Prudent bankers realize that every dollar saved through maximizing return or minimizing loss on problem loans creates essentially the same bottom-line effect as generating new income.
But quite often, bankers lack full understanding of the relationship between borrower and lender on a problem loan.
As result, the banker considers only his side of the story and pursues a workout that may be incorrectly designed from the start; or, he rushes to seize collateral. Both of these actions could result in the loss of superior resolutions.
Original loan documents are usually prepared on forms that have been modified to fit the circumstances. These documents are designed to favor the banker's position in the event of default.
Litigation as Las Resort
It is rare for the banker to resolve a defaulted loan through litigation that leads to seizure of the underlying security.
Successful collection through litigation is difficult, time-consuming, and expensive. Bankers are fought by their borrowers, using every tactic available to maximize their own return or minimize their losses.
From the moment the banker recognizes the asset as troubled, excessive concentration is placed on the creditor's position. Failure to address the borrower's objectives will result in a failed workout.
Due to lack of understanding of the bank's objectives and inexperience in dealing with troubled debt, borrowers often lie to themselves as well as their bankers when trying to resolve debt or business-related problems.
The vast majority of borrowers seek financing for a venture in which they invested a significant amount of time and money. Quite often, a borrower also feels a substantial emotional investment has been made.
Consequently, the borrower perceives a failure of the venture or investment as a personal failing - in addition to the economic loss.
The borrower is cognizant of the deterioration of the investment through his observation of declining cash flows and other related problems prior to delinquency.
However, the banker becomes aware of the problem only after the loan becomes delinquent or the borrower asks for modification.
Steps Toward Resolution
By the time delinquency becomes evident, the borrower has usually taken one or more of the following steps:
* Denied the severity of the problem and hoped for a miracle solution.
* Identified and initiated correction of income or expenses areas related to the situation in an effort to improve cash flow available for debt service.
* Endeavored to generate additional cash or sell all or part of the security.
* Sought alternate solutions such as refinancing or locating additional equity.
If he is unable to resolve the problem. delinquency follows and the borrower initiates discussion with the banker. His approach is one of these:
* "Things are a little tough right now and I just need a little time, more money, a lower rate, or some other concession."
* "I'm sorry |our' venture failed and I guess I'll have to give the collateral back to the bank."
* "I have a serious problem and cannot solve it alone. What can you for me?"
The banker takes a negative view of these options, since the bank will need to commit additional time and money to this loan - with no additional return to the bank. The loan is now considered impaired and may result in further deterioration of the bank's investment.
The banker also needs to address assets classification and its related charges against earning at this point, if it has not been addressed previously.
Banks with a "special assets" or similar department usually move the assets to the appropriate department at this time.
Smaller institutions use senior lenders to administer these problems. The bankers gathers financial information and other data to assemble his proposed resolution.
The borrower begins to sense an adversarial relationship. His account officer is either less willing than the borrower expected or his account officer is changed altogether.
He now perceives the bank as either hostile or indifferent to his needs. It is apparent that the bank is viewing the problem, and potential solutions, from the standpoint of its own best interest - not the borrower's.
A Lender's Options
After discussion, the borrower realizes that the banker's options rarely include giving him more money or better terms without extraction of more information and possibly additional collateral or other borrower concessions. He then realizes the bank's probable actions will be:
* Restructuring the debt under terms acceptable to both parties.
* Restructuring only with a pledge of the borrower's previously unpledged assets and additional concessions by the borrower.
* Accepting the collateral (usually, plus a note) in settlement of the debt.
* Initiating legal action in order to seize the collateral or obtain a judgment against the borrower.
Only a restructuring acceptable to both parties is initially agreeable to the borrower. He us now wary of providing additional information to the bank, as he doesn't want the information used against him.
The borrower's unwillingness to provide requested information causes the banker to react negatively: Complete information is necessary for a successful workout.
The typical borrower next pursues two avenues simultaneously. While gathering data requested by the bank, he seeks an attorney's advice on the problem at hand and possible protection of his corporate or personal assets in the event of litigation.
Armed with legal advice, the borrower is ready to engage the bank, further exacerbating the adversarial relationship.
Contrary to the assumption of most bankers, the borrower considers the use of bankruptcy a a tool at an early stage of financial difficulties.
Most attorneys are not skilled in debt restructuring. They usually refer clients to one of the few skilled debt-restructuring firms or to a bankruptcy attorney.
Bankruptcy attorneys are very adept at selling the benefits of bankruptcy over other resolutions.
Nonetheless, well-intentioned borrowers will avoid bankruptcy if the price is not excessive. Every borrower has a price he will pay to avoid bankruptcy.
The price differs, based on the borrower's financial situation and his perception if negative emotional or social stigma placed upon the bankrupt. Too often, bankers ignore the threat of bankruptcy, assuming the borrower will exhaust every other avenue first.
Instead, the borrower consults his attorney at an early stage. He receives advice on the best financial moves to posture him in the event of bankruptcy, well in excess of a planned filing.
Astute borrowers often establish their financial defensive moves prior to negotiating with their lenders. The public has a better perception of borrower that has passed through bankruptcy and is now doing well than of the borrower that drains all resources to satisfy creditors.
Most borrowers that exhaust every avenue to satisfy creditors usually end in bankruptcy, anyway.
A prudent trouble-debt restructuring agreement addresses the problem at hand in a fashion that is equitable to borrower and creditor alike.
This is the opportunity for the banker to solidify an impaired asset by improving his data, correcting any document deficiencies, and reiterating - if not strengthening - his position as the lender.
If the banker is able to understand the motivations of his customer, he has greatly strengthened his ability to close a transaction that achieves the goal of maximizing the value of the asset - even an impaired asset.
The best thing that can happen to a banker with a problem loan is the employment of a workout specialist by the borrower. A workout specialist establishes a credible link between two parties in an adversarial relationship.
The specialist already knows the information the banker needs and can explain the banker's position in a manner more acceptable to the borrower.
Furthermore, the workout specialist acts as a conduit to communicate to the banker the objectives and needs of the borrower. He can remove most of the emotional problems that cause restructuring negotiations to fail by inserting himself between the parties and extricating the personalities from the negotiations.
The specialist's primary objective is to close a transaction that meets the needs of the borrower and the bank within the limits of each. A properly designed debt restructuring will survive further economic changes and will exceed the normal Band-aid or quick-fix approaches so often used by bankers and borrowers.
Band-Aid restructured transactions usually fail, leaving both parties unhappy.
Additionally, federal bank examiners are hesitant to have faith in the viability of a particular debt restructuring when the previous restructuring failed.
A well-structured workout will usually have no additional adverse impact have no additional serves or assets classification. The restructured assets satisfies the needs and objectives of both lender and borrower.
As time progresses, the continued performance of a restructured assets lends credibility to the borrower and the lender and regains a potentially profitable relationship.
Mr. Daste is a partner in Daste, Taylor and Associates, Metairie, La., consultants on restructuring of problem loans, commercial negotiation, and valuation of problem assets.