ADVISOR LOANOLOGY
ADVISOR LENDING RISK & DEFAULTS
Charge-off:
When a loan is categorized as a "charge-off", it means that the lender has officially classified your defaulted loan as an uncollectible debt. Although the loan is written off from the lender’s active portfolio, borrowers are still legally responsible for repaying the outstanding balance and any accrued interest. The lender or a collection agency may pursue debt collection efforts, and the charge-off remains on your credit report for seven years, potentially affecting your future borrowing ability.
Default:
This term indicates that you've missed several loan payments, typically exceeding 90 days, putting your loan into a state of delinquency. This can lead to serious consequences, such as your lender demanding immediate repayment, accelerating the loan maturity, or even seizing collateral. Defaulting on a loan can significantly impact your credit score and hinder your ability to borrow future funds. However, it is possible to negotiate with the lender to resolve the default through a payment plan or loan modification.
Some of the key reasons for low defaults
Recession Resistant
Financial services is always one of the first industries to rebound from a recession. This industry typically sees rapid recoveries followed by strong growth.
Business Liquidity
The equity an advisor has in his/her practice is usually their biggest asset. There is a 50 to 1 buyer to seller ratio in wealth management M&A. Because the business assets are primarily client accounts, the advisor is able the sell a partial client list if needed. Valuations for the majority of advisors are 2-3 times recurring revenue.
Geographical Freedom
As long as the advisor is licensed in the state, advisors can add clients from any state. Since covid, most advisor/client meetings are done virtually.
Sophisticated Borrower
Advisors understand finance and the application of financial planning more than other industries.
Broker Dealer or Firm Support
Broker Dealers are eager to assist an advisor in financial pearl by helping to sell part or all of the advisor’s clients to another one of their advisors. They want to retain those clients and revenues regardless of the advisor servicing those clients. A few Broker Dealers will even formalize this assistance in the form of a tri-party agreement.
Recurring Revenue
Most advisors have more than 50% of their fees generated from a recurring revenue model. Clients are automatically billed a percentage of the portfolio assets the advisor manages and payment deducted from their investment accounts on a monthly or quarterly basis.
Regulated Industry
Advisors are regulated by or in combination FINRA, SEC and their state.
BrokerCheck
BrokerCheck is the financial services industry version of a CarFax. Financial advisors are the only profession where judgements and liens are made public information by a regulatory agency. All advisors must include a link to brokerCheck on their website. It is a tier 1 violation for an advisor to not to report a lien or judgement within 30 days.
Recruiting Liquidity
Advisors can switch their broker dealer and receive a recruiting bonus for doing so. Recruiting bonuses can range from 25% to 100% their annual revenue.
Unique Considerations for Financial Advisors
Unlike tangible assets like equipment or vehicles, a financial advisor's practice is built on intangible assets such as client relationships, reputation, and expertise. This distinction has significant implications in a loan default scenario.
Unique Considerations for Financial Advisors:
Unlike tangible assets like equipment or vehicles, a financial advisor's practice is built on intangible assets like client relationships, reputation, and expertise. This distinction has implications in a loan default scenario:
No Repossession of Your Practice (with some rare exceptions): Banks typically cannot repossess your financial advisor practice in the same way they might repossess a car or equipment if a loan defaults. This is because your practice is intrinsically tied to your licenses, certifications, and client relationships, which are not seizable assets. However, in rare instances, if the practice is structured as a legal entity (e.g., LLC) that took out the loan and has no other valuable assets, there's a remote possibility the lender could seek to dissolve the LLC or sell off its assets to recoup their losses. This wouldn't necessarily translate to taking over the client relationships or the core business of the practice. Another exception could involve fraudulent activity during the loan application process, which could lead to more severe legal consequences.
Lender Limitations Regarding Client Relationships:
Even in a default situation, lenders generally cannot interfere with your client relationships.
Client Confidentiality: Financial advisors are bound by strict client confidentiality regulations. Lenders cannot access confidential client information or directly contact your clients.
Termination of Services: The decision to terminate services with a client ultimately rests with the advisor, not the lender. However, a loan agreement might contain clauses restricting your ability to take on new clients if it could jeopardize repayment.
What Lenders Can Do:
While lenders can't directly seize your practice or client relationships, they have other options to recoup their losses:
Legal Action: The lender might sue you to recover the outstanding debt. This could involve wage garnishments or liens on your personal assets.
Foreclosure on Other Assets: If you pledged any personal assets (e.g., home) as collateral for the loan, the lender could foreclose on those assets to satisfy the debt.
Reporting to FINRA: The lender could report the default to FINRA, which could lead to regulatory scrutiny or disciplinary action.
Advisor Loan Default Avoidance Strategy
#1 Rule: Communicate
Successfully avoiding default on an SBA-backed loan requires proactive measures and consistent communication with your lender. Remember, the bank would rather not see your loan enter default either, as it is in the best interest of all parties to ensure the loan is repaid.
Navigating late payments and potential defaults can be a complex and stressful process for borrowers, but one of the most effective strategies to mitigate these challenges is maintaining proactive and consistent communication with your lender. At the 60-day mark of delinquency, without any borrower communication, lenders often escalate the situation by involving external counsel to send a demand letter. Not being able to make a payment on time is one thing but combine this with radio silence to the lender and they will assume the worse and get in defensive mode fast. The demand letter is usually taken to prompt a response and is typically avoidable through early dialogue. It's crucial that borrowers understand the importance of this timeframe; even bad news communicated upfront is better than silence. For example, informing the lender about an inability to make a payment, while explaining the steps being taken to rectify the financial situation, fosters a more cooperative relationship and can lead to potential solutions with a more cooperative lender.
Effective and regular communication is critical when dealing with late or significantly overdue payments. Even if the news is unfavorable, keeping the lender informed about ongoing efforts to address financial issues is fundamental.
Additionally, lenders often exhibit a degree of flexibility concerning default situations, depending on whether the loan is conventional or backed by the SBA. When borrowers show ongoing efforts to address their financial challenges, lenders typically focus on maintaining the relationship. This might involve relief measures such as payment deferrals or reduced payment schedules for a specified period. The willingness to provide such relief depends heavily on continuous dialogue, which allows the lender to assess the borrower’s commitment to improving their financial circumstances.
For SBA loans, especially those sold on the secondary market, lenders face additional constraints. Actions to support borrowers may require approval from secondary market investors, which can limit the range of possible solutions. However, despite these constraints, lenders strive to work within these limitations to support borrower viability and safeguard mutual interests. This demonstrates the critical role of communication and proactive engagement in developing tailored solutions to help borrowers navigate financial difficulties while maintaining the loan's integrity.
With both SBA loans and non-SBA business loans, default officially occurs after 30 days, and at 60 days of missed payments most banks go into full collection mode.
Open Communication is Key
Don't wait until you miss a payment to reach out to your lender. If you anticipate difficulty making a loan payment, contact your lender as soon as possible. Explain your situation and explore potential solutions.
Be Prepared with a Plan
Before contacting your lender, have a plan in mind. Be prepared to discuss your financial situation, the reasons for payment difficulties, and propose solutions like loan modifications or temporary payment adjustments.
Be Honest and Transparent
Honesty is crucial throughout the communication process. Provide your lender with accurate information about your finances and be transparent about your challenges.
Negotiate with Confidence
While being respectful, approach negotiations with a degree of confidence. Highlight your commitment to repaying the loan and your willingness to work collaboratively to find a solution.
Document Everything
Keep a record of all communication with your lender, including emails, phone logs, and any written agreements. This documentation can be invaluable if you encounter any issues later.
#2 Rule: Stay Calm, You Have Options
When facing financial hardship, borrowers can explore several bank workout options to avoid defaulting on their loan. It's essential to engage in a proactive dialogue with your lender to discuss potential solutions tailored to your unique circumstances. Here are a few strategies that may be available:
Interest-Only Payments: Some lenders may provide an option to make interest-only payments for a specific period. This arrangement reduces the loan's monthly costs temporarily, while keeping the loan from growing due to unpaid interest.
Loan Reamortization: This involves restructuring the loan payments over a longer term. While this could increase the total interest paid over the life of the loan, it can significantly reduce the monthly payments, easing the immediate financial burden.
Loan Refinancing: If you qualify, you may be able to refinance the loan at a lower interest rate or extend the term, both of which can lower the monthly payment.
Forbearance: In some situations, lenders may offer a temporary pause (forbearance) on payments. Interest continues to accrue during this period, but it could provide some short-term relief.
Loan Modification: This involves altering the terms of your loan, which could include reducing the interest rate, extending the loan term, or even deferring a portion of the principal balance to the end of the loan term, thereby lowering the monthly payments.
Lender-Specific Deferments: Some lenders who participate in the 7(a) loan program may offer their own deferment options to borrowers on a case-by-case basis. Borrowers should directly contact their respective lender to inquire about potential deferments or forbearance programs.
Loan Modifications: These are changes to the original loan agreement that may reduce the monthly payment, extend the repayment term, or reduce the interest rate. This could be a feasible option for those facing temporary hardship.
Repayment Extensions: Depending on the lender and the specific circumstances, some borrowers may qualify for an extension on their repayment term. While this would increase the total amount of interest paid, it could potentially make the monthly payments more manageable.
Deferrals: In some cases, borrowers may be granted a deferral, or temporary suspension of loan payments. During this time, the loan typically continues to accrue interest, but no payments are required. This can provide valuable time to regain financial stability.
Collateral Substitution: In certain situations, borrowers may be able to substitute collateral for their existing loan. This could free up cash flow or provide a more manageable payment structure.
This comprehensive guide was created for the less than 1% of advisors who will default on an SBA loan. This advisor guide is the only one of its kind, likely because so few are in need of it.
This guide was written for only a few dozen advisors over the next few years. While there may not be many advisors who will need or read this guide, for those few who find themselves in this predicate, we hope it helps. Advisors are punished more severely from a loan default than professionals in other industries considering other professionals don't have BrokerCheck.
While we can't help advisors with services regarding a loan default (other than this guide) we do assist any AdvisorLoans borrower with trying to help with mitigating a default scenario. We also connect you with the best attorneys for this on the vendor portal.
The information contained in this handbook is provided for informational purposes only and is not intended to be legal or financial advice. Every situation is unique, and you should consult with a qualified attorney to determine the best course of action for your specific circumstances. You can find such attorneys on the Advisorbox vendor portal.