Have you ever felt annoyed whenever your lenders ask for your updated financials? You are not alone. “Why are you asking for updated financials again? We never missed a payment and we’re paying on time.” is a typical response that servicers and lenders receive when collecting financials.
What are the typical documents that we collect? At minimum, we require property and obligor balance sheet and income statement, tax returns, debt schedules, information on their property such as rent roll and new/amended lease agreements, and personal financial statements of individual guarantors, among others. Would you agree that these are not difficult to provide? However, if you are not a priority for the borrowers, they won’t spend time on you – just like in any relationship.
Some servicers might hesitate to push the borrowers to provide financials as scheduled, but not AVANA CUSO. We understand that timely collection of financial reporting requirements is critical to risk management. We enforce the written word – the reporting requirement covenants in the loan agreement that borrowers and guarantors signed. Here are our tips to collecting financial reporting requirements:
1. 60 days prior to deadline – Notify the borrowers that their financial reporting requirements are due, so they’ll have ample time to prepare. Send them a secured upload link for data protection.
2. 30 days prior to deadline – Send a gentle reminder.
3. 2 weeks prior to deadline – Send another gentle reminder and call them.
4. Deadline – Call them and send a notice stating that the loan will be in default if they don’t send the requirements.
5. Default notice – Send a default letter stating a cure period according to the loan agreement and timing of imposing the default rate if they don’t comply.
6. Impose default rate – If the borrowers have not sent the required financials after the cure period, we impose the default interest rate until they are in compliance with the requirements.
In between the document collections, we would appreciate their cooperation and send them an updated list of pending items. We always try to build and maintain good relationship with borrowers; however, failure to provide the required financial reporting requirements under the loan covenants is an event of default. Borrowers and guarantors would typically avoid the default rate as much as possible. We might sound mean to uncooperative borrowers, but the threat of imposing default rate is one of the best leverages that we have under our sleeves. We have the right to do so under the loan agreement.
At AVANA CUSO, we highly understand the repercussions in failure and delay in collection of financial reporting requirements. These include but are not limited to the following:
1. Untimely detection of adverse change in risk essential to risk mitigation – In one of the loans that we handled, the borrower would not have informed us that their anchor tenant occupying majority of the subject property vacated if we were not regularly obtaining their rent roll. This increases their probability of payment default. Losing major tenants can also affect collateral value, consequently affecting the loss given default. Timely detection of changes in risk drives us to take appropriate actions to mitigate such risk.
2. Inability to measure financial health and covenants – We will not be able to measure the borrower’s financial covenants such as debt service coverage ratio and debt yield, along with their financial health indicators such as liquidity, leverage, profitability, performance, and other ratios without updated financials. These are essential to monitor the obligors’ capacity to continue to meet their debt service obligations. We can also observe trends and detect a potential future problem.
3. Risk of inappropriate risk grade – Our ability to appropriately risk grade the loans will be jeopardized. Accurate and timely risk grading of each loan in the portfolio is paramount in proper relationship management, portfolio management and establishing an adequate reserve for loan losses.
4. National Credit Union Administration (NCUA) examiners look for updated financials – During NCUA audits, examiners would look for and review updated financial data.
5. Maintaining relationship – not a repercussion but worth mentioning – regular collection of financials gives the servicer/lender the opportunity to catch up with the borrowers, guarantors, and management to maintain relationship with them.
Lenders/servicers would like to know what’s going on to stay on top of credit risk. I’d end with a quote from The Ancient One in Doctor Strange. We never lose our demons; we only learn to live above them. I find this applicable to risk management that we do here. Demons represent risks that are present in every loan. What we do is live above our risks through regularly collecting financial reporting requirements and performing loan reviews in our existing portfolio and work on continuously mitigating those risks.