Lenders and turnaround professionals have a long history of working together. In the inaugural issue of ABF Journal in December 2002, I wrote an article that defined the ways lenders and turnaround professionals are different and yet collaborate regularly. In the ensuing decade, this relationship has changed, and we have learned lessons both groups can utilize to benefit borrowers and other stakeholders.
The Great Recession Left Deep Scars
I cannot overstate the impact that the Great Recession had upon our current banking environment. Experts may argue whether Dodd-Frank really made the economy safer or if it is just an overly burdensome regulatory scheme that has done little beyond fueling rampant bank consolidation — especially for small and regional banks. Regardless, the compliance and requirements act as a steady damper upon lending officers at all levels of an organization and a reminder of what can happen. Historically low interest rates notwithstanding and an economy awash in cash with too little dealflow, lenders — especially at regulated banks — have not noticeably loosened up the Dodd-Frank standards.
In response to this life- and career-changing experience, and to impress upon the imminently-arriving bank examiners that credit officers have “gotten religion,” there is a strong tendency among lenders to take reserves earlier in the case of an underperforming borrower and to mark loans down more deeply than pre-recession.
This mindset also has contributed to the relative unwillingness of lenders to stay with a borrower through even an accelerated turnaround process, much less a protracted one. Today, credit officers rarely advise a borrower to get help from worthy turnaround firms. More commonly, lenders tell a borrower to seek either refinancing or a buyer, allowing the turnaround process to be the next lender or owner’s headache. Having already taken the markdown and recognized the loss and, given the increasing ability to sell the loan, lenders see far less reason to extend the process and take any
further risk. Workout has become simply out, despite the difficulty lenders face when trying to replace a borrower with new business — there are far too many dollars chasing too few deals.
This shift has been easier for turnaround firms that already included a sale or a refinancing process as part of their services. They have adapted while hoping that chief restructuring officers will be back in demand during the next downturn. However, while the economy is undoubtedly cyclical, each rotation is different, and many wonder whether the robustness of the turnaround profession will ever return.
The Ability of Lenders to Sell Debt
As previously mentioned, lenders can easily abandon the turnaround process by selling a loan. What made headlines in 2001 as a novel way for a large bank to deal with wholesale loan portfolio problems has now become a daily routine of “debt funds” clamoring to buy even one-off and mixed loans (e.g., commercial/industrial and real estate loans to a specific borrower).
Private equity funds — originally created by a surplus of cash in pension funds seeking to boost yields through alternative investments — now have too little dealflow. Many have migrated down-market in terms of minimum deal size and maximum risk acceptability, some turning to loan-to-own strategies or to buying debt that is still performing, albeit at a lower level than when initially originated.
Couple this with the tendency among lenders to mark down underperforming loans extra steeply to impress regulators, and there is often meat left on the bone for debt buyers to recoup — a process I call regulatory arbitrage. Then, of course, the nonregulated debt buyer is not in a hurry to liquidate, but can instead bide its time and even lend more where warranted.
For turnaround professionals, this has created an interesting dynamic. The regulated lender of yesterday would suggest, or sometimes require, the borrower to get help while scrupulously avoiding “controlling” the borrower to avoid the crosshairs of lender liability suits or the dreaded equitable subordination by unsecured creditors. However, the behavior of today’s nonregulated debt buyer is the complete opposite. Instead, these lenders notify the borrower that they have taken over as lender, direct the borrower to engage a certain turnaround professional (“No back talk!”) and almost dare the borrower to sue, saying that will only burnish the debt buyer’s street cred as a hardball player. It is then totally up to the turnaround firm to ensure ethical compliance by staying true to its client loyalty.
Bankruptcy in Disfavor
Lenders’ predilection for bankruptcy — a well-understood and trustworthy tool in workouts and restructuring — drove lenders and turnaround professionals together in the past. A secured lender’s rights would reliably be upheld (unless there were lien issues), and it would be in a preferred position to be the DIP lender and protect its position. Depending upon the situation, the lender could easily be in the driver’s seat by artfully drafting DIP loan terms and demanding appointment of a CRO where appropriate. Turnaround professionals had a central role to play as financial advisor to the debtor or as CRO, including preparing the borrower for bankruptcy or working to avoid it where possible. Turnaround professionals were like the mythical Charon, crucially guiding the debtor and its stakeholders across the River Styx of bankruptcy.
Somewhere along the line, lenders fell out of love with bankruptcy. Reasons include the relative ease and certainty of result in selling debt, the increasing propensity of creditor committees to challenge secured creditors, the increased use of non-bankruptcy alternatives under state law or — the most likely culprit — the expense and time required. Fewer lenders now favor bankruptcy as a preferred method of problem loan resolution, which has reduced the need for turnaround professionals to plan and implement a bankruptcy process.
Where do we go from here? Many turnaround professionals believe (or pray?) that the next downturn will reboot their erstwhile symbiotic relationship with lenders, returning them to the Promised Land of being critical to a lender dealing with an underperforming borrower. Other less sanguine members of the turnaround community have begun honing their skills in other directions, such as corporate governance, litigation support and investment banking. While the next downturn undoubtedly will create an uptick in utilization of turnaround professionals, it is unlikely that the halcyon days of lenders automatically telling borrowers to get help and providing a list of turnaround consultants will return. Lenders have other preferable alternatives, and increasingly tend to avoid any uncertainty of outcome. It’s probable that the future will not repeat the past, and turnaround professionals will have to become more versatile.