How Does Your Bank Define “Performing Loan”?

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This week I met with one of my commercial lenders, whom I will refer to as Barry, for lunch.   Barry thought I might be interested in some of the business banking options his bank could offer my law firm.  Essentially, Barry was prospecting for additional banking business.  The services and fees he offered sounded very appealing but I had to ask “would his bank call in a loan if the borrower is current on his payments.” I could tell from the look on his face that this question came from left field.  So I repeated my inquiry by asking why a bank would foreclose on a property if the borrower were performing on his obligations under the note.  Isn’t this considered a “good loan” versus all of those non-performing loans banks keep crying about?  Barry told me it’s “complicated.”  Actually it’s not if you understand what is taking place behind the scenes and why you need to be concerned. 

In today’s crazy lending world anything can happen and does which, for the unwary, can have devastating financial ramifications.  Within the past year I have had several business clients lose their property or end up in litigation with commercial lenders over their “performing” loans.  Typically the scenario centers on construction loans, income producing commercial property or multi family apartment buildings.  In every situation brought to my attention, my client was current on his loan, never missed or been late on a payment, and generally working fives times harder to produce income in a difficult environment.  Then without so much as phone call one of two scenarios occurs:

  • Monies on deposit with the lender are suddenly and without notice removed from the borrower’s account(s) (both business and personal); or
  • The bank sends the borrower a letter informing him the bank will not renew the loan (remember these are typically 5 year balloon notes) and or may call it into default.

If you eyes are bulging out of your head as your reading this let me tell you it can happen to you at any time.  Why – because it all has to do with the federal regulators and auditors definition of a “performing loan.”

Being current on your payments is only one facet of a performing loan the other is adequate security!

As many of you know commercial loans typically require 20% to 30% down and additional security (this has to do with the property’s general liquidity versus residential property.)  When values decline the commercial loans become less secure and the banks are forced to bring these loans back into line despite the payment history by the borrower.  To meet the regulator’s security guidelines banks can take your deposits (you grant your lender in the loan agreement the right to these deposits as security for your loan) and/or force you to bring additional collateral to the table.  If you cannot meet the banks demands, then unless you can find other financing, your loan will be reclassified as a non-performing loan and subject to foreclosure.

To protect yourself I recommend you never keep personal or business accounts with any bank where you have a commercial loan, do not allow the LLC that holds your commercial property to build up cash reserves, and protect all of your investments with LLCs.

P.S. – Barry told me his bank has never done any of the above but he did concede that federal regulators could force his bank to take similar action.

Photo: Sookie

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