Restructuring a Past-Due SME Facility
A regional bank has a USD 800,000 term loan outstanding to a family-owned food-processing SME, Harvestline Foods. The loan was originally 5 years at 9% fixed, with 3 years remaining. The borrower has missed the last two quarterly instalments (USD 55,000 each) and is now 180 days past due. The cause is genuine: a major supermarket customer cut its orders by 40% after a merger, and Harvestline's working capital cycle has stretched from 45 to 90 days. The business is still operating, has positive EBITDA of roughly USD 120,000 per year, and its owners have offered a personal guarantee on their home (estimated equity USD 250,000). The bank's credit policy says facilities 180+ days past due are classified as non-performing and must be provided for. The relationship manager wants to 'extend and pretend' by capitalising the arrears into the principal and resetting the term. The credit committee must decide.
1. Distinguish between a legitimate restructuring and 'extend and pretend', and assess which this case is.
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Legitimate restructuring vs. extend and pretend:
- A legitimate restructuring addresses a temporary cash-flow problem in a viable business. The borrower has a credible recovery path, the new terms are affordable from realistic cash flow, and the bank recognises any loss it cannot recover.
- Extend and pretend masks an impairment by rescheduling without testing viability, deferring recognition of loss, and relying on hope. It flatters the bank's NPL ratio and provisioning while the underlying credit quality deteriorates.
Assessing Harvestline:
- Supports viability: genuine external shock (customer loss post-merger), business still trading, positive EBITDA of USD 120k, owners willing to pledge real security (USD 250k home equity).
- Against viability: EBITDA of USD 120k cannot service the existing debt - annual instalments on USD 800k over 3 years are roughly USD 265k principal plus interest, far above EBITDA. The working-capital stretch to 90 days is severe and may not reverse quickly.
- Conclusion: This is a borderline case that could be a legitimate restructuring only if the new structure is genuinely affordable and the bank recognises the loss it is taking. Simply capitalising arrears and resetting the term to keep the loan 'performing' would be extend-and-pretend, because the cash flow does not support the existing principal.
2. Design a restructuring proposal that is both prudent and commercially sensible. Specify the key terms and the provisioning treatment.
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Proposed structure:
- Recognise the impairment first. At 180 days past due the facility is non-performing under policy. The bank should classify it as such and provision based on expected recovery, not restructure it back to performing on day one. A restructuring does not cure a default; it creates a new, tested facility.
- Right-size the debt to cash flow. EBITDA of USD 120k supports perhaps USD 40–50k of annual debt service (a 2.5–3x cover). At 9%, that supports a principal of roughly USD 300–400k over a long tenor. The bank should therefore consider a partial write-down or a debt-for-equity/equity-linked element for the portion that cannot be serviced - or accept a longer tenor with a step-up schedule.
- Tenor and schedule: Extend to 7–8 years with a 6-month principal moratorium, interest-only during stabilisation, then stepped amortisation aligned to the expected recovery of the supermarket contract.
- Security: Take the personal guarantee and register a charge over the home equity (USD 250k), plus a fixed and floating charge over receivables and inventory.
- Covenants and monitoring: Monthly management accounts, a minimum order-book covenant, a cap on owner drawings, and a requirement that the owners inject fresh equity or subordinated loans.
- Trigger for exit: If the order book does not recover within 12 months, the bank moves to enforcement.
Provisioning: Provision for the expected shortfall between carrying value and the present value of the restructured cash flows (a Stage 3 / lifetime expected credit loss approach). Do not reverse the NPL classification until the borrower has performed for a sustained period (commonly 12 months of punctual payments).
3. The relationship manager argues that taking the family home as security is 'over-collateralising' and will destroy the relationship. How should the committee weigh this?
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Weighing the argument:
- The RM's concern is real but misplaced. Taking a charge over the home is not punitive if the restructuring genuinely gives the business a path to repay. Security is taken to align incentives and to protect the bank if the recovery fails - not to force a sale.
- The owners volunteered it. A personal guarantee backed by home equity is a strong signal of owner commitment and is standard practice in SME lending. Refusing it would leave the bank under-secured on a non-performing facility.
- The alternative is worse for the relationship. If the bank does not restructure prudently, the likely outcome is enforcement and loss of the business anyway. A well-structured deal with realistic terms preserves the customer relationship far better than a slow collapse.
- Risk of over-reliance on security: The bank must not lend because of the collateral. The primary repayment source remains operating cash flow; the home equity is a secondary recovery. The committee should ensure the structure is affordable from EBITDA first, with security as backstop.
Recommendation: Take the guarantee and charge, but communicate it as part of a partnership restructuring, with clear milestones. Document the rationale so the decision is defensible to auditors and the regulator.