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Buy Your Loan Back From the Bank


Here's how you can negotiate a significant discount on your own debt

Trouble for America's lenders could mean opportunity for you. As banks scramble to shore up their balance sheets, savvy business owners have found it the perfect time to buy back debt at a substantial discount.

Why would a lender sell a $5 million loan, say, for $3 million? Over the past few years banks were only too happy to get paid Tuesday for a hamburger today. But many now would rather get what they can immediately and forgive the rest. Negotiating a discounted payout may be a way to actually take advantage of the credit crunch.

Liberal lending policies and ravaged stock prices have left many bank balance sheets a wasteland of toxic debt. As more companies fall victim to the soft economy, even loans that are still paying may look less reliable as assets. "Because of the widening of credit spreads, any loan older than 12 months is at a below-market rate and therefore selling at a discount, regardless of whether it's [paying] or not," says a director of a multibillion-dollar loan portfolio at a major bank who asked not to be identified. "Banks may look at a company and the current state of the economy and decide they're no longer comfortable with the credit."

If you've been making payments on time and aren't in violation of any covenants, you may be able to buy your loan back for 80 cents on the dollar. If the bank has reason to believe you might run into trouble down the road, the price could be as low as 50 cents on the dollar.

It's not just the risk that a loan will go into default that's motivating the banks. The Federal Deposit Insurance Corp. requires that banks maintain specific leverage and risk-based capital ratios if they want the agency to insure their depositors. So the amount of cash banks have to keep on their books is directly influenced by the value of the loans on their balance sheets. Banks that don't maintain enough cash on hand can expect higher insurance premiums, less access to bailout funds, and a raft of questions from the FDIC, among others, about their general health.

There are only two ways to improve a capital ratio: raise cash or sell assets. Raising enough cash to substantially improve the ratio is next to impossible. This leaves banks with the second option: shrinking their balance sheets and selling off loans.

For lenders, time is of the essence, and that's why you're the perfect buyer. Unlike a third party that would need to conduct due digilence, you already have an intimate understanding of your business and loan agreement. Because you can offer your bank a quick close, you may be able to command an enhanced discount.

To get a deal done, you'll need two things: a bank willing to play ball, and cash on hand when you're ready to negotiate. These days the first item is easy. As for the second, if you're not able to finance the purchase on your own, look to competing banks and private equity funds. You'll have to convince a new partner that your business can pay back the loan, of course, and loans that mature in 18 months or longer are more attractive than shorter-term ones. If you've got less than $3 million in principal outstanding, try to sell your loan to a competing bank. Healthy banks—those with large depositor bases or diversified holdings such as insurance—are still lending. Buying existing debt at a discount could be even more enticing to them than issuing new paper.

CALL A SPECIALIST

If your loan is larger, private equity may be the right route. Hedge funds and private equity firms increasingly are buying debt rather than equity. And market realities have sobered their expectations. They'll be looking for an annualized yield of 15% to 25%. That return is generated by the discount you negotiate for the principal and the interest you'll keep paying on the remainder of the loan.

If you lack private equity relationships, approach a small investment bank or business broker that specializes in your industry and ask for an introduction. Given the modest deal activity right now, intermediaries will likely be excited to get your call, and their fees are now highly negotiable. Alternatively, network at your local Association for Corporate Growth (nonmembers can attend) or Young Presidents' Organization events. Beware of so-called loan-to-own capital sources, or funds that have a reputation for buying troubled debt and hoping for a default, enabling them to seize the underlying secured assets.

Buying back debt at a markdown may have tax implications, so get your accountant involved. But given today's discounts, the benefits could greatly outweigh the risks. And, as a bonus, your new financial partner may prove to be a long-term source of capital for your business.

Return to the BW SmallBiz Feb/March 2009 Table of Contents


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