In this article we examine the three key challenges faced by businesses who are managing the legal process of loan sales and loan management, as well as the solutions available.
Key challenge 1: a lack of uniformity
Loan agreements are a long way from being uniform, which creates a challenge for those involved in their management. Loan sales, securitisations, individual assignments, defaults and insolvencies and industry wide challenges such as Libor reform have all increased the need for efficient management of the many and varied loan agreements held by lenders.
The management of loan portfolios is a continuous and expensive task: covenant compliance, credit monitoring, default management, title and security management and remediations as well as one off-events such as loan sales are examples of what is involved.
Recent challenges in the loan markets have drawn attention to the legal agreements and their precise legal terms. Libor reform exposed the lack of standardisation from one contract to the next which added to the difficulty of completing that remediation project.
The loan market has always been open to bespoke terms and negotiability for the larger borrowers, resulting in a great deal of variance. A portfolio of similar loans which have been individually negotiated by borrowers and lenders contain many differences even if they are all ostensibly of a similar type.
Regional variation in legal requirements
Loan agreements differ across jurisdictions as do the requirements for registration, the taking of security and the enforcement process.
Consumer loans rely more on standard, non-negotiable terms but are subject to a higher level of regulation in many jurisdictions and can be subject to alternative dispute processes such as complaints to an ombudsman’s office. Loan provisions contain universal similarities but there are also important local differences.
Key challenge 2: data storage and searchability
Loan documentation is still mostly held in paper or PDF form. Digitalisation of loan documents is comparatively new and original agreements can still be found in filing cabinets or desk drawers and expensive document storage facilities.
Traditionally we thought of contract terms or clauses; now we think of contract data. The difference is that contract data is each piece of information that you need to manage your loan portfolio.
We can identify the contract data that we need based on the reason why we need it. For example, in relation to the default management of a particular borrower, the contract data we need is the events of default, the mechanism for calling a default, the calculation of amounts owing and the enforcement process.
How to use technology to improve data management
That data, thanks to technological advances, can now be extracted from a data base without having to review the original loan agreement; it can be compared to other loan agreements; it can be used for risk analysis; it can inform negotiations and provide a holistic picture of a lender and borrower’s relationship.
It can be shared, transferred and converted into reports, including as part of M&A, asset sales or securitisations. Electronic agreements and e-signatures are recognised in law in many jurisdictions, eroding the reliance on paper (and the cost of storage) without undermining the validity of the legal agreement, such as its presentation as an exhibit in court proceedings.
Loan databases today tend to focus on commercial terms such as interest rates, principal amount outstanding or maturity dates rather than the underlying legal provisions. The result is that some of the legal issues which the industry is to required grapple with require a review of paper documents or PDFs (with variable levels of searchability) in order to ascertain whether a loan is assignable or amendable, what constitutes a default or what the interest rate is.
A portfolio of loans like these needs detailed review by human eyes, which can be slow and expensive. An obvious mistake is to review the same agreements for different reasons on multiple occasions as the data has not been captured the first time around.
Described in this way, the challenge may seem daunting but there are also several similarities across different loans which are helpful:
- Consumer loans are relatively standardised for each lending institution, with standard terms and conditions and template loan agreements which can be completed by sales, branch or support staff.
- Commercial terms are recognisable across different loans: interest rates, repayment clauses, events of default and security provisions have many variants but enough similarity across sectors and jurisdictions.
- Syndicated loans benefit from LMA (Loan Market Association) standard terms and whilst there is a good deal of bespoke drafting there is also widespread adoption of LMA style provisions recognisable from one contract to the next at the top end of the market.
Key challenge 3: complexity
The third key challenge is the complexity of the review required. As we have already discussed, there are a range of factors that add to that complexity.
Examples of complex review projects that the loans industry has faced in recent years include:
- Libor replacement and remediation.
- Loan book sales.
- Regulatory review projects.
- Capital optimisation and balance sheet management, including central bank liquidity posting.
From projects such as these we have learned the following important points:
- The industry needs to improve its storage of loan documents: digitalisation with searchable documents, extraction and accessibility of key data and the ready access to contract terms in cases of urgency will all pay dividends in the long run.
- Search technology and artificial intelligence solutions can be hard to deploy to a portfolio of paper documentation which has little standardisation; such technology often requires additional human review which reduces the efficiency and cost saving potential.
- Loans are assets but the value, transferability or pledgeability of such assets can be negatively impacted by the legal details in the loan agreement. It follows that complex and expensive reviews can be required in order to complete a transfer.
- Loans lawyers are scarce and expensive. Large scale reviews of loan documentation can be better handled by the growing alternative legal services markets, of which Johnson Hana is the leading example in Ireland.
- Every large-scale loan review project should contain a secondary ambition of digitalisation and data capture.
The solution: embrace outsourcing
Essentially the problem is this: a deep dive into loan agreement legal terms – for whatever reason – can be slow and expensive. There is no magic bullet for this but there are steps that Johnson Hana can recommend to ameliorate the problem:
- Embrace digitalisation: whilst portfolios may be too large to make a one-hit digitalisation project feasible, each project review, remediation or examination of a part of your loan portfolio should embrace digitalisation and data capture as the first essential step to any solution.
- Embrace standardisation: bespoke negotiations are an essential in the loans market, but greater standardisation will allow better application of lower cost technology solutions. Standardisation includes the loan agreement template you use, including formatting. The organisation of negotiation materials to include standardised fallbacks which can be offered in negotiation helps to create a standardised legal agreement whose contract data can be identified, stored and interrogated.
- Embrace alternative legal services providers: ALSPs such as Johnson Hana bring different solutions and tools to a problem by comparison with traditional law firms. Technology, cost-efficient human resourcing, project management and data analytics can be deployed to complete the task, leaving the subject matter in better shape than when they started.
The transition from paper to data is a substantial challenge but continuation with the status quo in a business world which is being rapidly changed by technology is no longer an option.
What can Johnson Hana offer?
Johnson Hana is Ireland’s leading alternative legal solutions provider. That means we disaggregate legal advisory and legal process work, and focus on the latter.
Legal Process Outsourcing – whereby a specific legal process is carved out and outsourced to us
Legal Process Secondments – to fulfil a temporary requirement for a qualified lawyer in a specialist area.
Historically, legal advisory and legal process work were tackled and billed in the same way. This means that all legal work has been as costly and time consuming as legal advice.
It doesn’t need to be.
We deliver legal process work through a combination of innovative legal technologies, robust project management methodologies, and expert lawyers. This approach reduces client legal spend by over 50%, while also providing totally transparent reporting and billing. This leaves our clients free to focus on the strategic, advisory work that really adds value.