"It's Dr. Evil, I didn't spend six years in Evil Medical School to be called "mister," thank you very much."
It's D-Day. Your bank manager has just broken the uncomfortable news that he will no longer be your point of contact and you should expect a phone call from a Mr G Reaper of the Asset Restructuring division. Congratulations . . . you're in the Bad Bank.
As usual, the answer to what you should expect next is— it depends. Here are some of the variables and possibilities:
1. The Bad Bank will almost certainly appoint (at your cost) an investigating accountant. This firm will spend a few weeks completing a mini-due diligence on the business and will then make recommendations to the bank.
2. Perversely, if your company is a real basket-case it could strengthen your hand. Let's say that the business has few tangible assets that could be sold (such as real estate or valuable factory equipment) and is only just breaking even each month. In this situation it's unlikely that liquidation will recover much of the bank's money, so they may instead let the company trade on and hope for better times. They'll be patient and supportive. The Bad Bank might even agree to write off or suspend part of the loan to help return the struggling business to a more solid footing.
3. The most dangerous situation for a PE investor is a portfolio company in the Bad Bank with valuable assets and a reasonable bottom line. In these circumstances there's a risk that the lender will sell off the business (or its assets) and try to recover their loan. Needless to say, the equity holders will probably be washed out.
The Economist recently raised the alarm about cash-strapped banks rushing to this solution as a way of freeing up funds and improving their liquidity position.
Worryingly, however, a large number of profitable companies that are still paying down their loans may go bust through no fault of their own. Simon Walker of the BVCA, an industry group, frets that British banks in particular are forcing sound firms into early liquidation over minor breaches of their loan agreements in order to reduce the size of their loan books.
4. Sometimes the Bad Bank will adopt a watchful waiting approach. They may conclude that the business has stumbled but is not at serious risk, or that a turnaround plan looks promising. In this situation they'll agree to let the company continue trading but will renegotiate the terms of the loan to reflect the higer risk involved. Examples of typical Bad Bank loan amendments include:
- Adding penalty interest to reprice the loan
- Cutting back undrawn loan facilities such as working capital and capex
- Changing the loan amortisation schedule so the debt gets paid back faster
- Charging the company a painful one-off amendment fee
- Increasing the frequency of reporting dates and covenant tests.
5. Finally, the approach the Bad Bank chooses will depend on the broader banking relationship. Bad Bank execs pride themselves on not being relationship managers—their game is recovering cash, not making friends. Having said this, over the past decade banks have become more sophisticated at managing their problems loans. During the 1990's they learned the hard way that carelessly rushing companies into liquidation wasn't a smart way of recovering maximum value and destroyed valuable business relationships. Nowadays they will at least pause and think about the bigger picture before pulling the trigger.
For example, I know one very high-net-worth individual whose company has run into serious problems. It's in the Bad Bank but they're being incredibly gentle and tolerant. Why? Another division of this banking group also manages his (large) private assets . . . that's called having leverage.
