Loss Mitigation - Compare/Contrast: Approach to Commercial Credit

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1 Effective Loss Mitigation Efforts Techniques to Reduce Risk Mary Kay Schneider Stephen Damore November 15, 2010 Loss Mitigation - Compare/Contrast: Approach to Commercial Credit Capital One Bank: Centralized commercial underwriting up to $3MM Score plus up to $1MM then judgmental Custom early warning system, with multiple feeds both internal & external Goal for losses = 140 bps through the cycle PNC Bank: Centralized commercial underwriting up to $3MM Score plus up to $250M then judgmental Custom early warning system with multiple feeds, both internal and external Goal for losses = 150 bps through the cycle 1

2 Loss Mitigation - Underwriting: Protecting on the Front End Know Your Customer protect against fraud Solid Underwriting follow the 5 C s of Credit Ask Does it make sense? Document for the approval Clear any loan exceptions early on Centralize the disbursement of funds Loss Mitigation - Managing the Portfolio: Recognition of Customer Deterioration Early warning signals: Behavior score deterioration FICO score deterioration of guarantors Overdrafts Embedded line usage Late payments Industry/franchise struggles Liens, suits, judgments being filed Collateral value deterioration Change in ownership and/or management Divorce/untimely death 2

3 Loss Mitigation - Monitoring Scope: Reviewing Risk Pass Credit: Periodic reviews Covenant tracking Borrowing Base tracking External due diligence Watch and Criticized: The scope and frequency of monitoring increases Special Assets is consulted and may drive the credit and action plan Loss Mitigation - Loan Workout: Protecting on the Back End Determine relevant course of action: Retain Exit Liquidate What factors should be considered in determining the best course of action? What types of modifications can be pursued? Are they feasible and what desired outcome can they produce? 3

4 Loss Mitigation Workout Strategy: Typically Employed Tactics Retain Establish timeline and action plan for borrower Assess borrower s progress against action plan Revise action plan to correct problems Re-assess whether retaining borrower is still the best option for the bank Obtain release of liability from borrower Exit Develop action plan with timeline for borrower to exit the bank Monitor borrower for compliance with loan terms Notify borrower if loan goes into default; provide time frame for curing default Send demand letter if default cannot be cured Obtain release of liability from borrower Liquidate Obtain judgment against borrower Obtain collateral through foreclosure or deed in lieu in full or partial debt payment Continue workout process through Recovery on loans that have been charged off Loss Mitigation - Case Studies: Who approved that loan? Borrower manufactures all natural Southwest style foods. The main facility is in NE Texas, with distribution centers in Louisiana and Arkansas. The company sells fresh or frozen, branded or private label, and individual or bulk packaging Loans consist of $500M RLOC for working capital and $500M comprised of three term loans. Secured by UCC filing on all assets. Full guaranties provided by two principals; minimal outside assets. Customer had good local market penetration, particularly in TX. Strong distribution network. Satisfactory cash flow and leverage. Borrower is a non-profit performing arts and arts education organization established in Ohio in Combines professional theatrical productions with comprehensive curriculum-based arts education. Serves over 100,000 annually. Supported by the city and community foundations. Artistic director is a 20 year veteran Loans consist of a $300M LOC and 2 term loans totaling $1,150M Secured by a first mortgage on commercial property valued at $3.5MM and a blanket lien on all assets valued at $290M Approved loans in 2006 based on strong collateral coverage, sufficient debt service coverage and community interest/involvement 4

5 Loss Mitigation - Case Studies: The Recession takes over Sales declined in 2008 and 2009; Chapter 11 filed in 4Q2009. COB debt at filing totaled $950M ($500M on the LOC and $450M on the term debt). Total debt was $2.5MM against $200M in unencumbered assets. Assets securing COB debt were listed at $800M. While revenues from productions remained stable, funds invested to be used for operating delivered sub par results in 2007 and 2008; operating income declined, such that debt service coverage was < 1:1. Operating profit improved in 2009, coming off of 2 years of losses, was driven by an increase in Education billings and contribution and grant increases. A new Finance Director was hired in 2008 and a new Marketing/External Affairs director was hired in Borrower has been unable to meet its projections over the past 3 years Loss Mitigation - Case Studies: The Final Outcome Proof of claim filed as secured lender; acknowledged by the debtor. Trustee noted that the UCC was filed in Arkansas rather than Texas. Since the assets are primarily located in Texas, the Trustee has taken the position that COB s lien does not cover any assets. Bankruptcy court ruled with Trustee. The bank charged off the entire $950M in 2Q10. Lesson: Proper documentation is essential to Loss Mitigation. Local community development fund of city forgave $46M loan Local community foundation support was clarified to be a grant, not a loan PNC consolidated embedded LOC of $300M and two term loans into one note for $1,277M over 3 year term with a 20 year amortization secured by $3.5MM first mortgage lien (38% LTV) and blanket filing on all assets This action supported by improved debt service coverage as the revised debt picture and the new structure reduced annual DSC by approx. $47M annually. Projected DSC at 1.2:1. Lesson: Benefit of taking time to completely understand debt picture and consulting with customer on overall debt structure. 5