Commercial lending has significant competitive pressures. In response, many banks have loosened underwriting standards and relaxed procedures to become more “borrower friendly”. To compound the risks, banks also remain susceptible to diminishing collateral values, limited due diligence and business decline. The key to mitigating loss is to act quickly and to know the current value of the loan portfolio.
Traditionally, bank internal loan review departments have relied on a delinquency-based approach to evaluate loan portfolios. However, Banks should require a periodic, in depth analysis to correlate loan and collateral values and to judge the health of the business, before it is too late. The lenders are generally the last to recognize the severity of the financial issues.
An asset manager’s job is to be regularly informed with performance and calculation data, but in the case of a distressed entity, that is simply not enough. An on-site professional independent business valuation by an expert could save the bank from significant loss.
Valuations can be tricky, especially when the assets become distressed. Assets, like cash, securities, commodities or bonds, have values that are known at any given point in time because the market determines their worth. The value of some assets – especially intangible assets, may not be as readily available or as precise. These are known as unique and hard-to-value assets. The following case study identifies warning signs and highlights best practices to diminish loss in commercial lending programs.
Case Study: Diminishing collateral values and health of a Company.
An international Bank provided a medical practice (the “Company”) with a loan of approximately $20,000,000. This loan was collateralized on the assets of the Company and the sole shareholder. Within six (6) months, the Company stopped making payments, and was put into special assets workout. Lakelet Advisory Group was engaged by the Company to assist with a sale and/or turnaround. Lakelet worked on-site, conducted numerous personal interviews, and performed hands-on inspection of the company’s financial and administrative records. Based on Lakelet’s valuation of the Company, it was revealed that the Company was not worth the loan value despite its stated asset base. The secured creditors were not willing to accept the facts as independently presented. Unfortunately within four (4) months the Company was forced into bankruptcy.
Here is a short list of Lakelet’s on-site findings mostly unknown to secured creditors:
- The CEO and several other Doctors were under investigation (both civil and criminal) with the Department of Justice for alleged fraudulent billing;
- A health insurance carrier that accounted for 30% of revenues, dropped the Company from its network within 45 days of the completion of the loan;
- Despite not being able to be reimbursed for their services, the Company continued to see and service patients from the abovementioned insurance carrier. This increased the accounts receivable with no possibility of collections. Moreover, costing the Company hundreds of thousands in non-reimbursable pharmaceuticals and medical services;
- The company continued to book these‘uncollectable’ services to their AR, thereby grossly overstating their AR;
- The company did not have an adequate collection process and 60% of the AR was over 120 days;
- The company failed to remit payroll taxes resulting in an IRS lien that added another dimension of complexity; and
- The CEO and executive team was ineffective in making necessary changes critical to saving the Company.
The secured creditors were not realistic about the enterprise value and should have had a professional valuation. An on-site analysis and a few days of basic due diligence could have prevent the severe economic loss of the secured creditors. The over reliance on the historical financial statements misinformed the creditors and other parties of the true economic condition of the Company.
Best practices to mitigate loss in commercial lending programs:
- Perform on-site periodic professional business valuations on all challenged loan portfolios;
- If a loan is placed in special assets, have an on-site professional independent business valuation performed immediately, and before employing a consultant(s) or turn-around professional(s); and
- Decide the next step and execute on said decision.
About Lakelet Advisory Group
Lakelet is qualified as a professional business valuation and advisory firm. We are Certified for Business Valuations by the American Institute of Certified Public Accountants (AICPA), Certified in Financial Forensics by the AICPA, and hold the specialty designation of Accredited in Business Valuation (ABV). In addition, our firm has experience in testifying as an Expert Witness in federal court.
Lakelet is also uniquely qualified to assist with turn-arounds, or finding buyers to allow troubled companies to be removed from bank portfolios.