Author’s note: following is an excerpt from my new book, Debt & Circuses: Protecting Business Owners From Their Enemies, Their Allies, and Themselves, released April, 2016. Available in print (bound softcover) and e-book versions. Note: you do not need a Kindle to read the e-book version.
Bombing the Rubble
It’s hard to get a sense that you are advancing the [Vietnam] war effort when you are prevented from doing anything more than bouncing the rubble of an utterly insignificant target. … In all candor, we thought our civilian commanders were complete idiots who didn’t have the least notion of what it took to win the war.
–John McCain, “Faith of My Fathers”, p. 185 (1999)
The next financial crisis, and we will have one, will catch the regulators unprepared, either from having a plan to address the coming problem, from a pure lack of resources to address the problem, or most likely both. The U.S. has had two waves of bank failures in the past 30 years, and we know what works and what does not work, more or less.
In the 1980s Savings and Loan crisis, the government formed the Resolution Trust Corporation to assume control over all of the assets of the failed Savings & Loans. The RTC “bad bank” strategy remains the least-bad option. In 2009, however, the government wanted to find a way to do better.
Online auctions had good results, but had huge overhead and transaction costs. Furthermore, privacy issues abounded. The auction company provided documentation with respect to loans to us that contained personal financial statements of guarantors who were friends or acquaintances.
The “loss-share bank” debacle deserves a book all its own. An acquiring bank would purchase all of the assets of a failed bank in partnership with the FDIC and was charged with liquidating all of the collateral (the agreements with the FDIC forbid sale of the loan itself absent a byzantine approval process) at a “commercially reasonable value” after “exhausting all collections remedies” within a given time frame, typically five to nine years. Loss share banks acquired over 300 failed institutions, and the results, in our experience, have been disastrous for the borrowers.
The FDIC also entered into so-called “structured sales” of loans with private equity firms such as Blackstone, Colony Capital, Lone Star Funding, and Rialto Capital. The results have been good for the FDIC and spectacular for the private equity (PE) firms (Blackstone, Lone Star and Colony are the first, second, and fourth largest PE firms as of 2014), who rake in hundreds of millions of dollars in asset management fees on top of their equity investment in partnership with the FDIC (in reality, zero-interest financing of the purchase).
And in some cases, particularly early in the aftermath of the Financial Crisis, the FDIC receiver itself would settle the loans directly with the borrowers. Surprisingly, FDIC receivers are the easiest to deal with and often approach the workout process reasonably and rationally. Part of the reason is political: the FDIC exists to protect the borrowers, not maximize their return on the purchased loan.
Also, the borrowers are constituents of the government and are therefore, at least nominally, the ultimate authority to whom the regulator reports. Yes, we understand this sounds farcical, but the FDIC doesn’t want bad press, which they will get if they mistreat bank customers. On the other hand, the private equity firms and loss-share banks can screw over the borrowers with reckless abandon with little to no media coverage.
The regulators fear the politicians and ultimately the voters, and the asset managers fear the regulators, nominally. The loss-share bank’s number one goal is to not draw any attention of the regulators to any settlement transactions it completes. This is why loss-share banks were/are inflexible.
The private equity groups, however, enjoy the fruits of regulatory capture and have less concern about the fate of the borrowers and otherwise no concern about anything other than hitting their return on investment goals. One would think that private equity asset managers would approach these cases in a more rational way, but most don’t. Why? Hiring.
What? Hiring? Yes. When the large private equity firms acquire large distressed debt portfolios, they have to staff up with bodies to handle the workload. And these people are typically who? They are former bankers, that’s who.
So the private equity asset manager likely a former banker, an in-house special asset professional. Therefore, that person is going to approach collecting, restructuring, etc., in the same way the banks do it. Loss-share banks are the same.
This is why, by and large, the loan workout game plan doesn’t change no matter the lender or owner of the loan. With commercial loans, the game plan is essentially the same regardless of the loan amount. What changes the strategy in each workout is the facts of the case and the personalities involved.
“The best asset managers are former real estate folks or people from industries other than financial services because they can understand the borrower’s difficulties and look at values and transaction costs with the proper perspective. They tend to be the toughest negotiators, but it’s worth it.”
Relying on Assurances by the Asset Manager (don’t).
Do not rely on anything the people working for the lenders say. Not promises, assurances, statements of fact, statements of opinion-nothing. Until the parties sign documents modifying the loan, or a closing occurs that releases all collateral, or the banking relationship otherwise terminates, the ONLY thing you can rely on are the lender covenants and requirements in the loan documents signed at the original closing.
The borrower may have a claim or action or defense against the bank if someone at the bank made a promise upon which the borrower relied to their detriment. Occasionally, you may have a claim to pursue, based heavily on facts and testimony. The claim’s chances of prevailing on the merits of this claim are remote, but that’s okay.
“The fact that you have a legal defense or counterclaim is great leverage against lenders because they cannot afford to lose those types of claims. Also, the claim inserts more uncertainty into the process, and more importantly it means more time and expense related to the collection for the lender.”
October, 2011. The lender that loaned our client the purchase money for his building failed, and another bank took over the loan. When he emailed the acquiring bank to determine the contact for his loan, he received an email back saying they could not locate his file in their system and that he should not make any payments until they found it.
Six months after the loss-share bank told him to stop paying, they contacted him to notify him that they found his file, but they would not talk to him until he brought his loan current. Amazingly (and foolishly), he made six months’ worth of payments, plus interest to bring the account to current status, and resumed making payments.
This ploy is extremely effective: “we can’t talk unless you bring the loan current” or “you must first sign this pre-negotiation agreement waiving all claims and defenses against us, and we can discuss your loan.”
Ninety days later, he told the bank he needed a renewal. The bank wanted to change his loan terms from a 30-year amortization to a 15-year amortization (a payment he couldn’t afford), plus they wanted a 20 percent principal payment (money he did not have). If he refused, they would advertise his building for foreclosure. The bank officer did say that if he paid the bank a fee of $15,000 (that would not be applied to principal or interest, just a fee), they would postpone foreclosure that month. He paid it. Dozens go through this situation every day so it’s not an uncommon occurrence. Those with foreclosure looming can click links like this to find resources that could help them stop a foreclosure on their property. After all, a foreclosure means more than losing property, it could be the loss of a home or livelihood too.
We became involved the next month, when the building was about to be foreclosed on again, and he could not work out a renewal. He had a paper trail of all of his interactions with the employees of the bank. However, time was short, and the bank was not interested in negotiating further.
Prior to the foreclosure date, we filed a bankruptcy of the entity that owned the property, which canceled the foreclosure. Thanks to victories on a few key initial motions, our client retained control of the property, and he was able to operate it. Commensurate with the filing in bankruptcy court, the client filed a lawsuit against the bank in state court under various lender liability causes of action, which provided negotiation leverage.
Explore lender liability possibilities with legal counsel if the borrower can allege any of the following acts by the lender:
- Appreciably altering its procedures for calculating credit availability or reporting requirements when the debtor fell into financial difficulty;
- Contravening its loan agreement with the debtor;
- Making management decisions for the debtor;
- Instructing the debtor which creditors should and should not be paid from available funds;
- Placing any of its employees as either a director or officer of the debtor;
- Influencing the removal from office of any of the debtor’s personnel;
- Requesting that the debtor take any particular action at a shareholders meeting;
- Any involvement in handling the debtor’s daily operations (no matter how innocuous); or
- Misleading other creditors to continue supplying the debtor with goods or services.
The bankruptcy and lawsuit ground on for months, but the bank did return to the negotiating table, and we worked out a deal. In exchange for our client dismissing the lawsuit, they agreed to cut the interest rate to 5 percent with monthly payments of interest plus a $1,000/month principal payment. The income from the property could support this payment. Most importantly, the bank agreed to release the guarantors.
Our client’s diligence in keeping all of his email correspondence with the bank was key to the outcome. Because this bank took actions that they should not have taken, among them the “fee” demanded and instructing him to default on the loan, we were able to put the pressure on the bank, which resulted in a positive outcome for our client.
 Believe us. We tried. We hired media consultants to push our clients’ experiences with bank failures and loss-share banks in local TV news media. The consistent response from the media (and the consultants, for that matter) was the situation was too complex to explain in a 3-minute news story.
 “Regulatory Capture” is a form of political corruption that occurs when a regulatory agency, created to act in the public interest, instead advances the commercial or political concerns of special interest groups that dominate the industry or sector it is charged with regulating. –definition from Wikipedia
This excerpt is reprinted from Debt & Circuses: Protecting Business Owners From Their Enemies, Their Allies, and Themselves, now vailable in print (bound softcover) and e-book versions. Copyright 2016 by SG Ascent, LLC.