Problem Loan Policy Steers State With Troubled Companies

Yesterday’s Chapter 7 bankruptcy filing by Yarnell’s Ice Cream Co. in Searcy revealed that the state of Arkansas was a secured creditor for loans totaling about $3.5 million.

Yarnell’s owed $1.96 million on a $2.5 million loan guaranteed by an Arkansas Development Finance Authority bond, along with $1.45 million on a 2001 $1.5 million community development block grant by the Arkansas Economic Development Commission. The company also owed $123,000 on a $2 million loan guaranteed by an AEDC bond from 1994.

By being a secured creditor, the state will be near the head of the line for receiving payments once liquidation or sale of the company’s assets take place. ADFA vice-president Gene Eagle tells Talk Business he’s in a "wait-and-see" mode as to whether the state will recoup its investment.

"It’s too early to tell. We always hope for the best but reserve for the worst. The more time this takes, the harder it becomes for others to capitalize on the value of the Yarnell’s premium brand name," Eagle said.

The Yarnell’s story brought renewed focus on the state’s policies towards investments in private companies. Recently, Talk Business reported on the subject noting that anywhere from 18% to 25% of the loans made by state agencies to private businesses were in some stage of default.

Eagle also provided information regarding ADFA’s policy on "problem loans," which is a designation for loans that suggest a lesser possibility for recovery. 

ADFA provides credit scores for its borrowers as part of its lending policy. When a loan is rated class 5 or 6, it becomes a "problem loan," requiring significant attention and communication with the borrower. Some factors that can lead to "problem loan" status include:

• A significant downturn in annual sales, gross income and/or profitability
• Two or more years of negative earnings whereby the equity of the company is impaired or has turned negative
• Loss of major and/or key clients that could or will impact future operating performance
• A negative level of working capital that will impact a firm’s ability to make timely payments to suppliers, lenders as well as payroll withholdings
• Missed payments as required by the payback schedule

ADFA‘s loan portfolio is reviewed annually by state bank examiners and, to date, they have not taken any exception to ADFA’s classification on loans or how the agency reserves for loan losses, says Eagle.

Currently, there are 12 loans identified as "problem loans" in ADFA’s portfolio and 8 are making efforts to pay all or part of their required monthly payments, according to Eagle. The 12 loans total $13.5 million, down from $16.8 million as previously reported.

The state’s policy for protecting the identity of borrowers in trouble is understandable. The Freedom of Information Act has been interpreted to protect those names so as not to damage their prospects for recovery or to put them at a disadvantage with competitors.

Eagle explained the agency’s handling of its problem loans and outlined some of the efforts ADFA makes when dealing with them. "Generally speaking, ADFA as well as other lenders — banks, commercial credit companies and others — will work with a borrower to attempt to see if the borrower has the capacity to work themselves out of their current situation," Eagle said. "This involves time and patience as the company attempts to solve its problem."

He noted that there are several options ADFA explores with its borrowers, including raising additional equity, obtaining a repayment plan with suppliers, recapturing lost accounts and gaining new accounts, cutting expenses and overhead, bringing in a partner whose strengths offset some management weaknesses, and obtaining a deferred payment plan with key lenders.

"When loans default there is usually some form of concession or loss involved and you manage those risks to an acceptable level. No one scenario dominates the potential outcomes," said Eagle. "At some time, more drastic changes are required to allow the company to revamp its operations and regain its market share and eventually return to profitability. ADFA has had its share of this type of borrower."

He can cite a number of success stories as well as failures. It’s part of the business.

"Clearly ADFA as well as other bank lenders in Arkansas, and nationally as well, have lost money on some projects. Considering that part of our mission is to improve the economic welfare of Arkansans which in turn improves the services that the state and local communities can provide to Arkansans via increased tax revenue, we feel we achieve our mission with an appropriate and manageable amount of risk," Eagle said.