Banks vs. other investors including Private Equity Groups and Public Shareholders

We are hearing the following from CFOs and Senior Fiancial Executives.

     Banks are still doing business but in a decidedly different manner than before.  This has created some rather unique situations.  Banks appear to be trying to be proactive and thoughtful in handling what seems to be the next inevitable bump in the road…..the rising corporate bankruptcy rates resulting in corporate loan defaults.

Banks vs. other investors including Private Equity Groups and Public Shareholders

     Many companies have several investors, the bank that provides the securitized loan; the Private Equity Groups who provided seed money along the way and the public shareholders.  Typically, the goals and objectives of these groups are in line with each other in the short run and in the long run.

 

     Most bank agreements contain language that states upon default/foreclosure, the bank has the legal right to replace senior management.  Typically, this standard clause is never executed before the banker pulls the line of credit or the bank, in corporate bankruptcy situations, as the primary creditor just liquidates a company’s assets to recoup money.  Banks are not in the business of running corporations.  In an apparent strategic move banks may decide in some instances that liquidation of assets is not an option because of the current state of the economy and a different strategy needs to be employed. 

 Scenario:

  • A bank may have issued credit to several companies in similar lines of business. 
  • One business seems to have weathered the storm better than their peers and is not currently in violation of the bank covenants and considering the environment seems very likely to be able to survive the economic downturn in the long run and eventually become profitable once again.  The senior management is solid.  However, unless some other source of money from another investor is infused into the company it looks like the company will within a short period of time be in violation of their loan covenants.
  • The second business has already breached their loan covenants and the loan is in default.

     The old ways may in some instances be passed over for a new strategy.  The banker is approaching the company that has strong management with an interesting proposition.   We know that you will probably break your loan covenants during the next quarter.  However, we feel comfortable with Management and want to make a proposal to you.   When the loan covenants are broken, we have the ability to pull your primary source of financing and/or fire everyone in Senior Management.  However, we will let you keep your loan and your job but with one catch.   We are going to be ousting the management of another business whose loan is in default and will be merging this business with your company, leaving you as the Management of the new entity.

     While this may be a proactive solution on the bankers’ side, it is not without side effects for Senior Management, private equity investors or public shareholders.   Senior Management is left to assess how to manage and merge two companies in a successful manner that does not derail the stability of their original business.  The private equity groups and shareholders are left with their investment significantly diminished, and a company unrecognizable when compared to the company they originally invested.  Only time will tell whether out of the box moves like this by bankers will be beneficial or harmful in the long run.

Bank Covenants and Senior Management:

     Most Banks have always viewed senior management as part of the mix when deciding whether or not to issue any type of corporate loan, securitized or non-securitized.  Now it seems that this informal review is becoming a bit more formal when it comes to small cap and mid cap companies.  It seems that some banks have already started, and others are going to be possibly following suit by adding the following line in loan agreements, “Firing the CFO other than for cause, triggers a loan default.” 

     The rational for this additional written covenant given to a CFO last week follows:  “Bankers have developed trust and confidence in the CFO that they will do the right thing in administering the credit agreement and in managing the business ethically.”  When the banker sees the CEO firing the CFO for reasons other than for cause, a huge “red flag” is raised.  From past experience this normally signals a change in what the bank signed up for when the loan was granted.

     One CFO who started off on the banking side explained that in bad times, numerous situations occur to cause more tension between the CEO and CFO.  In closely held public and private companies, independent of size, the CFO or Senior Financial person is put in the position of saying “no” to Management that is used to being able to keep their “sacred cow” departments, employees or perks or initiating any idea without regard to serious analysis of ROI (Return On Investment).  In difficult economic environments every allocation or use of a company’s assets are important to the company’s growth and/or survival.   In these types of showdowns, history shows the Senior Financial Executive is left to confront management and many times is forced to resign or is fired for “cost” cutting reasons.  In the perception of many bankers, particularly as it relates to small or mid cap companies, removing the CFO or Senior Financial Executive as a “cost” cutting measure or forced resignation is typically not considered a positive strategic business move and signals possible Senior Management problems that can lead to credit issues.

     Most Bankers consider the Senior Financial Executive, typically the CFO, an integral strategic and operations Executive, not someone who just gathers the numbers and publishes the reports.  A firing not based on cause, or forced resignation is interpreted as a sure sign that there is a disagreement related to the strategic and operating goals of the company among Senior Executive Management. This results in concerns on the banker’s part.

 

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s