Are Lenders Becoming Less Concerned About Lender Liability?

Deal Makers' Summit

This was one of hot topics discussed recently at the third annual Deal Makers' Summit, a private event I recently had the pleasure of attending, hosted by Chicago law firm Levenfeld Pearlstein LLC, and the boutique special situations advisory group, Fuel Break Capital Partners, Weston, CT. The attendees of this event were primarily private equity fund principals from the middle and lower middle market, where both deals and workouts tend to be more on the aggressive side. Nevertheless, many of the shared experiences and observations were instructive.

One recurring theme at the Summit was that current circumstances are not necessarily making bankers any less conservative in dealing with the troubled loans in their portfolios. Despite their pre-meltdown behavior, bankers are by nature an orthodox group. They have their protocols, processes and procedures. A banker who strays from the standard protocol in dealing with a problem loan, according to some, stands a better chance of getting fired. And so, many of the participants expressed a view that there is a dominant mind among bankers: “Why place yourself at risk to rescue a transaction that's already been written off?”

Mark Horita, a managing director at The Peakstone Group, Chicago, stated, “I do think that relative to pre-recession timeframes that some of the overly loose practices have come back to a more conservative approach. That said, the banks are experiencing a dramatically more conservative oversight environment, which forces them to probably be more conservative than they would be otherwise. To dig a little deeper, on the lending side, the relationship managers that we know are getting a fair amount of pressure to find lending opportunities. However they're working with credit officers who find themselves in the tough position of having to balance the pressure of trying to put money to work (and increase profits) with increased regulatory scrutiny ' and also in some cases, still cleaning up their balance sheets.”

A Different Perspective

Not everyone, however, shared the view that banks are becoming more conservative in their dealing with troubled assets.

One turnaround adviser, who asked to remain anonymous for obvious reasons, was a bit more blunt: “I've negotiated about a dozen workouts of underwater loans in the past year or so and never in my career have I seen workout guys I've liked less. Across the board, my experience is that the banks are going out of their way to hire guys who seem to have no soul.” To be fair, since the Deal Makers' Summit is attended primarily by private equity participants rather than lenders, the views expressed at the event were clearly biased toward the company perspective.

Jonathan Friedland, a Levenfeld partner and restructuring attorney with a focus on working with private equity funds and their troubled portfolio companies, put it more sanguinely. According to Friedland, “the trend is unmistakable. Traditional lenders are getting more and more comfortable using the same sort of creative and aggressive tactics which, until recently, I had seen only loan to own players use.”

Others agreed. Brian Boorstein, a Managing Partner at Granite Creek Partners, Chicago, an opportunistic PE fund, said: “historically, when we work with troubled companies, we see an opportunity to take out or work in concert with the incumbent lender and make a spread between what the it can realize from its collection efforts and what we can realize through financial sponsorship and leadership. Our role, which emanates from rights that are generally afforded to those in a senior security, includes investing additional capital, hiring or firing of senior management, or catalyzing changes in the business model. Suffice it to say, we have the same tool boxes but funds like us have been far more likely to be actively involved.”

Friedland clarified: “I've been involved in hundreds of deals where the loan documents permitted a lender to remove a company's board and replace it with one of its own choosing. But, until 2009, I had never been involved in a deal where a bank ' as opposed to a non-traditional lender, like a fund ' had actually exercised the right. Since 2009, I've been involved in several. My point is that banks are beginning to cross a line they never used to cross. They are starting to use the sort of strategies Brian has been using for years.”

Rich Bochicchio, a principal of Stamford, CT-based Seaward Partners, LLC, acknowledged the trend, but had a slightly different spin: “Things cycle, and right now bankers are being more aggressive, but it won't last. The young hotshots who were brought into the banks to resolve troubled situations that were already reserved for will move on, will generate new loans, and will eventually be asked to work out their own mistakes. As a buyer of troubled assets, do I have to work harder now? Sure. But am I still willing and able to do things that banks just can't or won't do? You bet.”

Bill Schwartz, a Levenfeld partner who represents a number of banks and other lenders in workout situations, confirmed the sentiments of others by saying “it isn't surprising, really, that banks are becoming more aggressive. Lender liability suits have never been easy to prevail upon. Because loan-to-own players have been very aggressive with a fair amount of success, it was only a matter of time before we started seeing some lenders try to adopt similar tactics.”

Others in the room did not necessarily agree. Matt Zakaras, a principal of Echelon Capital, Chicago, pointed out that because this tactic is unconventional among bank lenders and perhaps even unchallenged, it is not without risks: “I'm aware of a few cases where a lender has removed a board in this manner, but I am not aware of anyone then challenging the exercise of that right. Until there is a substantial body of case law supporting it, traditional lenders and their advisers will be slow to adopt the strategy.”

Conclusion

Regardless of whether this one particular strategy is being employed with more frequency, one feeling in the room was clear: The line between traditional and non-traditional lenders is blurring. One consequence of this is that traditional lenders seem less willing to take haircuts when they see another way out. As the old adage goes, some companies that ' a year or two ago ' just wanted their lender to come to the table, may find themselves being sorry for what they wished for.

Adam Schlagman is the Editor-in-Chief of this newsletter.

Work for bankruptcy counsel over the past few years has not been limited to representing parties in Chapter 11 cases. A significant amount of time for many has been spent advising clients on how to deal with loans that are currently in default, but which are not being actively prosecuted by lenders. In these scenarios, parties are operating in a state of limbo, for better or worse.

Phrases like “extend and pretend” have been heard countless times over the last few years when talking about a bank's proclivity not to deal with troubled loans in its portfolios. Countless are the stories of borrowers who simply could not get their lender to engage in a dialogue about how to work out a troubled loan. States of paralysis like this do not last forever, and my market intelligence indicates that, it has already started to break.

In the last few quarters, bank workout groups have started to recover from, and reinforce their ranks in response to, the tsunami of activity that began to besiege them several years ago. And, since much of this reinforcing was necessitated by massive layoffs, it appears that many of the loan officers responsible for making the bad loans in the first place are no longer employed by the particular lender. In addition, there are surely other reasons for the recent increase in dialogue, such as FDIC loss-sharing agreements, which certainly make write-downs more palatable. Regardless of the reasons, however, defaulted loans are less likely to be extended today than they were even one or two quarters ago ' at least based on the evidence I have seen.

Deal Makers' Summit

This was one of hot topics discussed recently at the third annual Deal Makers' Summit, a private event I recently had the pleasure of attending, hosted by Chicago law firm Levenfeld Pearlstein LLC, and the boutique special situations advisory group, Fuel Break Capital Partners, Weston, CT. The attendees of this event were primarily private equity fund principals from the middle and lower middle market, where both deals and workouts tend to be more on the aggressive side. Nevertheless, many of the shared experiences and observations were instructive.

One recurring theme at the Summit was that current circumstances are not necessarily making bankers any less conservative in dealing with the troubled loans in their portfolios. Despite their pre-meltdown behavior, bankers are by nature an orthodox group. They have their protocols, processes and procedures. A banker who strays from the standard protocol in dealing with a problem loan, according to some, stands a better chance of getting fired. And so, many of the participants expressed a view that there is a dominant mind among bankers: “Why place yourself at risk to rescue a transaction that's already been written off?”

Mark Horita, a managing director at The Peakstone Group, Chicago, stated, “I do think that relative to pre-recession timeframes that some of the overly loose practices have come back to a more conservative approach. That said, the banks are experiencing a dramatically more conservative oversight environment, which forces them to probably be more conservative than they would be otherwise. To dig a little deeper, on the lending side, the relationship managers that we know are getting a fair amount of pressure to find lending opportunities. However they're working with credit officers who find themselves in the tough position of having to balance the pressure of trying to put money to work (and increase profits) with increased regulatory scrutiny ' and also in some cases, still cleaning up their balance sheets.”

A Different Perspective

Not everyone, however, shared the view that banks are becoming more conservative in their dealing with troubled assets.

One turnaround adviser, who asked to remain anonymous for obvious reasons, was a bit more blunt: “I've negotiated about a dozen workouts of underwater loans in the past year or so and never in my career have I seen workout guys I've liked less. Across the board, my experience is that the banks are going out of their way to hire guys who seem to have no soul.” To be fair, since the Deal Makers' Summit is attended primarily by private equity participants rather than lenders, the views expressed at the event were clearly biased toward the company perspective.

Jonathan Friedland, a Levenfeld partner and restructuring attorney with a focus on working with private equity funds and their troubled portfolio companies, put it more sanguinely. According to Friedland, “the trend is unmistakable. Traditional lenders are getting more and more comfortable using the same sort of creative and aggressive tactics which, until recently, I had seen only loan to own players use.”

Others agreed. Brian Boorstein, a Managing Partner at Granite Creek Partners, Chicago, an opportunistic PE fund, said: “historically, when we work with troubled companies, we see an opportunity to take out or work in concert with the incumbent lender and make a spread between what the it can realize from its collection efforts and what we can realize through financial sponsorship and leadership. Our role, which emanates from rights that are generally afforded to those in a senior security, includes investing additional capital, hiring or firing of senior management, or catalyzing changes in the business model. Suffice it to say, we have the same tool boxes but funds like us have been far more likely to be actively involved.”

Friedland clarified: “I've been involved in hundreds of deals where the loan documents permitted a lender to remove a company's board and replace it with one of its own choosing. But, until 2009, I had never been involved in a deal where a bank ' as opposed to a non-traditional lender, like a fund ' had actually exercised the right. Since 2009, I've been involved in several. My point is that banks are beginning to cross a line they never used to cross. They are starting to use the sort of strategies Brian has been using for years.”

Rich Bochicchio, a principal of Stamford, CT-based Seaward Partners, LLC, acknowledged the trend, but had a slightly different spin: “Things cycle, and right now bankers are being more aggressive, but it won't last. The young hotshots who were brought into the banks to resolve troubled situations that were already reserved for will move on, will generate new loans, and will eventually be asked to work out their own mistakes. As a buyer of troubled assets, do I have to work harder now? Sure. But am I still willing and able to do things that banks just can't or won't do? You bet.”

Bill Schwartz, a Levenfeld partner who represents a number of banks and other lenders in workout situations, confirmed the sentiments of others by saying “it isn't surprising, really, that banks are becoming more aggressive. Lender liability suits have never been easy to prevail upon. Because loan-to-own players have been very aggressive with a fair amount of success, it was only a matter of time before we started seeing some lenders try to adopt similar tactics.”

Others in the room did not necessarily agree. Matt Zakaras, a principal of Echelon Capital, Chicago, pointed out that because this tactic is unconventional among bank lenders and perhaps even unchallenged, it is not without risks: “I'm aware of a few cases where a lender has removed a board in this manner, but I am not aware of anyone then challenging the exercise of that right. Until there is a substantial body of case law supporting it, traditional lenders and their advisers will be slow to adopt the strategy.”

Conclusion

Regardless of whether this one particular strategy is being employed with more frequency, one feeling in the room was clear: The line between traditional and non-traditional lenders is blurring. One consequence of this is that traditional lenders seem less willing to take haircuts when they see another way out. As the old adage goes, some companies that ' a year or two ago ' just wanted their lender to come to the table, may find themselves being sorry for what they wished for.

Adam Schlagman is the Editor-in-Chief of this newsletter.