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Knowing what to expect in any new business situation is vital. Surprises at Christmas and on birthdays are fine - in business, not so much. In the current economic downturn, many businesses with outstanding bank loans (and let’s face it - that’s most businesses) will find themselves in default of their loan documents and subsequently working with a bank “workout” officer - in many cases for the first time ever. This article offers tips from a bank attorney on what defaulted borrowers should expect in the early phases of the loan workout process and how to work with a bank workout officer to increase the chances for success in a workout situation.
You may be asking yourself why a bank attorney wants to give borrowers advice on how to deal with the loan workout process. The answer is simple – I have seen too many business owners and managers hinder their chances for a successful workout outcome because they did not understand the rules of the workout road and either reacted to the lender with hostility or were unwilling (or worse, unable) to produce information requested by the lender. Of course, some workout situations will defy an outcome that either side would describe as “successful,” but the more a newly defaulted borrower understands about the workout setting, the greater will be the chances for a successful outcome.
One of the most fundamental points any defaulted business borrower should keep in mind upon being introduced to the loan workout officer is that this person holds the immediate future of the borrower’s business in his or her hands. This is because the lender’s default remedies against the borrower (and any guarantors) typically are comprehensive, the exercise of any of which could result in significant business disruption and possible seizure and sale of the business’s assets (and personal assets of any individual guarantors). As a result, honest, proactive and non-hostile communication between a defaulted borrower and the bank workout officer will form the cornerstone of a good workout relationship.
The workout officer also likely will need a great deal of information from the newly defaulted business borrower that the borrower may never have been required to produced. High on this list will be a documented plan to turn the borrower’s business around, including company-specific financial projections based on realistic and fully-disclosed assumptions about the company’s future performance, the industry in which the company operates and the overall economy. These materials will form the road map for the workout relationship and must be carefully and professionally developed. For larger loans, the workout officer may suggest that the defaulted borrower work with a turnaround consultant - of the borrower’s choosing and satisfactory to the lender - to identify existing problems and help develop a turnaround/workout strategy.
Supporting the bigger-picture turnaround/workout plan will be information about a borrower’s short-term cash needs. Cash is king in any workout because cash is the only way to pay bills and keep the business going through a hoped-for turnaround. However, financial statements and projections based on accrual accounting provide little visibility into a borrower’s current and, more importantly, future cash sources and uses.
As a result, the workout officer may want to see a detailed, weekly cash budget for some future period (13 weeks is typical) and have the borrower update the budget weekly to reflect actual weekly results and a new week of projections. This is a standard monitoring tool often incorporated into a forbearance agreement in which a lender will agree to forbear from exercising its default remedies for a period of time as long as the borrower meets certain forbearance conditions (including adhering to the cash budget within acceptable variances). For business borrowers that have not rigorously budgeted cash sources and uses, this process can be very time-consuming but also very illuminating. Delay in producing or failure to produce a requested cash budget will signal a borrower’s lack of understanding of its own cash requirements and cast doubt on the viability of a turnaround plan.
If a loan is collateralized, the workout officer likely will require detailed reporting necessary to determine the true value of the assets comprising such collateral. Updated third-party appraisals of fixed asset collateral (i.e., real estate; machinery and equipment) may be required at the borrower’s cost, but a workout officer’s biggest questions – and thus his or her largest need for information - may revolve around the value of the business’s working capital assets (i.e., accounts receivable and inventory).
If a loan is secured by accounts receivable, a detailed accounts receivable aging likely will be required, as will detail on accounts receivable “dilution” (such as returns and claims by customers and other customer rights to deduct from payments due to the borrower). If a loan is secured by inventory, an aging of inventory may also be required, as well as additional reporting to help the workout officer determine if the borrower is carrying inventory at inflated values. As with the cash budget, delay in producing or failure to produce requested collateral reporting will signal a borrower’s poor understanding of its financial situation and result in a loss of credibility with the lender.
Every workout is different, and no workout outcome can ever be predicted with complete accuracy. Sometimes the asset values or cash flows required to implement a turnaround just do not exist. However, a newly-defaulted business borrower can give itself a fighting chance by understanding and appropriately reacting to the workout setting, properly communicating with the workout officer, and responding promptly and accurately to the workout officer’s requests for the unique information this setting often requires.
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