Over the last 5 years changes began to occur – technological factors forced the speed and quantity of information into the decision making process, competition increased for customers, personnel and the incentive compensation programs took on a new life. Within this environment New Bank entered into LCF marketplace determined to grow at the expense of all, including LCF. New Bank went on a hiring binge offered high salaries, very competitive loan products and lots of fast money for borrowers. LCF’s experienced loan officers left for the higher salaries, which included hefty incentive programs.

LCF’s history of credit extension had been based on, in part, the seasoned loan officers credit “feel” and whose track record was supported by a well performing loan portfolio. While credit culture had some structure and discipline, it was mostly relationship based. The regulators though not in agreement with this environment, had minimal arguments, as the performance was above average. Now, LCF was left young, inexperienced loan officers, and credit policy department that had not been through the down times.

The Loan
Tommy Fuller, an existing customer, who owned the 15-store Rhythm Clothing chain, presented Johnny Salesman, a loan proposal. Fuller sold clothing geared toward teenagers, whose style changed as often as their music tastes. Tommy was in his mid 30’s and had always been able to spot trends and been the first to market. He had an aggressive, “I can’t fail attitude” and the business had been fairly successful. This of course was not very difficult considering the robust economy. While the prior loan officer, Mark Grayhair, was not confident of Fuller’s ability or the business, he nevertheless had the loan fully secured (even when heavily discounted).

Fuller came in with a 7-store expansion plan that was to occur over four cities. Four of the stores were existing businesses, with the other three start-ups. This was an ambitious project, especially with all stores basically geared to open simultaneously. Fuller’s proposal was a request for $4 million to fund inventory buildup, leasehold improvements, and working capital. Store sizes were in the 15,000 sf range, which was a substantial increase over the prior stores. Further, minimal equity would be injected and a guarantee release was requested. Despite the existing relationship Fuller stated New Bank was aggressively pursing his business and an opportunity to fund this proposal.

Johnny Salesman presented the proposal via a PowerPoint presentation, which included high tech interactive charts graphs and projections that would cash flow the debt (at most any scenario). Johnny was the new breed loan officer that despite some minimal credit training could sell most anything. With his pipeline full and no fear of rejection, he proceeded to obtain approval at a prime rate of interest, normal collateral advance ratios and, limited personal guarantee requirements.

Results
LCF’s compliance department had been requesting year-end financial statements with ongoing comments of “we’re still finalizing”, “we’re having discussions with the auditors”, “we’ve had some issues with software”. After the grand opening 6 months prior, Johnny had not visited the stores, and had limited contact with Fuller. After a visit to pre-existing stores, Salesman was a little concerned when he learned that sales at the new stores were not at projected levels. Fuller stated that a new advertising campaign and changed inventory mix was anticipated to improve sales. Fuller did mention that additional working capital would be required – and that he would utilize favorable vendor financing.

Salesman felt fairly confident that Fuller would be able to achieve the revised projections and trusted Fuller’s ability obtain new vendor terms. Salesman had not experienced many problem loan situations, but thought his judgment was good enough and that Fuller would not let him down. An additional $200m Line of credit supported an increase in inventory. The trade worked out an “arrangement” for outstanding A/R and new invoices. LCF’s automated approval system did not provide an opportunity to directly address the issues, i.e., sales, vendors, and the facility was approved.

Problems
After loan closing Salesman decided to conduct an unannounced visit to the new stores. The locations were mediocre, with minimal traffic and strong competing stores. Economic conditions worsened and higher gas prices reduced the number of store visits by customers. Despite delinquent statements, the revised plan that was again not meeting projections and questionable collateral coverage, Salesman still believed that Fuller would turnaround operations. However, within a month a payment delinquency made executive management aware Fuller’s company may not be in sync with today’s teens. Loan review seemed to agree, despite Salesman’s vigorous arguments and transferred the account to Special Assets.

Special Assets’ Bill Realism met with Fuller, inspected all stores, obtained a third party collateral report, reviewed all documentation and became very concerned. Realism found the stores in poor locations, the personal guarantee was for collection not payment, and there was not an assignment of leases for the store locations. Realism had little faith that Fuller could produce sufficient cash flow to retire the debt. Realism’s 25 years of workout had resulted in very few turnaround consultants that could produce, but knew of one to resituate this one.

Actions
After realizing the significant collateral exposure LCF charged-off $1 million and restructured the debt. This was after a Chief Restructuring Officer and CFO were hired by the company, and guarantee amount was increased and modified. Three stores were closed and inventory liquidated to pay down debt. LCF recognized full recovery would only be realized through company sale, and only if EBITDA results improved.

Lessons
Salesman realized that under pressure Borrower’s have a tendency to behave differently, that assets aren’t worth as much in liquidation, and financial results are important. Large expansions are difficult especially when financial systems and controls are lacking. High leverage is a difficult obstacle and can create an irregular Rhythm. The high debt load ultimately resulted in a Chapter 11 filing, which evolved into a liquidating plan, and additional losses. LCF realized that old style loan committee meetings approve loans and discuss the merits of credit, help in maintaining discipline within the credit culture, and experience counts.

For improving your experience explore RMA/Chesapeake Chapter publications and workshops.