So you made a high-risk loan…now what? The actions a lender takes during the term of a loan can make or break the return. This article provides a best-practice checklist to help increase the likelihood of full recovery.
There was a lot of hair on the deal, but the borrower seemed earnest and the risk-reward analysis tilted the scales in favor of making the loan. So you authorized the wire and now you’re holding your breath.
Wait. What? You’re just sitting there hoping for the best?
Holding one’s breath is fine for pearl divers, but it’s not enough for hard money lenders. Hard money lenders must be like shark divers – ever-vigilant, lest they lose an arm or a leg.
Too many hard money lenders (also called private money or bridge loan lenders) skip important steps during the term of the loan, which can often mean the difference between getting their money back or not.
How can you better protect your investment? Start with the following checklist:
1) Keep your trust in check.
Borrowers cannot be trusted. Read that sentence again. When a borrower is in trouble, they’ll do whatever is necessary to protect their assets and their family. Most importantly, they typically begin to protect themselves well before the loan defaults.
It begins with them planting half-truths about how well the project or refinance is going. Fictions to get you, the lender, to feel more secure and to stop paying close attention.
2) Monitor the takeout story.
The borrower told you a story before you made your loan, that is, how they were going to pay it back. Write the story down, including dates and benchmarks. Send them your understanding of the story and have them confirm it. Then monitor the milestones. Does the story remain the same? Are they meeting the benchmarks? If not, why not?
Get comfortable asking for hard proof. If they can tell you aren’t fact-checking, you’re going hear even bigger fictions.
3) Monitor your collateral on a regular basis.
- If you have real estate as collateral, visit the site every week or two to speak with your borrower. If they aren’t on site much (red flag alert), let them know you stopped by and make arrangements for access. The more you see the property, the more difficult it will be for the borrower to hide anything and the better you will understand the property when a default occurs. Lenders should also talk to area brokers to get a handle on the market.
- If you have receivables as collateral, get weekly or daily accounts receivable agings. Insist they contain contact names and phone numbers for each account. Randomly check in with the account debtors to make sure the aging is accurate. Note: Your loan agreement needs to allow you to perform this kind of diligence.
- If you have inventory and equipment as collateral, stop in every few weeks to ensure the equipment is still in working order, and to spot check inventory. Ensure you are receiving updated inventory reports per your loan agreement and cross-check the report against inventory in place. Ask your borrower about any discrepancies. Lenders should also know their borrower’s biggest competitors since, in the event of a default, these may be the best options to buy your inventory.
4) Monitor your personal guarantors.
You should have received a personal financial statement (PFS) when the loan was made. Cross check the assets on a regular basis. For example, if the guarantor owns a house, check the county records to make sure she is still the owner (also make sure there are no co-owners). Check to ensure there is only one mortgage. And keep checking every few weeks to make sure no new liens are added. If you spot a new lien, you will know something isn’t right.
Lenders should request that borrowers update their PFS every three months on a short-term loan. Don’t just stick the PFS in a drawer, read it completely! Get the names of banks and account numbers for all accounts listed. Obtain monthly copies of actual bank statements, and if a borrower misses a month, call immediately to get a copy.
5) Speak with your borrower often.
Schedule brief weekly calls with your borrower. If the borrower postpones or misses more than one of these calls in any given month, it’s time to meet them in person to review their PFS, liberally picking up the phone and checking on any important or curious line items.
6) Monitor financial covenants
Most bankers do this because it does not take much work to see if a borrower is in covenant. Do not waive the reporting or offer extra time to produce. During that two-week extension, your collateral could be disappearing.
The more you monitor, the more likely you will get your money back.
Even following all these checklist items won’t guarantee a full recovery, but it should enhance your chances.
William Schwartz is a partner in Levenfeld Pearlstein’s Banking & Restructuring Group. He concentrates his practice on representing borrowers and lenders in financial services, litigation (including bankruptcy) and workouts.