By Andrew H. Moser
Whether it’s a growth company, a turnaround scenario, or a firm with a unique situation that expels it from fitting into the standard “credit box,” a majority of the middle-market companies that come before lenders today fall into one of the following categories: a company that is underdeveloped, under-professionalized or underperforming. Traditional lenders focus primarily on a company’s historical performance, allowing it to drive their decision-making and often preventing them from structuring a facility when faced with the aforementioned attributes. But for forward-looking lenders, history serves merely as a benchmark from which the lender can assess future opportunities and challenges, allowing a company to receive the financing needed to grow, restructure, or continue its business. A lender should evaluate not only where the company has been, but assess its likelihood of future success by determining if the management team can execute its business plan and navigate through the challenges that often arise. It is important for lenders to take the time to listen to the management team, learn about the business, and create a lending solution that paves a runway for long-term success. The key lies in accepting the basic premise that no two companies are the same, and that a “check the box” approach will often result in a denied loan or a diligence process that will ultimately prevent a lender from structuring a facility that can support a borrower’s individual circumstances and timely needs. Traditional underwriting data points should serve only as a starting point from which the lender must extrapolate the unique circumstances and goals of the company. The “new guard” of analysts and underwriters must be able to think beyond the norm, realizing that no deal can be evaluated through the same lens or solely from inside the numbers. They must develop a tailored set of criteria and ongoing monitoring points from a new and highly informed vantage point. With several new asset-based lending platforms entering the market, it is important that lenders reassess best practices and elevate the industry’s focus on specialization in underwriting, monitoring and, in some cases, asset recovery methodology. The most critical and fundamental challenges facing commercial lenders today in evaluating new asset-based loans and monitoring portfolio companies are:
1) The need to utilize meaningful and real-time information While there is a critical need for innovation in commercial asset-based lending, prudence and strong credit disciplines remain vital in best serving the needs of borrowers and meeting the expectations of investors. In the past two years, Salus has evaluated over $9.4 billion in prospective loans, yet has chosen to pursue only 15 percent of opportunities, demonstrating a continued focus on disciplined lending practices. Today’s environment has presented lenders with the need for real-time analytics and in many cases, a re-tooling of the very procedures ingrained in the industry which have been considered paramount to underwriting and monitoring of an asset-based loan for the past thirty years. As an example, the scope of pre-funding diligence must stretch beyond that of the traditional field examination. Lenders must look past the basic mechanics of systems, treasury functions, and payables analyses to focus more broadly on key performance and operational indicators, trends related to trade credit, and underlying trade or vendor terms. As a result, traditional CPA or accounting firms cannot often address everything a disciplined lender needs to perform a sophisticated analysis. Today’s lenders need to focus more on the operating fundamentals of the borrower’s business; learning their definition of and measuring adequate return on capital, evaluating the basic economic model of their business, and testing or sensitizing its ability to sustain stresses, foreseen and unforeseen. Further, an asset appraisal is only as good as the day it is issued, and ongoing monitoring of the company’s performance indicators is critical to understanding how appraisal values can change in real time. To successfully underwrite and proactively monitor a loan, lenders must expand the scope of traditional diligence and require third parties to extract the critical information that is unique to each borrower so that a lender can assess when timely intervention may be needed.
2) The general lack of adequate trade credit and factoring support available to many borrowers The “three-legged stool” of the middle-market has long been made up of equity, trade credit, and working capital. However, today’s borrowers are left with something more akin to a pogo stick. Whether healthy or in distress, many middle-market companies are locked in a constant search for access to adequate trade credit that is necessary to operate or grow their business. Trade terms, insurance and credit limits are often a challenge despite the fact that many vendors have product and want to ship it in support of their business plan. Whether the company becomes more professionalized internally or the management team seeks specialized outside advisors, the vendors and lenders must work hand-in-hand to create fair value for the company in granting credit. By working with the involved parties in approach towards this common goal, the company can often achieve favorable terms in a formalized credit agreement and attain the financing needed to fund their operations.
3) The critical need to evaluate the management team In today’s economic environment of turbulence and uncertainty, operators can no longer examine financial results in their spare time, but must focus on measuring key performance indicators continuously, as a matter of routine. Management teams need to know where their business is profitable and where they lose money, constantly measuring their actions against smart goals and appropriately defining what “adequate return on capital” means for their business. Most of all, they must look beyond the numbers and have their eyes and ears on the ground in order to proactively identify and mitigate trends that could drive their business off course. Today’s most successful managers surround themselves with a leadership team of independent advisors who complement their strengths and balance their weaknesses. They utilize specialists who have the appropriate expertise and experiences needed to achieve the company’s goals and resolve the challenges presented. From financial controls and reporting to distribution, logistics, sourcing, and trade credit, managers who collaborate with professionals have their fingers on the pulse of the constantly shifting market and are better positioned to chart a course for success that can withstand changes in the road ahead. Evaluating company management cannot be done through a financial audit or field exam alone, but rather requires spending meaningful time together, listening, learning and understanding how to best leverage each other’s operational experience. Lenders must go outside and beyond the traditional scope and utilize operating partners and advisors to conduct in-depth management interviews in order to gauge the capacity of the management team to execute on their stated goals and objectives.
4) The need to perform a thorough and in-depth analysis of the company’s business plan A business plan is just that, a plan, and it is known that each borrower may end up on the left side or right side of it. Few actually achieve their objectives dead on. It is critical in every lending situation to evaluate management’s ability not necessarily to achieve their plan, but to navigate through good times, bad times, challenges and opportunities. Lenders must dig into the underlying assumptions and measure the projections relative to historical and industry competitor benchmarks. Outside resources can be tapped to specifically focus on operational performance, systems issues, management evaluation, and market channel assessment to further endorse the projections. From there, the lender can design key ongoing monitoring points and performance indicators and proceed with assurance that the company is well positioned to achieve or navigate through its projection, and, more importantly, to react appropriately when faced with obstacles in the future. It is much too easy for lenders to create a standard checklist for each borrower, becoming stagnant in their diligence and monitoring. Instead, lenders must continually evolve to ensure real time best practices focused chiefly on preservation of capital. In doing so, lenders can structure facilities that provide maximum liquidity to borrowers while maintaining a proactive and informed approach to risk management and timely intervention. Lenders must challenge themselves to learn something from each deal and every recovery situation, translating life experiences into lending experiences, and conducting timely post-mortems to make necessary and proactive policy and procedure adjustments. Lenders must always seek to understand the underlying appraisal assumptions, challenge the results, and work resourcefully in finding alternative channels or approaches to maximizing recovery; remembering that the goal should be to maximize liquidity for the borrower while ensuring preservation of capital for the lender. Above all, lenders must strive for transformational lending ideas based on accountability, simplicity, flexibility and transparency. Accountability can be accomplished through realistic financial covenants, but even more so by getting out from behind the numbers to meet with borrowers and fully understand their business. Two-way communication is critical to the lender-borrower relationship and access to the lending decision makers keeps things simple and nimble on both sides. In the end, it all comes down to the lender’s ability to listen to their borrowers, learn everything they possible can about their unique situation and relevant market factors, and make lending decisions that reflect the borrower’s business objectives while maintaining lender accountability. By keeping in mind this simple and forward-thinking approach, commercial asset-based lenders can position themselves and their borrowers for mutual success, creating ideas that meet today’s needs and tomorrow’s challenges.
Author: Andy Moser is a Commercial Finance and Retail industry veteran, recognized by many, as well as his industry peers, for his contributions and creativity in asset-based lending over the last twenty years. At Salus Capital Partners, Andy serves as President/CEO and is responsible for the overall development and execution of; corporate strategy, business development, leadership and team building. He is charged foremost with creating a unique point of differentiation for Salus in competing across the marketplace, providing guidance and perspective in structuring transactions and above all, for the safety and soundness of the Salus loan portfolio. Andy has held numerous senior executive positions at leading financial institutions, and was most recently Senior Vice President and Head of Asset-Based Lending for First Niagara Bank and co-founder of the group as part of NewAlliance Bank in 2009. Prior to First Niagara, Andy held similar executive positions at GMAC Commercial Finance, Capital Source Retail Finance, Wells Fargo Retail Finance where he held the position of Co-COO, President of Paragon Capital and a Co-founder of the Asset-Based Lending Business at GBFC, Inc. (a division of the Gordon Brothers Companies) and recognized by many as one of the first and premier asset-based lenders to the retail industry. Andy is also an active member of multiple professional organizations and is a Director of the Commercial Finance Association (CFA).