July 2008

   

100 RED FLAGS

100 RED FLAGS
It seems an appropriate time to review a checklist of “Red Flags”  Listed below is a checklist of Red Flags that has been used by Risk Reviewers.  Reviewing the items on this list may bring to light some things in a portfolio that may need attention or may help a lender take a proactive stand with a certain credit:
 
ACCOUNT RECEIVABLE & INVENTORY LENDING

  • Accounts receivable collection problems
  • Inventory numbers that don’t change on interim financial statements
  • Inventory numbers that grow while revenues decline. (Hiding losses in inventory) If lending on accounts receivable, with a formula (less than 90 days) take care to distinguish between the invoice and the due date
  • Consigned inventory included in inventory that is pledged as collateral for the banks’ loan.
  • Using typical or standard advance rates on specialized inventory and lack caps
  • Large amounts of W.I.P. inventory that continues to show upward trends
  • Cross aging of Accounts Receivable to look at total amount-not just eliminating over 90 days
  • Advance rates set without benefit of a field exam
  • Frequent negative borrowing base (over advances) that continue without a definitive plan for correction or are corrected by simply increasing the advance rates
  • Including large contra accounts for Accounts Receivable advances where a large receivable also has a large payable to the same customer
  • Borrower unwilling to allow ABL auditors access to books and records.

ADMINISTRATION /FINANCIALS AND OTHER DUE DILIGENCE:
  • Unsigned financials and tax returns (not usable in subsequent court collection
  • efforts  if deal goes badly).  Allowing the excuse that the customer has filed for an extension on submission of personal or business tax returns for not getting updated income information – and then not following up six months later (the maximum time an extension can be valid) to see if the return is obtained
  • Lack of a good appraisal review process that recognizes deficiencies in appraisals or failure to review the appraisals until after the loan is on the books and it’s too late to reduce the loan amount.
  • Construction loans where the borrower draws against one project to fund shortfalls in  another.
  • Construction loans where the draw file structure is unorganized to the point that reconciliation of lien waivers, draw requests, inspection progress to draws, and overall management of the construction process is difficult at best
  • Construction loans – failure to include appropriate  chattel security verbiage in the mortgage or deed of trust (or separate security agreement) and file a UCC-1 fixture filing to cover all inventory and equipment located at the construction site
  • Failure to include appropriate chattel security verbiage in the mortgage or deed of trust (or separate security agreement) and file a UCC-1 fixture filing to cover all inventory and equipment located at the construction site on construction loans
  • Failure to require the completion of a real estate or equipment appraisal in order to determine the collateral value because it is not being required by competing banks.
  • Excessive lender analysis of the borrower’s management style, product concept with limited or no analysis of the borrower’s financial information
  • Over-reliance on the borrower’s perceived success that is not supported by tax  return data
  • Lack of Audited/Reviewed level financial statements for appropriate sized companies
  • Lack of timely inspections for floor plan, construction or other loans that are highly collateral reliant.  Lack of sufficiently detailed inspection reports
  • General failure to recognize and adequately address environmental liability exposure a borrower may represent
  • Lack of independent analysis of participations purchased from other banks, particularly if the lead bank is perceived as having greater expertise in the borrowers industry
  • Lack of a follow-up process after loan closing to assure receipt of all loan documentation and to confirm that all conditions described in loan committee packet have been met
  • Late receipt of financial statements or missing or outdated financials
  • Constant renewals or extensions
  • Qualified financials
  • Frequent change in account firm
  • Excessive temporary loans, or line increases that aren’t repaid and become permanent
  • No inspection requirements on Real Estate deals
  • Lack of documentation of customer calls by Relationship Manager
  • Large overdrafts covered by subsequent loans

COMPANY MANAGEMENT ( OR )  PRINCIPALS
  • Change in CFO or change in executive officers
  • Absentee owners
  • Too many family members involved in the business
  • Excessive credit inquiries or from unusual sources (casinos)
  • Large loans to officers/employees and/or unusual owner/partner withdrawals
  • Declining credit score of guarantor
  • Picture or name of borrower (or his company under indictment) in local arrest records of the newspaper
  • Broken promises
  • Decrease in deposits and/or moving accounts.  Continuous shifting to new banks as primary lender
  • Selling assets
  • High employee turnover and/or layoffs
  • Lender socializing excessively with borrower
  • Use of more than one bank for financing by a relatively small company. (Unless your bank is very large, your target market likely has companies that should center their banking with one institution).
  • Excessive/unsuccessful hedging by company principal to try to cover wide price swings in his product/commodity
  • The presence of other “lenders” in the relationship.  (Floor plan lender, bonding company, equipment lessors, landlords).  Who else is my borrower concerned about?

STRUCTURE AND CONTROLS
  • If the deal or loan structure does not make sense, it’s probably wrong
  • Capitalized interest
  • Loan covenants not being monitored or violations not being reported to senior management and/or formally addressed with the borrower and guarantors.  Excessive waivers to covenants or waivers without proper approval.
  • Lack of loan agreement or commitment letter when appropriate
  • Lack of proper analysis of underwriting
  • Stock or bond powers should not be dated, this can create delays
  • Unperfected security agreements
  • Lending solely against enterprise value (goodwill) has no value as collateral.  These are unsecured loans and should be monitored as such.
  • Over-reliance on collateral or guarantors and/or lack thereof when appropriate
  • Deals that rely heavily on guarantor support and guarantors show material liquidity but bank makes no effort to independently verify the existence and amount of liquidity
  • Complex business legal structures where the reason for the use of such structures cannot be readily explained
  • Working capital financing loans to contractors.  (Bonded jobs create A/R priority issues) A/P’s often have priority lien rights.  Get hard collateral
  • Doing construction lending without monitored budgets
  • Allowing a contractor to have a large amount of “specs” or models in residential developments
  • Project inspections not being completed or not being properly documented
  • Commercial lines of credit to contractors characterized as “for bonding purposes”.  (The bonding company wants to know that when the borrower hits trouble they can borrow on your line of credit to protect the bonding company’s exposure on the jobs). 
  • Inability to comply with no balance requirements on line borrowing and/or increasing revolving balances.
  • Major lease expiration before loan maturity

FINANCIAL STATEMENTS:
  • The income statement and balance sheet are completely unreliable
  • Increasing payroll tax liability
  • Any liability line item similar to “payroll taxes payable”.  It could be payroll taxes that are past due which can create a lien on newly created accounts receivable and inventory ahead of your prior blanket-filing lien.
  • Financial statements that disclose the presence of a book overdraft.  (If the company is “playing the float”, they are extremely illiquid and experiencing substantial financial pressure.
  • Borrower is moderately profitable, but working capital is showing declining trend.  Earnings are insufficient to meet term debt obligations and/or necessary capital expenditures.
  • Growth in “other assets” on the balance sheet of a corporate borrower.  Be on the lookout for assets that are really due from officers, employees, and stockholders,  as these are intangible and often increased in lieu of expensing salary to avoid showing a loss.
  • Net of depreciation, large leasehold improvement shown as fixed assets on the balance sheet (Could or should be spread as intangible)
  • Cash basis taxpayer that has never paid taxes on corporate income where bank “thinks” the borrower has equity in the business
  • Current ratios of just over 1:1 or below.  Few companies can operate beyond short term with a current ratio of less than 1:1
  • Depreciation and other non-cash charges never paid a loan back
  • Continuing increases in accounts payable and payable days
  • Capital expenditures well above historical averages
  • Borrowers that have no inventory and have revenue at a level where they can file their tax returns on a cash basis where the bank underwrites the borrower on the basis of their accrual based financial statements  The borrower has no economic incentive to write off old accounts receivable.
  • Escalating levels of debt at amounts the borrower has never before managed
  • Book overdrafts listed in current liabilities on either FYE or interim financiasl of the borrower, suggests cashflow  liquidity concerns… holding checks payable to trade and or bank.
  • The presence of substantial dollar amount of operating leases for capital equipment where the asset and liability do not show on the balance sheet.  Actual leverage may be much greater than it appears in the financial statements

BANKING RELATIONSHIP or POLICY ABUSES
  • Any loan relationship where the lender states  “Oh don’t worry about that one, he’s a great guy”  (Financials generally won’t justify the loan)
  • Loan participations with your bank having only a small percentage of the loan.  If problems develop, your bank management will have little say about how the problems are to be handled.
  • Flood insurance coverage insufficient, as the regulation requires coverage of the lesser of the amount of the loan or the maximum amount available under the National Flood Insurance Program.
  • Flood insurance determination waived by the lender.  This requirement cannot be waived and should be completed in a reasonable time prior to loan closing to meet flood notification requirements if the property is in a flood plain – regulatory agencies generally regard 10 days prior to loan closing as a reasonable time interval.
  • A high frequency of policy exceptions (high advance rates, extended terms, lack of guarantee, etc) that do not get management attention.
  • Relatively small company that does not have all of their deposit accounts with you. (Borrower has opportunity to Kite checks between the banks to artificially create a working capital  loan)
  • Loans to any industry that can be characterized as “specialized where the bank does not have specialized knowledge of that industry to mitigate the risk. (e.g. auto dealers, pawnshops, hotel/motel and contractors).  The account officer doesn’t understand the customers’ business or financial information.
  • Lending t borrowers n industries where there is no material trade support (consultants, medical practices, and temporary staffing firms).  If they run into trouble, their financial flexibility is low as they have no trade suppliers to “stretch” if necessary if cash gets tight.
  • Failure to recognize Regulation H reportable real estate transactions that are outside lending advance rates governed by the Regulation
  • Lender seeking over-rides - % high compared to other lenders
  • Large number of single pay notes in portfolio
  • Inappropriate use of single loan authority by lender
  • Over-use of tolerance limits that are built into the system

MISCELLANEOUS
  • Cancellation of  insurance
  • Late tax payments of any  kind
  • Payment delinquency
  • Borrower asks for principal repayment waivers
  • Lawsuits/M&M liens.  Multiple unpaid liens of a significant dollar level


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President's Letter

Dear Chesapeake Chapter Members:

As my term as President of your local Chesapeake Chapter is winding down, I’d like to take this opportunity reflect on some of the Chapter’s successes this year and thank those who made them possible.

The Chesapeake Chapter had some great programming events that were developed locally for our general membership meetings. Although it seems that both time and budget constraints may have placed some downward pressure on our event attendance, the Chapter had some fantastic programs in 2007-2008. These diverse and enriching events including the following: a timely event on How the Subprime Meltdown Shook Other Markets, a purely social Wine Tasting & Mixer, a half day Risk Management Forum, our annual Senior Executives Forum, a half day Real Estate Forum, a Community Bank Roundtable for DC and Beltway area banks, and lastly our annual Regulators' View of Banking in the Current Market.

The Young Financial Professionals Group (YFP) continued provide programming specifically targeted toward individuals with ten or less years of industry experience who are committed to a career in banking. The YFP offered three programs in 2007-2008, two educational programs (Excelling in the Workplace and Assertive vs. Aggressive Communication) and one joint social event / happy hour with the New/Young Professional Network of the MACPA.

In addition to the local programming the chapter co-sponsored several educational events with RMA National including: Analyzing Business Tax Returns, Analyzing Personal Financial Statements, Understanding & Interpreting Real Estate Appraisals, Real Estate Fundamentals, Interactive Real Estate Lending, UCA II: Credit Risk Analysis, and Construction Loan Management.

All in all, it was a very busy and successful year for the Chapter. I would like to personally thank all of my fellow Board Members and the volunteers that worked so hard throughout the year to make it a success. I am truly grateful for your wisdom, support, and friendship throughout my years on the board and especially during my past year as President.

For any of those out there who are reading this letter and have some interest in becoming more active with the Chapter, please feel free to contact me (or any other Board Member) to discuss volunteer opportunities. From my personal experience as a volunteer both on the local and national level, I can honestly say that is rewarding and enriching endeavor.

Thad Ulrich
PNC Bank

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Young Financial Professionals

As we prepare to fill our calendars with fall and winter events, please keep these months and relevant topics in mind for the Young Financial Professionals. In October we are planning an event to learn why Title Insurance is so important, in general and especially today. In February we are planning an event that will reveal the Foreclosure process from beginning to end, and in May we will learn in the ins and outs of Bankruptcy. Please stay tuned for specific dates and times.

We are always open to new ideas for topics, and we welcome suggestions. We also need people to sit on a Steering Committee or mini board for the Young Financial Professional Group. As a part of the Steering Committee you will have an opportunity to plan events, gain leadership experience, meet new people and network with others that share the same career path. If you've been in Banking for 10 years or less and would like to become more involved, give me a call.

Lance Johnson
Co-Chair
Young Financial Professionals
(410) 558-4222

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RMA Annual Risk Management Conference

Baltimore, MD
Saturday, October 18, 2008 to Tuesday, October 21, 2008
Click here for details.

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Welcome New Members

Nerrissa Ali-Aziz
Preferred Business Xchange LLC

Kerby R. Baden
Invotex Group

Emily Behls
First Mariner Bank

Scott Bender
Colombo Bank

Marlene Benicewicz
First Mariner Bank

Carrie Bivens
First Mariner Bank

Jennifer L. Campbell
Chevy Chase Bank FSB

Matthew L. Canzater
Board of Governors Federal Reserve Sys

Rodney Dunn
Manufacturers & Traders Trust Co

John Elmer
Colombo Bank

Karen Fleming
Chevy Chase Bank FSB

Laura Glennon
Fannie Mae

Linda Hale
First Mariner Bank

Mike Helmus
Provident Bank

Ying Huang
Fannie Mae

Colleen Hutchinson
USA Capital LLC

Dean Jager
Preferred Business Xchange LLC

Daniel N. Kovac
OBA Federal Savings Bank

Myles N. Livingston
Susquehanna Bank

Jane Logan
First Mariner Bank

Hannah Lowe
Manufacturers & Traders Trust Co

Juan Marulanda
Preferred Business Xchange LLC

Adam G. Nalls
Provident Bank

Lisa M. Newport
Grant Thornton LLP

Carolyn Renz
First Mariner Bank

Shannon Retallack
Manufacturers & Traders Trust Co

Talisa M. Robinson
Wells Fargo Bank NA

Robert Wade
First Mariner Bank

Tina Werking
Preferred Business Xchange LLC

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