Loan Portfolio Protection: Risk Management for Commercial Lenders
Is their Loan Portfolio at Risk?
At a recent conference of the American Bankers Association, an unscientific survey was taken.
Several bank presidents and CEOs were asked the following questions;
Do you have any business loans that are at risk?
The short answer is yes.
When asked if they had a significant portion of their loan portfolio with a small number of clients, they again answered, yes. Nothing unusual so far.
So the third question seemed to be more challenging.
What are you doing to protect yourself, the loan portfolio and your investors from those loans losing value should the owner suddenly die, become disabled, or be involved in a partner dispute? That question got a number of nervous responses such as: “Not much; I should be doing more; I’m not sure what I can do? “
Banks are the backbone of the small business world as they provide capital in the form of loans for operating capital, loans for capital investments to expand buildings, businesses and hire staff. In return, bankers earn their living by making good loans to credit-worthy customers and businesses.
Sadly sometimes businesses suffer adverse market conditions, costs of raw materials change, labor costs rise, the entire industry on a global scale can decline as we have seen in oil and gas, myriad of factors out of their control can change. In most cases the banker and the client are aware of the risks when they make the loan and with their skill set can manage those risks.
But what risks are present that most bankers and clients can’t predict and hope to ignore?
Death or disability of the business owner. What happens when the business owner tragically dies of a heart attack or is hit by the proverbial “bus” or becomes disabled and is no longer able to run the company? Additionally, with multiple owners of the business, we have seen a tremendous uptick in ‘partner stress’ particularly related to timing and terms of the business exit strategy. Partner disputes can be devastating.
That’s when the “now what” questions get asked.
1. Did the business owner have a will? 2. Were the owner’s assets properly titled in a trust? 3. Did the owner have a trust? 4. Was there a succession plan in place? Was it written? Communicated? 5. Did they have life, health, long-term care or key man insurance? 6. Is there disability insurance in place? 7. Was there a buy/sell agreement with the partner(s)? Shareholder agreement? 8. Was their proper funding for these triggers? 9. Will the company’s legal structure allow the business to continue to operate? 10. What happens to my loans should the business get sold?
The worst case scenario is that the business is unable to continue to operate or an ill-equipped partner or family member takes over and runs the business into the ground. When the sole proprietor dies, will the business die with him?
Or, the distraction, expense, and challenges of partner discord is just too much, and the business suffers financially. Oftentimes forced to sell, and the relationship with the banker, as well as the loan, is truly at risk.
How Big is the Market?
The small business market is significant to community banks and in many cases their key source of revenue and profits.
According to the Small Business Administration, in 2010, there were 27.9 million small businesses with fewer than 500 employees and 75% were sole proprietorships. The U.S. Census Bureau provides the following recap of businesses by employee size.
No. of Employees No. of Firms No. of Establishments Employment Annual Payroll ($000) 0 to 4 3,532,058 3,540,155 5,857,662 $230,422,086 5 to 9 978,993 993,101 6,431,931 $218,085,669 10 to 19 592,963 626,981 7,961,281 $284,251,614 20 to 99 481,496 651,624 18,880,001 $746,085,051 100 to 499 81,243 350,197 15,867,437 $690,509,553 Source: U.S. Census Bureau
Are there additional benefits of working with loan portfolio clients?
Besides protecting your loan portfolio, there are real benefits. A few examples follow:
Keeping the Money
One of the first is keeping assets and loans. By playing a key role in working with the business owner before a catastrophe strikes puts you in a position of strategic partner with the remaining partners, heirs or successors. A recent study by Scott Stathis, managing director of BISRA, a research and consulting firm for banks and credit unions, found that 82% of investment services executives estimated they kept less than 30% of the assets upon the sale of the business, which is often what occurs upon the death of the owner, or with disputes that just cannot be resolved. Bank executives can dramatically improve their position by creating a more in-depth relationship with the client and their management team through financial advisory work.
A recent study by Kehrer Bielan Research and Consulting, suggests that customer loyalty is impacted by the clients’ involvement in investing with a bank or credit union.
According to their research, nearly half of the households that invest with their primary bank or credit union say they would not switch if presented with a competitive offer, while only 25% without an investment relationship say they would not switch.
Lastly, an additional comment from the Kehrer Bielan group found that households working with an investment advisor in their bank or credit union, on average kept a 38% higher checking account balance and had 140% higher savings account balances than households that did not have an investment account relationship.
Who Protects the Loan Portfolio?
The follow on question to the executives at the ABA Conference was more focused on why bankers don’t ask more questions or get more involved in the process of planning and who could help.
The answer for “why they don’t” was interesting. Several of the bank presidents’ answers were:
1. We don’t hire people with a skill set to do that. 2. We don’t train our bankers to do that. 3. It’s not in their DNA. 4. We’re more focused on “getting the loan”.
So if the personal banker or the loan officer is not the right person, who is and how would it work?
How to Protect the Portfolio
While financial planners have many of the skills and much of the knowledge needed to start and manage the process, they would want to act as the process coordinator and recruit specialists into the process.
Building a team of specialists for the benefit of the bank and client ensures that skill sets and experiences from multiple sources are being used. The team in this case would most likely include the following:
1. Attorney: their focus is on wills, succession documents, articles of organization for the business,
trusts and working with the owner to properly title assets. 2. CPA: many decisions made for the business and for the benefit of the owner’s family will have tax
ramifications that should be planned for and addressed. 3. Business Succession Planning Specialist: in many of the more complex cases, it is important to have this expertise to guide the process. Often this individual/firm has worked on a multitude of situations and provides the ability to coordinate the advice; thus will ultimately get things done. 4. Trust Administration: picking a trust administrator focused on administrative only functions, not investing can have an impact on the execution of the wishes, the design of the trust documents and how assets are titled. 5. Family Dynamics Coach: While this practice is not as common as the others mentioned above, it is often the case that the family dynamics are the most difficult. What is the role of the again matriarch and founder of the firm? How do the children fit in and when is it appropriate to challenge the decisions of the parents?
By working with a financial planner in your institution, and coupling with outside resources where appropriate, they can create a holistic estate and succession plan to protect the business, the owner’s family and the bank’s loan portfolio.
Engage the financial planner in meetings with business owners to help them understand the unforeseen consequences of not having the proper structure in place to protect all parties.
Just like rebalancing a portfolio when market conditions change, meeting regularly with a loan portfolio client keeps the advisor aware of changes in the client’s health, marital status or other conditions that could affect the business. The impact of those changes should be part of your game plan in order to continue to derive benefit from having the account with the bank.
If you do not currently have an investment advisory or wealth management program, consider adding a relationship. Additionally, you should seek out additional resources available to assist with these challenging issues. The role of utilizing an experienced business succession planning expert to facilitate the process, cannot be overlooked.
Keep in mind that your goals are protecting your loan portfolio and picking up some additional non- interest income for the bank. As well as being properly positioned to assist with investing the assets following the liquidity event, and perpetuating that client relationship into the next generation of ownership.
So look over the loan portfolio and consider the concentration of the loans, the risk involved should anything happen to any of the business owners or major loan holders and consider working with an advisor and outside resources to put some risk management tools in place.
For more information about business succession planning services, call Executive Solutions at 402-991- 1700 or visit us online at EXECSO.COM