Five Steps for Monitoring Business Loan Portfolios
As banks continue to tighten lending standards, many small business owners are turning to credit unions for business loans and other services.
As a result, many credit unions have seen strong growth in their business-loan portfolios, according to “Strategies for Monitoring Credit Union Member Business Loans During a Recession,” a white paper from CUNA's business and consumer publishing department.
But as the economy sputters, unemployment rises, and consumers grow more reluctant to spend, many small business owners are seeing their cash flow dry up to a trickle.
Credit unions offering services to small businesses should carefully monitor the quality of their portfolios and take quick actions when necessary. Signs of weakness among your small-business borrowers include missed payments, missed loan clean-up provisions, or delays in required financial reporting.
The most important advice for business lenders is to be vigilant, watch for early warning signals, and take these five steps:
1. Monitor financial reporting. As you monitor the health of your borrower's small business, answer these questions:
2. Validate collateral. Many small business loans are collateralized by working capital (accounts receivable and inventory). The loan balance should be based on an advance rate, such as 75% or 80% of the 30- to 60-day accounts receivable balance.
Inventory should be more heavily discounted, with 50% of finished goods and no advance on raw materials.
These are conservative valuations. You'll need to review your loan agreements to determine specific limits for each borrower. Review this information at least quarterly and enter the accounting into your risk rating for each borrower. Monitor the data on each borrower through a covenant compliance worksheet.
Also, review the collateral by doing site visits, checking rent receipts, and monitoring current economic trends. Are vacancies occurring in the area that would affect overall cash flow and the underlying collateral value?
A loan-to-value ratio of 75% or lower is a good benchmark to protect your underlying real estate collateral value.
3. Loan documentation. As you check underlying loan documentation, ask these questions:
4. Communication. Meet regularly with your small-business borrowers. Ask questions and check out their facilities. Ask about any trends relating to the borrower's customers, shipments, and cash flow.
If you have to restructure a loan with a small-business borrower, the key to success is communication with the borrower and your knowledge of the borrower's business, loan payments, and collateral position. Find out what the borrower intends to do to turn things around.
Options for restructuring business loans can include:
Deterioration can occur quickly in this economy, which makes monitoring business borrowers more important than ever. Waiting to receive an annual report is too risky, and it can lead to contentious negotiations if the borrower feels backed into a corner. The solution is early intervention, which preserves options for both parties.
5. Risk-rating worksheet. This is your most important tool. You should complete one of these for each loan.
Monitor and update each worksheet as soon as you receive the borrower's financial reports. The worksheet should be part of your credit union's business lending policy and it should be used throughout your credit union.
While reporting might be done annually, business loan officers should immediately let your credit union's senior management know of any decreases in a business borrower's ability to repay, collateral value, or financial position.
You'll never be able to protect your credit union against all business losses. There's not much you can do if a borrower siphons off cash or sells collateral without paying down the loan or line of credit. These cases, fortunately, are rare.
It's more common for the borrower to experience declining real estate value that erodes the borrower's equity cushion. But if cash flow is there—even at a reduced level—you should be able to maintain a performing loan.
The key is to act quickly. Don't lose your window of opportunity. Business borrowers who can react quickly and keep their businesses profitable during a recession are relationships you want to retain. By working together to restructure a loan, you can create a win-win for both parties.
Reprinted with Permission from Credit Union Magazine online.
Powered by Comment Script
|Renew Membership Online|
|Update Member Information|
|Frequently Asked Questions|
|CUNA Councils Connect|
|In the Spotlight|
|Council Web Polls|
|Additional Resources from CUNA|
|All Past Conferences|
|Excellence in Lending Awards|
|Phil Greer Lifetime Achievement Award|
|CLC Scholarship Fund|
|CUNA Council Calendar|
|Speaker Proposal Form|