to hold a $225,000 second lien on standby. Assuming the borrower doesn’t have $225,000 more, you need to know where the extra cash to close will come from before you spend any more time on the request.
Understanding and discussing the loan purpose with the borrower upfront can avoid misunderstandings, strengthens your understanding of the borrower and avoids wasting your and your borrowers time. In fact, I believe that if someone had asked what the loan purpose was and really had taken the time to understand it when Enron, Worldcom or Countrywide wanted to borrow from their banks, these loans wouldn’t have been made because they didn’t make sense.
Original article for InsideBanking by Frank Murray, Bennigton Capital
The economic downturn in United States of America has indirectly and directly impacted most of the individuals, businesses and financial institutions. The housing industry is one of the greatest hit of this economic downturn. Foreclosures, short sales and mortgage loans’ frauds have created many challenges for financial institutions all across the country. The need of the hour is to understand the potential risks associated with these situations and to act proactively.
The Financial Crimes Enforcement Network (FinCEN) periodically releases mortgage fraud report, Mortgage Loan Fraud SAR Filings. This report provides information on reporting activities, geographic locations, and other filing trends. The most recent third quarter of 2010, mortgage fraud report, shows possible mortgage loan fraud (MLF) characterized by filers increased 2 percent up from MLF SARs in the 2009 third quarter. In 2010 Q3, California and Florida were the highest ranked states based on total numbers of subjects, followed by New York and Illinois. Within metropolitan areas, New York ranked highest in the number of MLF subjects with activity dates after January 1, 2008, and Miami ranked highest based on activity dates before January 1, 2008.
Following are some potential areas of mortgage loan fraud reported in mortgage fraud report.
- Debt elimination scam
- Misrepresentation of income or employment
- SSN fraud or theft
- Loan modification fraud
- Foreclosure rescue fraud
- Fraud against federal housing recovery programs
- Straw buyer
- Appraisal fraud
- Property flip
- Occupancy fraud
Awareness with the above mentioned areas of fraud in mortgage loans will help bankers and financial institutions to review substance over the form, in case by case basis.
One of the areas of fraud is advance fee scams for debt elimination in which third party perpetrators fraudulently promised to obtain mortgage loan forgiveness from financial institutions for borrowers. There are many such schemes going on all across the country. The financial institutions should be very careful when analyzing the documentation to see if a third party (most likely a separate business entity) is sending all the documentation on behalf of the client.
Another factor as discussed above is misrepresentation of income or employment. The financial statements given to the bankers differ significantly from the annual tax returns of the clients, which might be an indicator of potential mortgage fraud. The bankers however should consider the differences between generally accepted accounting principles and tax provisions to eliminate the true differences first and then to compare the financial statements with the tax returns. An example of such a difference is the depreciation expense. There are many depreciation incentives provided by the Federal Government for businesses these days, which can cause greater disparities between the financial statements and tax returns. Also all the bank accounts on which the clients has signing authority (accounts opened with parents, minors etc) should be analyzed while analyzing the financial situation of a client.
Fraudulent use of social security number (SSN) is also one of the potential areas of mortgage loan fraud these days. The parties involved in the transaction might use a SSN which do not belong to them to obtain loans. If no proper SSN verification is done by the lenders at the time to extending loans then later on title related issues can rise.
Frivolous legal challenges to terms and conditions of the mortgage loans can possibly reflect the mortgage loan modification. Some of the documents which might be used to defraud are advance fee scams for debt elimination in which third party perpetrators fraudulently promised to obtain mortgage loan forgiveness from financial institutions for borrowers. Some other factors are fraudulent payment methods such as fictitious “bonded promissory notes,” fraudulent cashiers’ checks, or other worthless monetary instruments.
Many different kinds of foreclosure rescue schemes are out there. One of the schemes is where a financial institution might receive an initial request for short sale from a third party hired by a client. After getting the fees from the clients and telling them that short sale process has been started with the bank, the third party disappears.
Related party transactions such as using a friend of relative in the short sale process still implies that original property owner will still not be able to make the house mortgage payments and eventually will end up in a foreclosure. Often such properties are flipped again which might result in the foreclosure down the road when the price of the property will be dropped even more. Straw buyers are often used to structure such kind of transactions.
Shehla Begum, has a Masters in Business Administration for the University of Central Oklahoma. She currently works as an Indian Tribal Government Specialist with the Internal Revenue Service. She has been a field agent and completed IRS training for Bank Secrecy Act.