Saturday, March 1, 2008

Small Business Advice: Renegotiating Credit

A spate of successful lender-liability suits has made banks more receptive to well-reasoned proposals from struggling borrowers

If there's a single thread that ran through Ronald O. Samarro's 25 years as a vice-president of banks, it's that the typical small-business borrower has little idea how to approach the typical small-business lender. Item: "A principal [behind on payments] would come in and dump a stack of papers half a foot high on my desk," Samarro recalls from tough tours of asset-based duty at such institutions as Irving Trust and Bankers Trust, "and then he'd stand there and say, 'Here's my company.' " " I'm supposed to do the spreadsheeting?" Samarro would complain.

His patience at last worn thin, Samarro departed the halls of lending (and of collecting) back in 1984 in order to help needy CEOs talk -- and talk back to -- bankers. Now, as president of Abbott Associates, a one-person (himself), five-computer loan arranger that services debt-plagued small businesses, he lectures to heads of $500,000- to $100-million companies seeking repair of loans: "Don't make the banker guess what you need; tell him what you need.''

Speaking boldly is easy when you're Standard Oil, a lot harder when you're a $2.3-million company that failed to meet the covenants of a demand note on which $318,000 was outstanding -- and which therefore was being demanded. The delinquency wasn't really his client's fault, Samarro told the lender. He explained that funds representing a $300,000 sale of nail-polish remover to Nigeria had been frozen due to a political squabble that nobody here could undo; therefore another $300,000 of customized inventory had to be written off as well -- money that the company would have used to service the loan. That could happen to anybody, the bank concurred, agreeing to a six-month moratorium. With the bank's forbearance in hand, Samarro had time to soothe other creditors and bolster his client's rank in the cosmetics industry.

A few years back, that mission would have been impossible. Most banks with a troubled loan would have foreclosed, thrusting the debtor into liquidation. But a recent spate of successful lender-liability suits accusing banks of such self-concerned actions as wrongful termination and excessive control over borrowers has made lending institutions leery, lest even their shakiest customers turn around and bite the hand that stopped feeding them. Even if the covenants of a secured loan have been so severely violated that repayment has been judged hopeless, lenders remain open to propositions that will relieve them from pulling the chain.

Because judgments against them have reduced the communication of most bankers to a studied vagueness, the burden of specific solutions to a loan problem falls to the faltering business. All the better, since lender-liability leverage gives the business a good chance of prevailing. Bankers won't make trouble if the solution is handled right. Samarro's advice: "Prepare a formal business plan that you propose to operate under, so when you make the presentation it's crisp and makes sense.''

Unfortunately, small-business management may not have the internal expertise to determine which balance-sheet ratios are scaring the banker. Or it may be that the bank has become jittery over the level of trade debt the client is carrying, because it threatens its own ability to collect; of course, it doesn't dare say as much. The bewildered borrower is apt to interpret the downgrading of credit as a personal vendetta: I don't know why, but the guy just doesn't like me, so screw him and his bank. That, clearly, is the wrong approach. Better, Samarro's way: "Describe the situation honestly, seek their understanding, and ask them to cooperate.''

When covenants start busting out all over, a banker's thoughts understandably turn to liquidation procedures. Action, not promises, is what counts now. "Go to bondholders and stockholders, and renegotiate the balance sheet. Set up a payment plan," Samarro urges, "and the bank will feel like continuing." Speed is crucial. The aim is to keep the operation going. More than once, Samarro has arrived on the scene after both the chief executive officer and his attorney had agreed that Chapter 11 was the only way out. But he showed them more palatable routes. A forbearance agreement from the lender and extended billing terms from suppliers, for example, often do the trick.

Obviously, the original financing package has to be scrapped, and a whole new deal constructed. The financial diagnosis of what ails the business and its recommended cure should be carefully printed and bound. There should be lots of charts and tables, accompanied by optimistic (but not unrealistic) commentary. "Then," says Samarro, "you've defused an alienated situation, and you've started to reestablish credibility with the bank.''

A self-appraisal of company assets, for example, may disclose the possibility of remortgaging real estate. And if the bank will go along with allowing interest payments to be skipped until cash flow improves per projections, the pro forma future can be made to look a lot brighter. Indeed, new sources of funds may pop up. In one case, Samarro found an individual investor who was willing to participate in the loan with the bank when the bank refused to come up with all the needed funds. The bank was first secured lender, but, unsecured by assets, the outside co-lender was given warrants to take over the company if repayment came up short.

Samarro recommends projecting the components of assets month by month over the next three years -- what accounts receivables are going to be, what the depreciated value of machinery and equipment will be, what comprises the customer list, what inventory consists of and how it breaks out by percentages, and so on. Then demonstrate in a cash-flow projection how the business is going to pay back not only the bank's loan, but every other creditor. By leaving no loan unturned, there's an implied obligation in so formal a presentation for the banker to respond with like alacrity. But don't trust the spoken word, warns Samarro. Put everything down on paper. "You can't rely on a banker to make his own interpretations. When he reports to his fellow bankers, he may not remember what you told him.''

If the bank still threatens liquidation of the loan, implied meagerness of collection is always an effective forestalling tactic. It works not only among asset-based bankers, but with other aggrieved creditors as well. On behalf of a CEO who had misappropriated $750,000 of tax withholdings -- a felony -- Samarro was able to negotiate a five-year payback schedule with the Internal Revenue Service. "The IRS has little interest in pursuing an individual," he concludes. "Sure, they'll probably get their judgment, but then the poor guy will grow old and never pay. They're better off keeping the company alive and getting paid out of proceeds." When Samarro determined that a major reason why a company was having trouble servicing its debt was that it was being strangled by featherbedding, he put it to the union. "Here's your choice: either I close this place tomorrow and allow the bank to collect its money, or you get the extra men off the machines and let us live.''

Oddly, the surfacing of a troubled obligation will occasionally call for a yet larger loan, rather than a schedule for reduction. "Give us more against what you've got," a bold CEO might plead of a secured lender selfishly tying up too much collateral. "You're asking me to hobble along with this piddling sum when you could restructure the loan and free me from creditors." In the light of lender liability, that plea is particularly telling, because if the company ultimately files for bankruptcy, it can sue the bank for sitting on an overabundance of collateral.

A banker may admit that the projections add up, but he just doesn't want to go along with the new deal. In which case, Samarro suggests, offer to find another lender to take out the loan-weary officer -- but only if he promises to give you more time. Of course, you don't pay anything on the loan in the meantime. A really pushy borrower might even suggest that the banker write a bridge loan until the new lender comes on stream. If a take-out banker can't be found -- indicating, of course, that the loan is questionable -- try bargaining for forgiveness of part of the debt. "I might come back to that banker and say your judgment was right -- you're in hot water," Samarro suggests. "The most I can raise on your collateral package is one-half the loan. If you forgive half, I'll give you half. Now isn't that better than liquidating? The problem could be there was too much debt to begin with. With the forgiveness of indebtedness, it's possible that the company can service the remainder and survive.''

Not that asset-based lenders are apt to forget, Samarro says, but it can't hurt reminding a recalcitrant bank that come bankruptcy, "customers do not pay, inventory shrinks, liquidation values turn into a tenth of what they're represented to be, and you end up taking a bigger hit." At that stage, however, the odds drop considerably, since it's not apt to be the kindly loan officer who makes the decision, but the bank's workout unit -- broadly perceived as a band of cutthroats whose sole pleasure in life comes in browbeating debtors. Once a loan-workouter himself, Samarro doesn't disagree. "Workout guys can be very difficult. But you have to understand their point of view. By the time a loan gets to workout, management has created a credibility gap: 'Sure, we're getting more sales; yes, we'll pay you this month.' Then they keep failing to deliver, and the bank gets disgusted.''

If the business can't be rescued after all this, the CEO himself will likely need help paying off the bank, so that he doesn't get sued for personal guarantees. Even here there are techniques to wind down a business, says Samarro, such as getting on the phone and collecting payables, so that in the business's last gasps, cash trickle is channeled into paying down the loan.

What, at his asset-lending heart, is Samarro's real secret? "It's that no credit man wants to accept 10¢ on the dollar after writing 100," he admits. "The loan officer went on the line that the company's credit was good. Suddenly he has to go to his superiors and admit he made a mistake? You tell him, 'Yeah, it was a mistake -- but here's how to get it back.' ''

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What to do with a seriously delinquent asset-based loan

Your strategy should be to come up with a written repayment plan -- don't rely on verbal communication -- that shows your bank it does not have to liquidate. Here are tips from ex-banker Ronald O. Samarro:

* Explain what the problem is and spell out a solution. Quickly.

* Review your assets from the bank's point of view. Can real estate be remortgaged? Has accounts-receivable turnover improved?

* Make the bank comfortable. Negotiate payments with other creditors; subordinate old debt; revamp your balance sheet.

* Ability to service debt is a key factor. Give the bank performance standards to track. Detail cash flow month by month.

* Restructure your loan, and spell out what you need. If you have to take less, reorient your plan to the lesser amount. Scale down sales, if need be, to take pressure off other parts of the business.

* Ask for forbearance, such as payment of interest only, or of principal only, for a 12-month period.

* Ask for forgiveness of part of the loan if, with lessened debt, company can survive. Remember, a banker would rather get 50¢ on the dollar than a dime.

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