If you originate USDA guaranteed loans, eventually you will need to work out a problem credit. The steps you take as the lead lender are critical to ensuring a positive outcome for all parties, including the borrower, secondary market participant and Agency. We want to share our “lessons learned” from a troubled USDA business & industry credit that ran right to the edge of default but was brought back to current status, because the lessons hold for any lender.
A few years ago we consolidated equipment and real estate debt for a longstanding manufacturing customer into a single B&I note, lowering their monthly payment. This was a strong operator with deep industry knowledge and contacts. His rural location and disciplined cost structure gave him a pricing edge versus his competitors, but financial management had always lagged the shop floor performance. That gap surfaced when the loan slipped past due early last year. Once the loan hit 3 weeks past due, we scheduled an in-person meeting and learned the business had taken a major working capital hit when a customer defaulted on a large contract and a 7-figure receivable had to be completely written off. Simultaneously the controller left the business and the books were indecipherable. To the owner's credit, he recognized he had a problem and was willing to listen to proposals to reorganize the business.
Since this was a USDA guaranteed loan we needed to work this out under 7 CFR Part 5001 regulations, which requires the lender to notify USDA when a borrower is thirty days past due and meet with the borrower within forty-five days. We elected to fast track this process, notifying the Agency and holding our in-person meeting ahead of the statutory requirement, keeping the Agency briefed throughout our discovery process. This candid communication helped us to establish trust with the Agency that was critical for our successful outcome.
After several meetings, an outside investor surfaced and agreed to inject working capital into the business, contingent upon our borrower landing a large, multi-year job contract. Our borrower’s bid was accepted, but there was a catch; the customer insisted on 90 day payment terms. This gave us a path to bring the loan back current, but we were already 60+ days past due and knew the loan would cross the 90 day past due mark because all of the working capital was needed to buy material and make payroll.
So we did the work. We analyzed the job pipeline, the operating expense load, and the raw material costs, then built a rolling three week cash flow plan. Some weeks the borrower made a full payment, some weeks half, some weeks none, always matched to what the business could pay while still buying material, building product, and meeting payroll. We never formally deferred or rescheduled the note; the borrower stayed obligated under the original terms, and we simply accepted what he could pay while he worked back toward current. The regulation gives a lender room to operate this way when the path points toward a permanent cure without adding risk to the lender or the Agency. Every step went to USDA, to the secondary market holders, and to our own loan committee on weekly email updates.
It is worth understanding just how much room the regulation gives a lender to work out a delinquent credit like this, because the tools available shaped our confidence even though we never had to use most of them. Section 5001.515 states that when a borrower defaults, the lender must act prudently and expeditiously to bring the account current or cure the default through restructuring if a realistic plan can be developed. The objective is a permanent cure that does not add risk to the lender or the Agency. To get there, the rule lays out a menu of curative actions, all subject to Agency concurrence and the rights of any holder: deferment of principal and/or interest, an additional unguaranteed temporary loan from the lender to bring the account current, re-amortization or rescheduling of payments, transfer and assumption, reorganization, interest rate changes, and troubled debt restructure. In this case we were able avoid using these modification tools and the borrower remained obligated under the original note terms throughout. What we extended was time and patience rather than a change in terms, largely due to the fact that the borrower was able to land a sizeable job pipeline that gave us a clear path back to current status.
That communication is why our workout was successful. At ninety days delinquent the USDA guaranteed loan regulations turn toward a liquidation decision, and under Section 5001.511 a holder can make written demand that the lender or the Agency repurchase the guaranteed portion at par. Once a loan has been delinquent more than sixty days and the lender has not repurchased, the regulation also points toward an interest termination letter, after which the guarantee stops covering interest accrual to the holder. At its peak the loan was 105 days past due, but the secondary market holders did not demand their guarantee be made whole. They trusted we were servicing in good faith because we had been fully transparent and communicative with our repayment plan. Slowly but surely, the borrower made accelerated payments as cash flow allowed. Finally, ten months later, the loan was brought current. Today the borrower carries strong cash position, a robust job pipeline of contracted work, and the financial management discipline to match its operations. Lender, borrower, secondary market, and USDA all came out whole, not by accident, but because we were working with a high integrity borrower and developed an achievable plan before the problem hardened into one no one could fix.