Longer-term/permanent options are designed to permanently reduce the borrower’s loan. Most borrowers will require a combination of options to ensure repayment. In all cases, the bank must be able to demonstrate (based on reasonable documented financial information) that the borrower's projected cash flow will be sufficient to meet the restructured payment terms.
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Specific options that may be considered include:
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| i. | Interest and Arrears capitalization - adds past due payments and/or accrued interest arrears to the outstanding principal balance for repayment under a sustainable revised repayment program. Workout Unit should always attempt to have the borrower bring past due payments and interest current at the time a loan is rescheduled. Capitalization, intended to be used selectively, is likely to be more widespread when borrowers have been in default for an extended period. This measure should be applied only once, and in an amount that does not exceed a pre-defined size relative to the overall principle as defined in the bank's Remedial/restructuring policy. The bank should also formally confirm that the borrower understands and accepts the capitalization conditions.
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| ii. | Interest rate reduction - involves the permanent (or temporary) reduction of the interest rate (fixed or variable) to a fair and sustainable rate. This option could be considered when the evolution of interest rates has resulted in the borrower receiving finance at an exorbitant cost, compared with prevailing market conditions. However, banks should ensure that lower interest rate is sufficient to cover the relevant credit risk.
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| iii. | Extension of maturity - extension of the maturity of the loan (i.e., of the last contractual loan installment date) allows a reduction in installment amounts by spreading the repayments over a longer period
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| iv. | Rescheduled Payments - the existing contractual payment schedule is adjusted to a new sustainable repayment program based on a realistic assessment of the borrower's cash flows, both current and forecasted. This is usually used in combination with an extension of maturity. In addition to normal rescheduling, additional repayment options include:
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| | a. | Partial repayment - a payment is made against the credit facility (e.g., from a sale of assets) that is lower than the outstanding balance. This option is used to substantially reduce the loan at risk and to enable a sustainable repayment program for the remaining outstanding amount. This option is generally preferable, from the bank's standpoint to the balloon, bullet or step-up options described below.
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| | b. | Balloon or bullet payments - are used in the case of more marginal borrowers whose sustainable cash flow is insufficient to fully repay the loan within the rescheduled tenor. A balloon payment is a final installment substantially larger than the regularly scheduled installments. Bullet loans carry no regular installment payments. They are payable in full at the maturity date and frequently contain provisions allowing the capitalization of interest throughout the life of the loan.
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| | | These options are generally only be used/considered in exceptional circumstances, and when the bank can duly document future cash flow availability to meet the payment. Bullet loans are frequently used in conjunction with loan splitting. In this case, the unsustainable portion of the loan represented by the bullet loan should be fully provisioned and written off in accordance with bank policy.
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| | c. | Step-up payments - should be used when the bank can ensure and demonstrate that there is a good reason to expect that the borrower's future cash flow will be sufficient to meet increases (step-up) in payments.
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| v. | Sale by owner/assisted sale - this option is used when the borrower agrees to voluntarily dispose of the secured assets to partially or fully repay the loan. It is usually combined with the partial repayment option or conditional loan forgiveness. The borrower must be monitored closely to ensure that the sale is conducted in a timely manner and the agreement should contain a covenant allowing the borrower to conduct the sale if the borrower fails to do so within the specified timeframe.
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| vi. | Conditional loan forgiveness - involves the bank forfeiting the right to legally recover part or the whole of the amount of an outstanding loan upon the borrower's performance of certain conditions. This measure may be used when the bank agrees to a “reduced payment in full and final settlement", whereby the bank agrees to forgive all the remaining loan if the borrower repays the reduced amount of the principal balance within an agreed timeframe. This option should be used to encourage owners to make an additional financial contribution to the company and to ensure that their interests are aligned with the banks. It is particularly appropriate in those cases where the net present value of the borrower's projected repayment capacity (taking into consideration all the collateral and potential cash flow) is lower than the total loan. In these cases the bank may consider:
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| | a) | Partial write-off in return for a cash equity contribution from an owner(s), particularly in those cases where the owner(s) have not guaranteed the loan.
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| | b) | Partial write-off in the framework of a cash capital increase from a third- party investor where they have not assumed the role of guarantor.
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| | c) | Partial write-off in the case of a particularly successful business restructuring that materially deviates from the operating plan that served as the basis for the restructuring.
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| | d) | Partial write-off in those cases when the above-average engagement of the owner(s) (i.e. successful sale of excess assets) guarantees a higher level of repayment to the bank(s).
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| | e) | Loan can also be written off if: (i) the collateral has no economic value, and such action ensures the continuation of the company's operations; (ii) it is evident that the owner has invested his entire property in the business and has lost it; (iii) the borrower possesses significant “know-how", and the bank has confidence in the management; or, (iv) the problems were caused by objective external factors.
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| | Banks should apply loan forgiveness options carefully since the possibility of forgiveness can give rise to moral hazard, weaken the payment discipline, and encourage “strategic defaults". Therefore, banks should define specific forgiveness policies and procedures to ensure strong controls are in place.
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| vii. | Fresh money - providing new financing arrangements to support the recovery of a distressed borrower is usually not a standalone viable restructuring solution but should be combined with other measures addressing existing arrears. It should only be applied in exceptional cases and requires a thorough assessment of the borrower's ability to repay. For loans with significant amount, independent sector experts should be used to validate the viability of proposed business plans and cash flow projections.
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| | The Banks are recommended to have strict policies prohibiting lending new monies or allowing roll-overs. There are, however, three specific situations where it may be warranted. They are: (i) the need for fresh money to be used for working capital to restart the business; (ii) advances required to protect the bank's collateral position; or, (iii) small advances to prevent large contingent exposures (guarantees) from being called.
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| viii. | Loan splitting - is used to address collateral and cash flow shortfalls. In this option, the loan is split into two parts: (i) the portion representing the amount that can be repaid from sustainable cash flow is repaid in equal installments of principal and interest; and (ii) the remaining portion represents “excess loan" (which can be subordinated). This portion can be used in combination with payments from the sale of specific assets or bullet payments at the maturity.
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