Loan Defaults Increasing As Result of Slowdown

May 30, 2002
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GRAND RAPIDS — Many banks are experiencing problems with delinquent loans as a result of a weakened economy, according to a local law firm that has seen an increase in the legal workload related to problem credit.

“What I’m seeing right now in the marketplace is really a direct result of what has been happening with the economy generally during calendar year 2001,” said Dan Gosch, a member of Dickinson Wright.

“My phone started ringing on Jan. 4 and it really hasn’t stopped. It’s been building up at an accelerating pace ever since, in terms of the number of matters that I’ve seen locally and across the state, and to a little lesser degree across the country,” he said. 

More companies are experiencing financial difficulty right now and it’s not hard to guess what industry segments they’re in and why some of them are having financial problems, he said.

The difficulties some companies are experiencing results, more times than not, in defaults under loan agreements with their lenders. 

As Gosch explained, defaults can take a lot of different forms, ranging from failure to comply with financial covenants, to failure to make scheduled payments of principle and interest in accordance with loan agreements.

Obviously, banks have an interest in obtaining repayment of the loans they’ve made to companies.

The typical scenario is one in which the bank will try to work with its borrower in order to find some means by which the borrower can repay its indebtedness, restructure its business or perhaps alter its operations, Gosch said. 

The process, generically referred to as a “work-out,” is one in which both parties try to meet their objectives through loan restructuring so the company can repay creditors and continue operations, and keep its employees on the payroll.

It’s a familiar scenario that has played out before through periods of economic slowdown, he observed.

“You can go back to the 1980s and go right through the economic cycles,” he said. “When I started doing this kind of work in 1983, we were at one level of the cycle. There were some slow times in the late ‘80s; we started to pick back up and then we boomed through the ‘90s.”

During the 90s, the “work-out” and solvency work diminished quite dramatically, he added. But everybody in the legal community he’s talked to in recent weeks, locally, around the Midwest and around the country, are just “going gangbusters” right now.

That’s evidenced not only in the number of workout transactions taking place, but in the number of bankruptcy filings. It’s typical of economic cycles, he said. Bankruptcy work slows down when the economy is going strong and picks up dramatically when the economy goes soft.

“In this business there tends to be a certain level of domino effect. The perfect example is the auto industry,” Gosch observed.

“You take a problem that might be faced by Ford, for example, because of the Explorer problem they’re having right now.”

If Ford cuts back on production of Explorers, it starts using fewer parts. That trickles down to the parts supplier, then travels further on down the chain. Eventually it gets down to Mr. X’s tool and die shop in Kalamazoo.

At the lower levels of the chain, margins are thinner and volumes are smaller. What the Tier-1 suppliers can absorb is a lot different from what Mr. X’s company can absorb.

“Generally speaking, it takes longer to recover the further on down the chain you are,” Gosch said. “It’s easier to get in trouble or to fall down.”

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