The bank’s perspective
According to accounting and regulatory rules, if a loan modification is requested and granted due to the business’ financial difficulties, then the loan should be classified as a Troubled Debt Restructure (TDR) and reported as such in its quarterly call reports to its regulators.
No bank wants to haphazardly grant these modifications because there are serious ramifications for the bank. Modifications shouldn’t be requested because the owner’s income has been reduced and is keeping him or her from living beyond current means, such as scheduling an annual trip to Europe or paying a child’s Ivy League tuition.
Instead the reason for the request should be there is a temporary, existential threat to the business that could be assisted by a short-term modification of the loan terms.
When asking for temporary assistance from a lender, the owner must be prepared. He or she should have current and accurate financial statements, demonstrating what the problems are and explaining the plan to surmount them.
Owners should not expect the bank to lower the interest rate or reduce principal payments for the entire remaining term of the loan, but only for a short time, usually less than one year. The bank will want to frequently review the business’ financial statements to determine whether the modification is necessary in the future because the new interest rate will probably be unprofitable for the bank.
Why answer may be ‘no’
Unfortunately, there are circumstances when a lender has no authority to make decisions regarding a loan other than to pursue its collection until it is fully paid or the property has been foreclosed upon and sold. This might happen when a bank in another state financed the business and communications break down.
Another reason might be that the loan has been sold to the secondary market as a piece of a much larger mortgage-backed security that has been divided into separate branches with numerous owners that are represented by a loan servicer.
The advantage of this type of financing is a low, fixed-interest rate with a distant maturity date. One of the downsides is there is nobody to speak with other than a collector or an attorney demanding payment if trouble occurs.
Apples to apples
When businesses are evaluating offers of loans, don’t view the institution through the same lens as when choosing a mortgage loan for a personal residence. The owner should assess whether a personal banking relationship can be established with the loan officer and senior bank management — a service characteristic more often found in community banks than in larger financial institutions. There, the bank’s management can become internal advocates for the business owner.
These are just a few of the concerns business owners should be aware of, if they’re interested in modifying their existing loan. As with many professional decisions, it’s always a smart decision to properly prepare and consult with a current lender before making this step.
Contact Fred Dawson Jr. is an executive vice president and the chief credit officer for Commerce Bank of Arizona, an Arizona based community bank specializing in serving small to mid-size businesses in Arizona. He may be reached at email@example.com or (520) 325-5200.