Stay-at-home orders and social distancing measures aimed at slowing the spread of COVID-19 have caused severe economic hardships for many businesses, threatening their ability to meet loan obligations.

In the early stages of the pandemic, the four federal agencies supervising banks and credit unions (Federal Reserve, FDIC, OCC and NCUA) with the state regulators issued an interagency statement to address anticipated disruption. The interagency statement encouraged banks to work with borrowers to provide loan payment deferrals and other flexibility, describing the situation where a short-term loan modification granted to a borrower that was current in response to COVID related financial problems a borrower faces would not be considered a troubled debt restructuring.

Unfortunately, some borrowers who thought they needed three months for their deferment have come back for another. Some areas of the country and many industries are not doing as well as hoped, and while we wait for more sectors of the economy to reopen, examiners will come calling.

Banks and credit unions should prepare by referring to the agencies’ examiner guidance issued in June that listed 10 different areas of interest. That examiner’s guidance makes it clear that the examiners are expected to continue to assess credits in line with the interagency credit classification standards, keeping in mind constraints posed by the pandemic. With this in mind, below are some tips for dealing with nonperforming loans in light of the current economic uncertainty.

• Banks should be contacting borrowers, talking about what financial recovery looks like for them. Use this time as an opportunity to find out what unique challenges a business is facing, how they are revising economic forecasts, and what steps they are taking to pivot in response to the pandemic.
• Consider whether the challenges a borrower is facing are unique to that business or are consistent with the difficulties that other members of the relevant industry are experiencing.
• Make sure that borrowers know that if they’re going to have trouble making loan payments, or are likely to be out of compliance with financial covenants in their loan documents, it is best to let the bank know as soon as possible, preferably ahead of time.
• Encourage borrowers to be realistic about the financial difficulties they expect to face in the coming weeks and months. The bank may work with a borrower to modify the terms of its loan to prevent it from going into default.
• If the borrower waits until the loan is in default, the bank’s options may be limited due to regulatory constraints.
• Most importantly, be proactive and check in with borrowers frequently, including visiting their place of business (as local COVID-19 restrictions allow); borrowers should not be allowed to ignore the situation or fail to respond to emails or phone calls from the bank. Failure to provide requested financial information in response to changed circumstances is often the primary reason banks initiate enforcement action on troubled loans.
• Re-familiarize yourself with loan documents. The loan documents, which typically include a loan agreement and one or more promissory notes, may also include a security agreement, one or more real estate mortgages (called a deed of trust in Missouri), deposit account control agreements, and other documents whereby the borrower has granted the bank a lien on specific assets as collateral for the loan. Make sure you understand the loan terms, including the maturity date, whether the borrower has additional borrowing capacity on lines of credit, whether the borrower has options in terms of interest rate, and what circumstances may trigger an event of default on the loan. Also, review what assets are pledged as collateral, including real estate and other fixed assets, accounts receivable, deposit accounts at other banks or all of the above.
• Run updated UCC searches to confirm that financing statements have been properly filed to the extent necessary to perfect the bank’s security interest in the collateral. If applicable, it is advisable to run updated title searches on all real estate collateral to check for mechanic’s liens, tax liens, or other liens that could take priority over the bank’s lien.
• Review loan guarantees and understand how they tie into the overall loan structure. Owners of the business or affiliated companies may have given guarantees. Determine whether the guaranty is limited to a certain dollar amount, or whether liability under the guaranty may be triggered by certain events.
• Review the conditions under which a borrower may obtain additional funds on existing lines of credit. Often, a condition to funding is that no material adverse change shall have occurred in the borrower’s business or is reasonably likely to occur.
• Review the circumstances that may trigger a default in addition to failure to make a loan payment when due. Also, look at what cure rights are afforded in the loan documents and the availability of grace periods for certain types of defaults.
• Review the bank’s remedies in the event of a default. For example, does the bank have the right to appoint a receiver to take control of the borrower’s business or assets
• Understanding the bank’s collateral position and its available remedies in case of a default is crucial to developing an effective loan workout strategy if the loan does go into default.

Undoubtedly, banks will be more willing to work with borrowers who are proactive, thoughtful and make prudent decisions. Borrowers who are seen as sloppy or reactive rather than proactive are likely to be more challenging to work with during this extended period of economic uncertainty.