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Frayed Emotions: There’s No Crying in Asset-Based Lending

Date: Jul 24, 2013 @ 07:00 AM
Filed Under: Crisis Management

With the economy on a slow but upward curve and businesses beginning to break out of a long stalemate with spending, companies are now looking for credit or temporary infusions of cash. And while traditional lending institutions stand at the ready, many borrowers—both healthy and those facing cash-flow shortfalls—are turning instead to asset-based lenders.

Those lenders are not hard to find, primarily because many of the large national banks have recognized the need for asset-based lending and have expanded their operations to include it. In short, asset-based lending has become a very common way for companies to get the cash they need.

No matter the source or structure of a loan, the unexpected can happen to any borrower and lender. When problems arise and a loan is at risk of default, stress can cloud judgment and paralyze rational thought. When that happens, the last thing a company needs is emotional decision making—whether by corporate management, a financial institution or a legal partner.

Remember the 1992 movie, A League of their Own? It’s about the United States’ first professional women’s baseball league. The year was 1943, and World War II was threatening Major League Baseball. In an attempt to bring hope to a struggling nation, a women’s league was formed. A cantankerous coach—played by Tom Hanks—was brought in to coach one of the teams. Problem was, he knew very little about women’s baseball and didn’t want to be part of it. His cavalier attitude elicited emotion from the players—ending with tears and his classic line, “There’s no crying in baseball.”

The coach’s message was simple: emotion will not have a positive impact on the outcome of the game. Likewise, emotion has no place in lending. Reacting to stress with an emotional response will not improve the outcome of a financial situation. If anything, it can lead to denial, poor decision making and even passing decision making to unqualified parties.

Sources of Stress

Banks and asset-based lenders differ in many ways, including the sources that cause stress.

For example, a bank’s primary concern when evaluating a loan application is cash flow. As long as repayment goes as planned, the bank’s rating with the Federal Reserve remains satisfactory. However, when repayment stalls—whether due to bankruptcy or default—the Fed may determine that the bank’s loan portfolio is carrying too many risky loans. To prevent that from happening, a bank will sometimes react out of emotion by writing some of their  loans down to zero unnecessarily to keep federal regulators satisfied and to keep their ratings favorable—even if it means leaving money on the table. Sometimes, these actions occur when a bank determines it no longer wants to participate in an industry (i.e. real estate development, agriculture, construction, etc).

Asset-based lenders are not necessarily driven by ratings or even industry groups. Their primary concern is the quality of a customer’s collateral and their own ability to liquidate that collateral quickly and profitably if the company defaults on the loan. When collateral value begins to deteriorate—possibly threatening a lender’s ability to recoup its investment—a lender’s stress level can rise, and decisions may be made based on emotion rather than rational thinking. 

Another cause of lender stress is the discovery of fraud. While most borrowers are honest and want to build trust with a lender, fraud happens often enough that lenders must be prepared to deal rationally with its financial, relational and legal ramifications. The emotional response is for a lender to immediately sever ties with the borrower. However, this reaction is generally unproductive.

And let’s not overlook the granddaddy of all stress makers—an unexpected bankruptcy. Webster’s Dictionary uses words like “utter ruin,” “failure” and “depletion” to describe it. And unless level heads prevail, such an emotionally charged situation can leave in its wake a swath of poor decisions that can affect families, businesses, lenders and communities for years to come.

Best Practices

When one or more of these situations occur, it’s not uncommon for a lender’s first reaction to be an emotional one. However, acting on those emotions rarely leads to the best possible outcomes.

Before throwing in the proverbial towel on a client, a lender owes it to themselves—and to their client—to step back and consider other options. Let’s look more closely at two specific situations that require a level head and pragmatic decision making.

Bankruptcy

When a company is in bankruptcy, they want to know that their lender is committed to helping them reach the best possible outcomes. Conversely, a lender often wants to separate itself from the drama and risk associated with a company in bankruptcy. Because it is standard procedure to hire a bankruptcy attorney, many lenders are relieved to pass the buck, assuming that once they’ve handed things over to the attorney, their involvement is over. However, because the attorney’s focus is on legal outcomes rather than financial ones, this approach can create a whole new set of challenges.

One key decision that should never be left to the bankruptcy attorney is the value of collateral. An attorney is likely to base a company’s value on the original value of its collateral. However, there are other factors to consider, including market conditions, competition and the importance of equipment to the survival of the company. Unless these factors are considered, the outcome may not benefit the company or the lender in the long term. Always work closely with the attorney to make sure any legal decisions also support financial business objectives at the lowest legal cost.

Fraud

While it might sound counter intuitive, fraud is not typically committed with the intent to defraud. More often, fraud is committed when a borrower moves money around in an attempt to meet payroll, purchase inventory or temporarily improve cash flow. This can be tempting, particularly when the person responsible may intend to “undo” their action before it is discovered. However, once done successfully, it becomes even more tempting to do it again. What may have begun as an attempt to keep the company alive can quickly escalate to something that cannot be justified or condoned. Whether done once or a hundred times, it constitutes fraud, and once discovered by the lender, can tear a lender/borrower relationship apart and lead to decisions that impair or prevent recovery.

This is the time to have a cool head. The more rational the response, the better the outcome for everyone. While a lender has the right to react strongly to the discovery of fraud, the best course of action is to step back and decide what’s in best interest of all parties.  

In one real-life example of fraud, the CFO of a company with an outstanding asset-based loan falsely increased the value of the company’s collateral to continue advancing funds from the lender. He later claimed that he thought it was in the best interest of the company it and would self-correct down the road. However, as an audit approached, he came clean. But it was too late; the fraud had already been perpetuated. While the lender could have pursued legal action — which would likely have put the company out of business — it did not let emotion override good business sense. After the CFO was let go, the lender worked closely with remaining executive leadership to correct and confirm all balance sheets and collateral valuations. Whether the company survives remains to be seen. However, its success or failure will not be determined by a lender allowing emotion to dictate the outcome.

If a lender wants to recover any portion of its investment, it is critical to step back from an emotionally-charged situation and consider more rational ways to create a positive outcome. While a lender may have the right to be aggressive and to prosecute—and even put the company out of business—if a situation is approached logically, there’s a chance of preserving value, reputations and relationships for the longer term.

Whether bankruptcy, fraud or another situation that threatens the terms of an asset-based loan, the best approach is always to step away from the situation and take a snapshot of the facts. The worst thing a lender can do is to let emotions take the place of good business sense. After all, any financial lending situation — if handled properly and rationally — could be the beginning of a very long and lucrative relationship for both borrower and lender.

Peter L. Tourtellot
Principal | Anderson Bauman Tourtellot Vos & Company
Peter Tourtellot is a founding principal of Anderson Bauman Tourtellot Vos & Company, a corporate revitalization company that works with companies in more than 40 industries throughout the United States. Founded in 1989, ABTV brings successful outcomes to companies in distress.

In his capacity as a turnaround professional, Tourtellot has served as interim CEO and president of companies in a wide variety of industry sectors, as well as a consultant to many others.

A leader in the development of the turnaround management profession, he is a past president and chairman of the Turnaround Management Association and a past president and chair of its Carolinas chapter. He has served as chairman of the association’s Certification Oversight Committee, a position that was created upon the merger of the Association of Certified Turnaround Professionals into the Turnaround Management Association in January 2008. He also serves as chair of the academic committee for the Carolinas Chapter of the TMA.

Tourtellot is a past president and chairman of the Association of Certified Turnaround Professionals and served as vice president of education and a member of their board of directors prior to the merger.

Tourtellot is a member of the advisory board for the Love School of Business at Elon University where he served as chairman from 2003 until 2010.
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