Accounts-receivable secured lending: looking over your shoulder

RMA Journal, The, July-August, 2004 by Mark Zoeller

Some interim financial statements do not even carry the name of the legal borrower. I do not know why loan officers are willing to settle for financial statements with an inaccurate or incomplete name.

Whether the line requires monthly or daily borrowing-base certificates, the loan officer should check them for accuracy. In one recent instance, the loan officer failed to notice that the ineligible amount had not changed for several months and did not match the A/R aging.

Some banks require borrowers to submit quarterly financial-covenant-compliance certificates. The loan officer needs to check their accuracy, too. In vet another recent example, the loan agreement limited dividends to the amount of profit. The agreement also had a minimum tangible net worth covenant. The borrower, however, paid dividends exceeding prior-year profits, and interim losses lowered tangible net worth to below the minimum. The borrower's certificates showed both covenants to be in compliance, but the loan officer failed to notice the violations.

A few banks get A/R and A/P agings only quarterly; but these are usually for A/R lines that have low activity levels. If they are for more active lines, quarterly is not frequent enough. Most banks, in fact, get agings monthly, but the ritual often is for the loan officer to verify the eligible A/R amount by subtracting the over-90-day A/Rs from the total. The loan officer then sticks the aging, along with the financial statement, in the file, and they never again see the light of day. Some of the things loan officers may ignore include:

* Credit memos in the 90-day column (or three-billing-cycles column). Standard practice in the A/R lending industry is to add back the credit memos to the 90-day column, thus increasing ineligibles. If these credit memos apply to invoices in the 90-day column, they should be applied to those invoices and not shown as open items.

* Concentrations with cross agings that are moving toward being ineligible. Cross agings mean that if, say, 25% of a specific debtor's A/R becomes ineligible, the entire amount of the A/R from that debtor becomes ineligible. Thus, if the entirety of a 40% concentration becomes ineligible because 25% of its total moved into the 90-day column, the bank could suddenly have a large overloan. For example, assume a total A/R of $1 billion with one customer accounting for 40% of it; if $100 million of that debtor's A/R slips into the 90-day column, the entire $400 minion becomes ineligible. The loan officer needs to follow up when the $100 million is first in the 60-day column.

* Increasing staleness of AP.

* Agings numbers that do not balance with the financial statements and the borrowing-base certificate.

As a loan workout officer in the 1980s, I saw that one of my newly assigned problem-loan borrowers had previously failed to give the bank A/R agings. When I finally got an aging, I learned that the A/R balance not only was smaller than on the financial statement, but that a large portion of the A/R was more than 180 days past due.