Summary: The Special Assets department handles loans that are out of compliance and in trouble. Lenders assign loans to this department to mitigate potential losses. This change marks a turning point in your relationship with the lender, as they likely want to exit the lending relationship.
A company can improve its chances of success in this transition by getting legal and financial advice early in the process. This article provides an overview of what to expect, how to prepare for the transition, and the available financial options. We cover the following:
- What is Special Assets?
- What to do if assigned to Special Assets?
- What to expect in Special Assets?
- Will you need a new loan?
- Financial alternatives
1. What is Special Assets?
A lender’s Special Assets department or Bank Workout Group manages loans that fall out of compliance. They handle all management, administrative, forbearance, and legal requirements of these loans. Their objective is to minimize potential bank losses.
Loans transferred to the Special Assets group are in default or are expected to default soon. A default can happen due to missed payments, falling out of covenant, or both.
Getting your loan assigned to Special Assets marks a significant turning point in your relationship with the lender. They have lost confidence in your business and consider your loan risky. Their focus now is to reduce their financial risk and exposure.
Most lenders typically want to take the loan off their books as quickly as practical. It’s unusual for a client to return to the commercial banking group. Usually, they move on to a different lender.
2. What to do if assigned to Special Assets?
The assignment of an account to the Special Assets department usually does not come as a surprise. Most companies are aware of their compliance issues and know this development is a possibility.
Unfortunately, this assignment may come as a surprise to some companies. They now find themselves facing a major challenge with little time to prepare.
You can do a few things to improve your chances of a successful transition.
a) Get legal advice
Consider getting legal advice from an attorney familiar with loan workouts and Special Assets. This first step is probably the most important one.
The Special Assets team is likely to start enforcing your contract to the letter. They are very familiar with the bank’s loan documents. This can put you at a disadvantage during negotiations. A competent attorney can help you understand your responsibilities and enforce your rights.
During loan workout negotiations, your lender will likely provide you with a forbearance agreement. These agreements can be one-sided and solely benefit the bank. A seasoned attorney can help you understand your obligations and the bank’s responsibilities.
Not getting the right legal advice early on can be costly and have long-lasting consequences. An attorney can help you develop a legal strategy that increases your chances of success.
b) Get financial advice
An outside financial expert (e.g., CPA) familiar with Special Assets, forbearance agreements, workout negotiations, and restructurings can be a great resource. They can provide an unbiased business evaluation and help you develop a realistic turnaround plan.
c) Get an accurate picture of your business
A company can be out of compliance for several reasons. Some companies have serious structural problems that require major changes. In other cases, the company is structurally sound but is affected by a recession or similar circumstances.
It is not unusual for some business owners to downplay the magnitude of their problems. While this position is understandable, it is not productive and may backfire.
Work with your finance and legal team to perform a comprehensive and unbiased review of your company. Use this review to develop a plan to turn the company around.
d) Improve liquidity
Work on improving your company’s liquidity. A strong cash position is essential to continue operations while avoiding common problems.
Develop a plan to build a cash reserve. Focus on collecting overdue accounts, trimming unnecessary costs, and cutting unprofitable products.
3. What to expect in Special Assets?
Every lender manages its Special Assets department differently. However, you should expect your relationship with the lender to change considerably.
Don’t underestimate the potential effect or magnitude of these changes. Your lender now considers you a risky client.
a) New relationship manager
Your loan will be assigned to a new relationship manager from the Special Assets group. They will manage all aspects of your loan, including negotiating the forbearance agreement.
Developing a productive working relationship with the new manager improves your chances of success. This task may not be easy since the relationship could become adversarial.
Remember, the Special Assets group objective is to limit bank losses and collect as much as possible. This goal is drastically different from the objectives of your previous commercial loan manager.
Note that the previous commercial banker assigned to your loan won’t be able to help you anymore. Lenders have a clear separation between the Special Assets team and regular commercial bankers.
b) Increased monitoring
Your lender will start monitoring your loan more closely. Consequently, your reporting requirements and workload will increase. Be prepared for these activities.
Providing your lender with timely and accurate reports is essential. Otherwise, their enforcement actions may intensify.
c) Collateral evaluations (updates)
Your lender will evaluate your collateral to ensure all valuations are accurate. This evaluation may require appraisers to visit your facilities or auditors to review your accounts.
Lenders often use third-party appraisers and auditors. The cost of these services is passed on to the client.
d) Increased costs
Expect your financing costs to increase. Aside from the added cost of updated collateral evaluations, lenders can increase their financing rate to the higher “default rate.”
The increased costs will affect your profitability and cash flow. For this reason, companies should consider increasing their liquidity and conserving cash.
4. Will you need a new loan?
Few companies transferred to the Special Assets department get to stay with their current lender. Usually, the lender is looking to exit the relationship as quickly and cleanly as possible.
You must find a new lender to replace your existing loan. However, you should not expect to get the same terms or type of loan from the new lender. Your options may be limited, and your financing cost will increase. Expect the increase in financing cost to be substantial.
Larger middle-market companies typically have more options than their smaller counterparts. Companies with EBITDA of $5 million to $15 million have fewer options. We cover these options in the next section.
5. Financing alternatives
Lower middle-market companies have few financing options. This limitation is because these companies are too big for conventional small business lenders, and they are too small for middle-market lenders. However, four alternatives can work well for these companies.
a) SBA Loan
Companies that need a financing package smaller than $5 million should consider refinancing with an SBA-backed lender. These loans typically have the lowest cost and are easier to get than conventional loans.
Only a few SBA-backed lenders are comfortable financing turnaround situations. Consequently, you must evaluate several providers until you find one that meets your needs.
b) Asset-based loan
An asset-based loan (ABL) allows you to leverage different assets, such as accounts receivable, inventory, machinery, and equipment. Asset-based loans are more flexible than conventional financing lines. They also have simpler qualification requirements and fewer covenants.
Transactions secured by accounts receivable or inventory use a revolving line of financing. Transactions secured by machinery and equipment use term loans. A facility can have a revolving line and a term loan if it is secured by mixed collateral. Read “What is an Asset-Based Loan?” to learn more.
c) Ledgered line of credit
A ledgered line of credit, also called sales ledger financing, is an asset-based loan that finances accounts receivables only. It provides a flexible revolving line with fewer covenants than a line of credit or an ABL.
The line allows companies to leverage up to 90% of their eligible receivables. Availability adapts as you add new eligible receivables and as clients pay invoices.
d) Invoice factoring
An invoice factoring line provides a revolving line of financing secured by accounts receivable. The line has fewer qualification requirements and covenants than the previous options. It is a good solution for companies that cannot get the other options mentioned in this article.
Factoring lines have some drawbacks. They are more expensive than other solutions and require ongoing lender monitoring. Consequently, companies should use the line as a stepping stone to a more affordable solution. Read “How Does Invoice Factoring Work?” to learn more.
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