Are You Prepared for the Next Generation of Problem Loans?? They May Already Reside on Your Balance Sheet!

J. Michael Allen, Senior Credit Officer State Bank and Trust-Atlanta, GA

404-266-4501 mike.allen@statebt.com

2017 Georgia Banking School

Troubled Assets – Course 218 May 11, 2017

ALL MATERIAL HEREIN IS WRITTEN BYTHE AUTHOR AND MAY NOT BE COPIED WITHOUT HIS OR HER WRITTEN PERMISSION. THE EXHIBITS SHOWN ARE PROPRIETARTY FORMS OF THE BANKS WHO GRACIOUSLY SUPPLIED THEM AND CANNOT BE COPIED OR USED WITHOUT THEIR EXPRESSED PERMISSION GBA AND THE AUTHOR MAKE NO REPRESENTATIONS OR WARRANTIES AS TO THE BINDING AND LEGAL EFFECT OF THE ENCLOSED EXAMPLES. PARTICIPANTS SHOULD CONSULT THEIR OWN LEGAL COUNCIL REGARDING ENFORCEMENT APPLICABILITY OF THESE DOCUMENTS.11111

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Section 1 3

Relationship Driven Policy Governed Do You Know Your Customer Cash Flow Focused Pro-Active Ownership of Customers Healthy Skepticism Are Actions governed by Your Company’s Values Balance of advocacy & objectivity

What Is Your Institution’s Credit Culture? Is It:

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How does your customer make money? Use of your proceeds? How will you get paid back? What are the risks to repayment? Have I mitigated the repayment risks?

How Do You Lend Money

Section 1 5

Find a default trigger

• Loan maturity

• Payment default

• Covenant violation

Make a formal demand for payment ASAP

Take steps to find and to garnishee assets and/or sue for judgment

If you agree to waive default or re-set the loan:

• Use a forbearance agreement

• Include “waiver of claims” clause to hold harmless the bank

• Get additional collateral or guarantor support

Don’t cave in to a threat of bankruptcy

Five Practical Workout Steps and Tips

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Request for restructure

Collateral over advances

Overdrafts

Late Payments

Tax problems - payroll taxes paid?

Conversion of trade debt to notes payable

Rapid growth in plant and equipment

What are the Troubled Signs to Look For?

Mismatched asset financing

No strategic plan or direction

High personnel turnover

Frequent accountant changes

Evasiveness of borrower

Non-compliance of loan agreement terms

Remember – The Debtor Knows More Than You!

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Documentation Review - What are you looking for? Do I tell all?

New lien search and collateral valuation - true liquidated value

Financial analysis

Related family debt search - why is this important?

Evaluate operational problems

Evaluate financial problems

Are there environmental concerns?

Can this borrower survive?

Decide what your plan is and execute

Analyzing the Problem Loan: A Nine Step Process

Tools to Help You Analyze the Problem

Site Visit

Section 2 9

Venue - your place or theirs? Pricing Amount Collateral Short term maturities Forbearance Agreements

Acknowledgement of debt by debtor and guarantors Release of lender liability claims Payments on the note Payment of forbearance fee Pledge of additional collateral Board approval or no

Your Weapons

FOCUS: The goal? Return OF my investment and not ON my investment!

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Is a workout the better path or is it better to liquidate?

Pre-work out letter

No agreements until put in writing

Go into negotiations with eyes open

No guarantees of a happy ending

Select the advisors of your choice

Workout Negotiations

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June 1, 2013 Ms. Ima Walker 1234 Missing Payments Road Walking, HM 22222

Re: Auto Loan 123456789 Dear Ms. Walker, Pay by Friday or walk. Sincerely, Your Banker Bankersville, USA

Section 3 12

Documentation flaws - can I fix them and in time?

Relationship history - “course of dealing” - How am I handling overdrafts?

Lender Liability Risks – Is there a basis for a claim?

Promising future or additional financing

Good faith and fair dealing - ethics

Am I obligated to additional financing

Control and interference

Breach of Fiduciary Duty

Fraud

Exercise caution in documentation – especially memos and emails

Is there anything that I should be afraid of (You do not know what you do not know!!!!)?

Use the sixth “C” – Common Sense

Participation Risk(s)

Collusion Risk

Miscellaneous Considerations

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Guarantor Defenses:

Release of principal guarantor

Release of co-guarantor

Change in terms and proper disclosure

Lender fails to follow loan agreement

Lender fails to dispose of collateral in commercially reasonable manner

Guarantees

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Construction Draw

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Fund Control

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Challenge: Most Construction contract defaults are payment related!

Funds Control Continued…

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Program should include: Review of monthly GC pay application request

The collection of invoice support

Audit of each line item of the draw request, matching the percentage completion to the appropriate invoice

Rapid and accurate distribution of draw proceeds upon approval

Change order tracking

Lien waiver collection

Maintenance of records

Audit support

Don’t let this…..

18

Reflecting on Recent Times Today

SO….ARE THE BEST TIMES BEHIND US?

WILL OUR PORTFOLIOS SEE MORE QUALITY EROSION?

IF SO….HOW HIGH WILL THE NEGATIVE STATICS GO?

IS IT POSSIBLE TO REPEAT THE PAST??????

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Reality Check – Are We Repeating the Past

Past Lessons Learned/Credit Management

Due Diligence is key and must be commensurate with the credit size and risk. We must be independent and not rely on the deal sponsor or other parties to the transaction. Financial modeling is not due diligence

Our Analysis and Focus must go beyond the Financial aspects and into Operating and Industry issues

Historical performance is far more important in making an underwriting decision. Projections while appropriate, should not drive the credit decision, and can be misleading

Yield cannot compensate or justify excessive Credit Risk

Valuation/Values are not static and therefore our analysis should take into account all scenarios (good or bad). Since we rely on value for fallback, the valuation assumptions should be from a “buyers” point of view and presume and unplanned sale

Analysis of Financial Risk and Debt Service capability must take into account the whole debt/capital structure not just our position in the credit

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Past Lessons Learned/Credit Management Continued

While Lack of Syndication ability may mean that the credit risk is potentially unwarranted, Subscription demand does not always mean that the credit is a prudent one

Micro management of credit and the loan Portfolios cannot save us from inordinate loan losses. Overall Portfolio Management including limits in size, diversification, concentration, exceptions, RR profile, etc. are necessary to long term success in credit

Excellent Credit Administrative and Loan Review processes are limited in terms of risk of loss reduction where Fallback/Alternatives at the outset were weak

In the long run, Excessively Large Credit Exposures cannot be justified, particularly in cases where Fallback, Asset Coverage and Cash Flow are variable and out control of risk is limited

There is not substitute for Real Equity

Understanding the total liability/creditor exposure is mandatory (off balance sheet debt)

Getting Secured and acting early is key to loss avoidance, most likely when beliefs are positive

Reality Check – Are We Repeating the Past

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Past Lessons Learned/Credit Management Continued

Cash Flow is King…Covenants and Structure don’t repay the loan

Over-reliance on “Relationship” can lead to imprudent credit risk, and loss of loan dollars and the relationship

The 4C’s of Management (capacity, character, competence, cooperativeness) are essential and as critical as the primary source of payment

Reality Check – Are We Repeating the Past

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Past Lessons Learned/People Management

Credit Risk Taking needs to be balanced and measured against our Lenders – their skills, capabilities and limitations. Training and communication is essential

Independent & Objective Credit thinking is unbeatable over time Incentives should not be based solely on loan production, but also include credit quality and

risk management activities

Portfolio Growth & Officer Growth must be in harmony

Ignorance and Lack of Action are the biggest enemy in PLM

Accountability for Pro-Active Risk Management needs to be at the individual and corporate level

The repatriation of SAD/Credit Officers to Line and vice versa has great benefit over the long run

A Strong Problem Loan Management Function Capability should not be viewed as optional or secondary

Reality Check – Are We Repeating the Past

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Clearly, We Are Smarter & Better than Yesteryears

BUT

Looks Like We Have Made Some of the Same and Maybe Some New Mistakes

WHY?

Reality Check – Are We Repeating the Past

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Outlook and Avoiding the Past

Being A Winning Lending Institution

The Winners are those that will: Have Culture and Discipline to Apply the Risk Management Tools & Lessons Learned, (particularly

the Portfolio Management Level)

Read the Warning Signs Early – At the Individual and Portfolio Level

Cull out the Winners from the Losers Early – Migration Analysis

Be Pro-Active in Managing High Risk Assets – Sense of Urgency

Think like “Traders” and not be afraid to Sell Risky or Known Problem Assets

Be Brutally Honest and Thorough on the Origination and Review of Credit (DO NOT “SELL” CREDIT TO APPROVAL AUTHORITY) Stay within their Lending Capacity and Competencies Staff Properly and Arm their Officers with the Knowledge, Tools and Support

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LET US REMEMBER……………

“Those who Forget and Fail to Learn from the Past are Condemned to Repeat It”

and

“It’s a Person’s Ignorance that gets Them Into Trouble and Their Arrogance that Keeps Them There

Bad Loans – Have We Really Learned From Our Past Mistakes?

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