September 2015

Dodging Risk & Driving Growth: Proactive Management for Potentially Troubled Borrowers

Clear Thinking Group’s Lee Diercks shares proactive strategies asset-based lenders can take to minimize
risk while supporting consistent growth. He suggests enlisting the help of third-party financial advisors
and underwriters, requiring a solid business plan from borrowers and focusing on strategy, execution
and revenue generation.



Lee Diercks, Partner, Clear Thinking Group

Lee Diercks,
Partner,
Clear Thinking Group

Recently, I met with a senior manager of one of the nation’s larger asset-based lending institutions. During our meeting, he told me that his bank had experienced a record year in loan commitments and outstandings, with virtually no write-offs. However, while he was pleased with the bank’s current performance, he expressed considerable concern about how his company would achieve similar results in 2015. In subsequent meetings, other lenders around the country voiced similar worries, with most questioning how to deliver continued positive performance in a very competitive lending environment without assuming more risk.

Statistics and anecdotes alike illustrate that as economic expansion takes hold, lenders typically fall into the trap of relaxing credit standards in an attempt to procure more business. According to the “institutional memory hypothesis,” whose accuracy has been proven over time, banks ease their credit standards as the occurrence of their last loan write-off fades deeper into history.

Taking this into consideration, how do lenders avoid some of the historical and cyclical traps they typically encounter, while continuing to drive consistent growth? According to a number of lenders, the key to solid performance during the coming year lies in retaining existing customers without incurring more risk and attracting new clients without lowering credit standards. Obviously, the latter constitutes the least costly option in a highly competitive marketplace. Thus, the challenge for the lender is how to retain those borrowers that may be struggling financially and whose credit would, in the past, have been turned over and, concurrently, limit risk with those borrowers. The following five proactive strategies should bode well for lenders in achieving both objectives.

Soliciting Third-Party Help

Financial advisors have long complained that lenders always wait too long to involve them in the process of helping troubled borrowers. As we all know, such borrowers are usually short of two key components: time and working capital. The earlier a consulting entity enters the picture, the more time it has to work on addressing these shortages.

Not surprisingly, there has always been a catch here, namely, getting a consultant or advisor in the door before the borrower in question has defaulted on its loan. The best way for any lender to address this issue is suggesting that the borrower consider commissioning an outside organization to conduct an operational review or business plan assessment. Such an objective third-party review — which is usually executed at minimal cost or, by some firms, free of charge — can be completed rather quickly and painlessly, so borrowers need not worry about being issued the type of threateningly stern directives given under more dire financial circumstances. In fact, most borrowers tend to readily accept the concept of a third party review as a form of assistance, rather than as a type of punishment.

The typical outcome of an operational review or assessment is a list of specific findings and recommendations, the implementation of which borrowers generally perceive as not only catalysts for improving their cash flow, but for enhancing revenues and profitability. Recently, Clear Thinking Group performed an operational review of a retailer that was experiencing some difficulties. The lender had suggested to the borrower that in executing the review, our firm could function as another set of eyes, identifying areas and methods for operational improvement.

During our review, we indeed found opportunities to improve the merchant’s operations — and, consequently, sparked significant cost savings — as well as enhance sales and marketing efforts, reduce employee turnover, set up a succession plan for family members and ultimately bolster cash flow and profitability. Over time and after implementing a number of our recommendations, this borrower was removed from the lender’s “watch” list. It has since shown a marked improvement in its financial position.

Completed Business Plan

According to the Small Business Administration, the No. 1 reason small businesses fail is that they do not have a well thought out, comprehensive business plan. However, we have encountered an equal number of mid- and large-size businesses that have also not developed such a detailed plan. Rarely do our clients have any sort of business plan that they can show us, other than perhaps a projected topline end of the month or year profit and loss statement.

Maintaining a business plan does not guarantee success for any entity, but experiencing the process of “building” one requires a great deal of thought about what the company will achieve and how it will fulfill its mission. Even more importantly, the plan itself provides a foundation of metrics that can be measured against and a roadmap of actions necessary to achieve the expected results.

Lenders can help themselves and their borrowers by placing more of an emphasis on requiring business plans and projected financials from their clients. Of course, this assumes that the borrower knows how to build a formal business plan and cash flow projections. However, this is hardly the case; in actuality, a lack of knowledge in how to craft a business plan heads the list of rationales for never having written one.

Proposing that borrowers who are not experienced in the area of business plan preparation solicit the necessary assistance from a third-party firm benefits lenders in the long run. Case in point: recently, Clear Thinking Group was engaged to assist a family-owned business in developing a business plan that also included a succession plan. The client hired our firm at the behest of its lender, whose principals were aware that it faced succession issues.

Although the client was not in true financial difficulty, it had experienced a few “lean” years and available cash reserves were beginning to dwindle. We worked with the organization to develop a short- and long-term plan that addressed revenue creation, cash management and expense reduction as well as a succession framework. Following the course prescribed in the plan has improved the company’s liquidity and afforded it a “roadmap” for the future.

Addressing Strategy & Execution

Recently there have been a number of troubled businesses that have supposedly fixed their balance sheet problems, only to be back in trouble a short while later. Although seeming to have a repaired balance sheet, these companies never really eradicated strategy and execution problems.

Unfortunately, bad balance sheets do not burden companies at random. Rather, they are created by troubled companies, typically through the poorly conceived strategies and poor execution that resulted in poor performance. Amassing a significant amount of cash or removing debts from a balance sheet does not necessarily signal that a business will perform well over the near and long term.

Lenders can do a big service to themselves and those borrowers that have cleaned up their balance sheets by being proactive and asking the tough questions, including how the business will address strategic or operational issues. Cooperation among lenders and borrowers in grappling with these issues will hopefully lead to the undertaking of initiatives that will ensure a long-term fix. Obtaining the appropriate objective third-party input can go a long way in prioritizing the actions necessary here.

Focus on Revenue Generation

Borrowers that find themselves in tough liquidity situations often go into a defensive mode by focusing on eliminating expenses and trying to survive on what little cash they have, in the hope that revenues will improve in the near term. However, while cutting expenses works for a while, companies can only take the practice so far.

For this reason, lenders must actively challenge borrowers’ plans to grow revenue of the short- and long-term varieties. Borrowers tend to be more optimistic than realistic when it comes to revenue plans. Lenders must be careful to reject “hockey stick” revenue growth plans that have little chance of succeeding. The essential strategy for obtaining realistic figures is benchmarking revenue performance and growth plans with those of other peer companies in the borrower’s industry. A third-party consultant can easily perform this benchmarking exercise, and provide insight into what actions may best result in driving revenue performance.

Underwriting Assistance

Lately, some lenders have begun engaging consulting firms to help guide underwriting or loan renewal. Using an objective third party with direct experience in the borrower’s industry to rationally review business plans and operational activities yields prospective lenders a level of expertise not normally found within the confines of their own institution. While a lender validates a borrower’s financial status, collateral, and the like, outside “experts” can look at the actual operational processes that drive the strategic execution. This type of analysis not only affords the lender a better look at the business, it also results in numerous recommendations the borrower can implement in order to improve its business.

Admittedly, nothing is for certain in today’s business climate. However, taking a proactive stance should go far toward minimizing the risks incurred by lenders in partnering with a majority of troubled borrowers, no matter what their size.