Recently, the world’s economic situation has tightened up more than ever. Tougher market conditions have squeezed the cash flows of many individuals, corporations, and government borrowers. As a result, more borrowers cannot repay their loans as scheduled. One way you can support your borrowers is by introducing loan restructuring.

Loan restructuring refers to a process whereby the borrower or debtor facing financial difficulties contacts the lender to renegotiate loan terms to get a lesser interest rate or an extended payment tenor than originally agreed on. Think of it as a measure debtors take to avoid defaulting. For loan restructuring to work, it is more proactive that borrowers contact the lender and discuss beforehand their likelihood to default than to wait till they are contacted by you, the lender, or the creditor. Moreover, loan restructuring is a lesser alternative before the debtor declares bankruptcy.  

This article will discuss loan restructuring and how you can employ loan restructuring to support your borrowers during a financial crisis or hardship.

Types of Loan Restructuring 

There are several types of loan restructuring. Some of the most common include:

1. Modifying the outstanding amount
2. Loan modification
3. Debt-for-equity swap
4. Interest rate modification
5. Payment deferral
6. Term extension
7. Waiving previously incurred penalty charges
8. Loan consolidation

The loan restructuring type you adopt for your borrower primarily depends on the type of loan. Notably, you are not obligated to agree to a loan restructuring modification for your borrowers. You can insist on the initially agreed repayment schedule, which your borrowers must adhere to, or face late penalty fees. However, as a fast-thinking lender, you must understand that you risk receiving far less than your principal and interest payments should the borrower, especially a company, be forced into bankruptcy or liquidation. Hence, it is essential that you factually weigh your options.

Reasons Why Borrowers Ask for Loan Restructuring

There are several reasons why a borrower might consider loan restructuring, all of which usually stem from a desire to make their loan obligations more manageable in light of changes to their financial situation or the broader economic environment. Here are some common reasons why borrowers request loan restructuring:

1. Financial Hardship: The most common reason for loan restructuring is financial hardship. This can arise from various circumstances such as job loss, reduction in income, significant medical expenses, or other unforeseen financial burdens that impact the borrower’s ability to keep up with their original loan repayment terms. For companies, it could be economic fluctuation, high operational costs, yet more loss than profit, and many other reasons. In such cases, restructuring can be the most viable option. 
2. Interest Rate Reduction: Due to economic fluctuation, when interest rates in the market decrease significantly, borrowers may seek to restructure their loans to take advantage of the lower rates. This can reduce the amount of interest paid over the life of the loan.
3. Extended Loan Term: Some of your borrowers might request a longer repayment period to reduce their monthly payments. This will make the repayment more affordable on a daily basis. While this can mean paying more interest over time, it immediately relieves their cash flow problems.
4. Avoiding Default: Restructuring a loan can be a proactive step for borrowers on the brink of default. Some of your borrowers will renegotiate the loan terms to avoid the negative consequences of a default, such as damage to their credit score, potential legal action, and loss of assets.
5. Adjustment to Fixed Rate: This is another reason borrowers may seek loan restructuring. Borrowers with variable-rate loans may seek to restructure to a fixed rate to gain predictability in their monthly payments, especially if they anticipate rising interest rates in the future.
6. Consolidation of Debts: Loan consolidation is worth mentioning here as a reason for loan restructuring. Some borrowers may seek loan restructuring as a way to consolidate multiple debts into a single loan. This can simplify financial management, possibly reduce the overall interest rate, and extend the repayment term.

Each of these reasons reflects the reality that financial circumstances are dynamic and can change in ways that make the original terms of a loan untenable to your borrowers. 

How Loan Restructuring Works

The first step in loan restructuring is for your borrower to assess their financial condition and then initiate contact with you to express interest in restructuring their loan. The borrower will be required to submit documentation that may include financial statements, proof of income, proof of hardship, and a detailed explanation of why they’re requesting loan restructuring.

Once this is done, you must review the submitted information against your criteria for restructuring loans. If you then consider restructuring feasible, you can begin negotiations on the new terms of the loan with your borrower. Once you both reach an agreement, the new terms will be formalized in an updated loan agreement, which both parties will sign.

Criteria You Should Consider When Evaluating a Loan Restructuring Request

1. Proof of Financial Hardship: You must ensure that you have substantial evidence of the hardship causing the borrower’s financial strain.
2. Stability of Income: Before accepting the restructuring of your borrower’s loan, get proof of stable income that the borrower can meet the revised payment terms.
3. Borrower’s Payment History: It is important to evaluate the borrower’s previous payment history. This history can demonstrate the borrower’s commitment to repaying their debts.
4. Overall Debt Burden: Assess other debts owed by your borrower. This can help you to determine the borrower’s total financial obligations.

Pros and Cons of Accepting a Loan Restructuring Request

Pros

1. Reduced Default Risk: You can lower the risk of borrowers defaulting when you restructure their loans. This ensures a continuous flow of payments, albeit on adjusted terms.
2. Preservation of Customer Relationships: Offering restructuring options demonstrates your commitment to working with borrowers during tough times, which can enhance customer loyalty and retention.
3. Improved Loan Performance: Restructured loans can perform better than those that remain unchanged but are at risk of default. This could positively impact your portfolio quality.
4. Regulatory Compliance and Reputation: In some jurisdictions, regulators encourage lenders to work with distressed borrowers, so offering restructuring can also be a matter of compliance and good public relations.
5. Mitigation of Losses: Through restructuring, you can mitigate potential losses associated with foreclosure or the collection process, which can be costly and time-consuming.

Cons

1. Potential for Reduced Profitability: Adjusted terms might result in lower interest income over the life of the loan, which can affect your profitability.
2. Resource Intensiveness: The process of evaluating loan restructuring requests and renegotiating terms requires significant administrative effort and resources, which could be allocated elsewhere.
3. Risk of Strategic Default: Some borrowers might seek restructuring not out of genuine need but as a strategy to reduce their obligations.
4. Adverse Selection: You might face adverse selection, where the option to restructure attracts a higher proportion of risky borrowers. This can affect your overall portfolio risk profile.
5. Impact on Credit Reporting: How you report the restructuring to credit bureaus can impact how you’re perceived in the industry and the borrower’s credit score, which in turn can affect your risk assessment models.

Conclusion

While there are clear benefits to accepting loan restructuring requests, you must carefully weigh these against the potential drawbacks. The decision to restructure a loan often involves a complex assessment of the borrower’s situation, the current economic environment, and your capacity to manage restructured loans effectively. Therefore, evaluate and assess promptly before accepting a loan restructuring request.