Surviving Special Assets: What Business Borrowers Should Know About Their Bank’s Workout Group
Few business events are more jarring than being notified that your company’s lender has moved you to Special Assets. Owners and managers soon realize that the company’s survival hinges on the results of a demanding and confusing process, just at a time when they need to be entirely focused on running the business.
Many companies survive their journey through Special Assets and come out stronger as a result, either because the process forces new discipline on the business or because it serves as a catalyst to restructure finances and operations through a Workout or Chapter 11. But many do not survive. The difference often hinges on how well the company understands the process and on the skill and experience of the professionals it turns to for help. While every situation is unique, this article summarizes the standard guidance our partners provide to business clients to effectively navigate Special Assets.
What is Special Assets?
This is a bank’s workout group that deals exclusively with what the bank considers to be problem loans. When a loan gets assigned to the bank’s Special Assets Group (“SAG”), it typically means that the bank has lost faith in the loan, is willing or wants to say goodbye to the borrower as a customer, and the priority has shifted from “relationship banking” to protecting the bank’s position and collecting money owed.
Can the Bank Move a Borrower to Special Assets Even When Payments are Current?
This can be extraordinarily frustrating to commercial borrowers, but the answer is unequivocally yes. Loan defaults can be either monetary (in the case of missed payments), or covenant defaults, which can cover a wide range of non-monetary obligations created by the loan documents. Most loan agreements, in addition to repayment, require borrowers to provide the lender with periodic financial reporting; to maintain certain asset-to-debt and other financial coverage ratios; to protect, preserve and insure the collateral; and to not permit any other liens without the lender’s consent. Asset-based lending, which involves a borrowing base comprised of eligible assets (for example, accounts receivable and inventory), typically comes with intense lender monitoring and supervision and greater possibility of non-monetary default.
How does the Banking Relationship Change with SAG?
When a borrower is moved to Special Assets, it marks a fundamental shift in the banking relationship. Your friends at the bank, including even senior officers, are likely to be walled-off from what happens next. Even if they continue to communicate, they are unlikely to have any influence over SAG.
So, what kind of relationship should you expect with SAG? Much depends on the personalities involved and on whether the bank’s faith in the borrower has been compromised. Often, experienced SAG bankers will try to strike a positive tone at the outset. But a pleasant demeanor or expressions of concern should not be confused with support for management or the company. SAG's goal is to reduce problem loan commitments as rapidly as possible and minimize loan losses. Many banks set the compensation in their workout units to specifically reinforce these objectives. SAG will pursue its own interests with little regard to the implications for business operations, other creditors, management, employees, or shareholders.
How to Navigate SAG
Effectively dealing with SAG requires an understanding of how the game is played, in addition to having a firm grasp on the company’s objectives, resources and options. While every situation is unique, these general principles can be applied to just about every business that finds itself in Special Assets:
Maintain Credibility. Credibility is critical. Often, from the bank’s perspective, lost credibility is the reason a borrower got assigned to Special Assets. In such cases, the business, with help from its professionals, must rebuild credibility. In SAG, broken promises are routine, which accounts for the skepticism displayed by many experienced workout bankers. Our advice: be honest and forthright, but manage expectations carefully; under-promise, over-deliver; and strive hard to avoid surprises.
Never Forget that Cash is King. It’s axiomatic that no business can operate without cash. Conserve or build liquidity by collecting slow accounts, cutting expenses, liquidating nonessential assets, and eliminating unprofitable business units or product lines. Often this means booking losses as assets are written-down to market value. These losses are less important than the cash generated. Unless specifically negotiated in advance, do not depend on the bank to make additional credit available during a cash shortfall.
Craft a Conservative Business Plan. Developing and articulating a conservative business plan is a key to navigating SAG. The company's performance will be measured against the plan. Make sure the bankers understand the factors that may impact results. Demonstrate to SAG that the business is doing all it can to improve its economic circumstances. Provide accurate and timely reporting.
Proactively Pursue Alternative Financing. It is important to understand the company's alternatives and the changes that are necessary to make a refinance feasible. SAG will expect to have refinancing options well-defined before agreeing to a long-term forbearance. More importantly, few businesses emerge from SAG and return to the lender’s traditional commercial banking, so finding alternative financing and a new banking relationship must be top of mind for management.
Beware of Short-Term or One-Sided Deals with the Bank. Workout bankers will often “incrementalize” the borrower – that is, they gradually turn up the pressure with demands for personal guarantees or added collateral as a precondition to continued forbearance. Adding new collateral and guarantees should be strongly resisted and granted only in concert with a restructuring of the loan terms that permits a reasonable chance of success. The suitable quid pro quo may be some combination of adequate credit line availability, default waivers, revised covenants, extended amortization, or lower interest rates. Borrowers should resist SAG’s requests to keep the credit relationship on a short fuse (i.e., a series of rolling 30-day extensions). Instead, try to hammer out a longer-term arrangement (six months or longer) that provides some certainty that the credit facilities will be available subject to reasonable performance hurdles.
Expect to Pay More for Everything. The SAG experience is expensive. Some banks will ratchet up interest rates and tack on additional fees at every opportunity. This is done for two reasons: First, the risk (at least from the bank’s perspective) has increased and the bank should therefore be compensated. Second, higher costs provide the company an incentive to refinance elsewhere. SAG also tends to be liberal in the use of legal counsel and advisors at the company's expense. It is up to management to exert some control over the bank's spending.
Stay Focused. The path out of SAG is predicated on making a plan and achieving it. The bank is an unavoidable distraction; nevertheless, management must remain focused on customers, vendors, employees, and operations. If the company's performance can turn the corner, doors will open to financing alternatives that will allow it to say goodbye to SAG.
Get Help. Dealing with SAG is time consuming, just when the business demands maximum management focus. Guidance from experienced attorneys is essential to navigating through a workout. Depending on the circumstances, the company may also benefit from a financial advisor to lighten management's load, instill greater confidence at the bank, and position the company to refinance with a new lender.
Chapter 11 is the Backstop. In just about every SAG workout, it is the credible threat of Chapter 11 (overt or implied), and the bank’s likely outcome in Chapter 11, that motivates SAG to negotiate fairly. Put another way, a successful SAG workout takes place "in the shadow" of Chapter 11. That's the reason we make sure clients are knowledgeable about the pros and cons of Chapter 11 even though the goal may be to avoid it, and that's why it is crucial a company hires a highly skilled Chapter 11 attorney to help it navigate Special Assets. At its core, Chapter 11 is a forced debt restructuring, so it makes sense that SAG bankers are keen to avoid it. They also don’t like it because of the many protections it grants to borrowers and because leverage generally shifts in the borrower’s favor.
A trip through Special Assets can be challenging for owners and managers. But with proper education and guidance, along with a healthy dose of fortitude and patience, most companies can survive and even emerge leaner and stronger.
Robert Gonzales guides companies through workouts, restructurings, structured sales, and orderly liquidations. He also represents Unsecured Creditors Committees, asset purchasers, and other parties in Chapter 11 cases.