Donald F. Clarke
Asset Based Lending Consultants

Unless we live in an alternative universe, it is indisputable that the COVID-19 pandemic has altered the meaning of “normalcy” in almost all aspects of our lives, including how we conduct field examinations in the asset-based lending space.

COVID-19, which reared its ugly head sometime in late Q4/19 and continues now in the spring of 2021, has and continues to influence the way we approach field examinations, which is one of the most crucial disciplines in ABL.

Field examinations are important because in ABL, assets loaned against are actively changing all the time compared with more static assets such as fixed assets, real estate, etc. The changing assets in ABL transactions can disappear or degrade in relatively short time periods and leave an ABL lender over-advanced or without its base collateral. Field examinations are done in order to constantly monitor assets qualitatively and quantitatively during the entire lifespan of a loan.

Normally, field exams are scheduled to mirror the risk perceptions of the borrower, with increased frequency focused on higher risk borrowers. However, the COVID-19 pandemic has greatly impeded the ability of lenders to do on-site field examinations in a timely manner, if at all. Field examinations in ABL and being physically in the field are indeed both sacrosanct and mutually inclusive.

New Techniques

As we wait to once again engage borrowers in doing site visits, we are now doing “desktop” field examinations, which is somewhat of an oxymoron. But, at Asset Based Lending Consultants, we have been doing desktop field exams for more than five years as a necessity to save costs compared with the preferred and time-tested practice of going on site. Even in this paradigm, we would make visits if inventory was involved.

When conducting remote field examinations, it is important to establish a secure data room for uploads from a borrower. This data room must be secured because it will house privileged information electronically and the field examiner must protect against a data breach by opportunistic bad players. Normally, the field examiner would establish a separate data room for the borrower to upload the documents that they need for data extrapolation and analysis. At Asset Based Lending Consultants, we tell borrowers that we prefer the information in a format exportable to Excel for ease of extrapolation by the assigned analyst. From this position, we should be able to extract all the relevant data we need except for the physical aspects of seeing inventory.

What should field examiners do when inventory is a part of the equation? Field examiners can use Facetime or WhatsApp to communicate with warehouse personnel in an attempt to “see” and test count inventory. In this process, the examiner should obtain still shots of the warehouse before counting so they get a panoramic look at the inventory globally. To protect themselves from being “set up” by the borrower, a field examiner should count from the floor to the records as follows:

1) Pick some high value items from a prior report and even some smaller ones in order to cover as large a part of the inventory as possible.

2) Ask warehouse personnel to count while watching and recording counts before doubling back to the system to see if the records jive. Field examiners should make sure warehouse personnel open some boxes. This would be a normal practice that would otherwise be done by the field examiner themselves. In cases when inventory is spread out over large areas, use drone technology.

How can field examiners keep data flowing and avoid the “out-of-sight out-of-mind” dilemma? As the name implies, field examination means being in the field and when an examiner is not present, they tend to forget things, either conveniently or otherwise. So I recommend constant email reminders of outstanding documents needed. Keep the list organic, strike off things as you get them and send a daily list of outstanding items. It is important to keep account managers in the loop so they know the status of documents and challenges being faced by the analysts.

When an examination is completed, it is important to archive data for future use. This is crucial and may require you to not allow the borrower the ability to delete files once uploaded into the data room. Archiving this data is key for future reference and can become vital evidence in the event of legal challenges down the road.

Questions to Ask a Borrower

When working with a borrower on a remote field examination, here are some of the most pertinent questions to ask:

  • How is the supply side of the business impacted? Obviously, the point here is if the borrower loses access to inventory needed for either manufacturing or resale to its customer base, then its trajectory as a “going concern” is questionable.
  • How is the distribution side impacted? Conversely, on the distribution side, if there are no takes of the product and inventory, then the same “going concern” anxieties prevail.
  • How are the borrower’s operations internally impacted? If a borrower relies on labor-intensive processes, then COVID-19 will have a bigger impact than if its processes were more automated. If the pandemic made it necessary to reconfigure facilities, how long will the process take and how much will it cost?

Field Examinations Following COVID-19

Needless to say, once the pandemic ends, there will be a rush to assess where borrowers stand. This rush, some of which is happening right now, will require some strategic planning by lenders.

Lenders should triage their portfolios based on what they knew prior to COVID-19. They would have known, for example, borrowers who were problematic versus those who were strong. The priority should be trying to see the former group first. Lenders also can look at borrowing bases coming in during the COVID-19 pandemic to see which ones were fully utilized or over-advanced. Lenders should begin with these.

Here are some additional considerations to keep in mind when conducting field examinations in a post-pandemic environment:

  • Assess the “collateral” damage ABL lenders have sustained. This process will require a deep dive into inventory, including dealing with shelf life issues, as well as an examination of the health of accounts receivable debtors that make up a lender’s collateral. How many of them are still alive, wounded in action or dead on arrival? Do we as field examiners suggest an attempt to resuscitate or liquidate a borrower based on our findings? Do we get a 13-week cash flow plan to look at attainability on the survivors? Should we evaluate and critique?
  • Triage the dying and dead and look for exit ramps. Once field examiners determine this category of borrowers, they must obtain a complete name and address listing for debtor AR demand letters for a lender to begin the process seamlessly. They also must ask some important questions: If inventory is a part of the equation, are rents past due and do they need to be paid for a lender to have access to inventory? What mechanisms need to be engaged to start the exit process? Any insight from a field examiner will be priceless to the process.
  • Prop up borrowers showing signs of life. For borrowers in this category, the credit might have to be re-underwritten with input from the field examination team. This will require field examiners to determine if the numbers indicate that a borrower has a vibrant pulse.
  • Discuss staffing needs and requirements post-pandemic. The new field examination skill set will require experience with difficult exams, as I suspect most field exams will fit that description in the post-pandemic environment. Field examiners will have to understand cash flow projections and be able to calculate things like break-even sales while analyzing below-the-line expenses to determine sustainability. A strong accounting background will be paramount here.
  • Build new databases. For those who have made it to the other side of the pandemic, how does a field examination now determine the “new normal?” Given that ABL is a data-driven applied science that uses data to establish advance rates and eligibility on collateral, what do we now use? Do we start anew? Are prior data and metrics pre-COVID-19 considered irrelevant and not useful? Field examiners may need to build new databases after the pandemic to deal with these questions.

Future Areas of Focus

In summation, when conducting field examination analysis of debtors in the post-COVID-19 pandemic world, examiners need to focus on:

1) The qualitative aspects of the collateral, or, in short, how much liquidity (cash) will ever come from those assets. An asset on the balance sheet aging or perpetual inventory does not necessarily result in cash. If it doesn’t, examiners need to qualitatively assess A/R, which will mean doing deeper research on existing debtors who make up current A/R to see their statuses. This could be a Herculean task, if not an impossible one.

2) The quantitative aspects, meaning using all the proven and treated methods examiners use to determine that assets exist. Will some disingenuous fraudsters use the cover of COVID-19 to snooker us? You bet! We need to focus now more than ever, as desperate people do desperate things.

3) The quality of earnings, meaning the determination of whether or not “earnings” shown are really resulting in cash to the liquidity of the borrower. If dead A/R and inventory are on the balance sheet, you need to question the quality of earnings.

Excerpts of this article were taken from an article previously written by Donald Clarke for another publication.

Donald Clarke, president of Asset Based Lending Consultants and the ABLC company group, including Don Clarke Enterprises (DCE), has 38 years of experience in commercial lending, asset-based lending, commercial leasing, quality of earnings certification and continuing education training focusing on corporate lending disciplines for Fortune 500 companies.