Space Cowboys and Special Assets
Link to article here.
Clint Eastwood starred in the classic year 2000 movie, Space Cowboys, about a retired astronaut who, along with his colleagues, was sent back to space to fix a satellite he helped build in the 1960s. It turned out (in the movie) that NASA had no one around with any knowledge of the dated technology built into the satellite, so they had to turn to a retired astronaut to solve the problem. The importance of this particular satellite was that it was carrying an old nuclear warhead at risk of detonating.
Flash forward to 2019 and one could argue we are dealing with the same crises in the field of special assets. The good battle-tested professionals who were in their 40s and 50s during the 2008 downturn are now in their 50s and 60s and thinking about retirement or joining a more lucrative turnaround firm. This combined with banks focused intensely on their expense ratios as mandated by Wall Street and the slimming down of non-revenue producing divisions, has a created a dearth of experienced special assets professionals. It’s easy to see why banks are holding on to assets and trimming expenses to maximize profits while they can, but it’s a clear risk to do so at the expense of your front line of defense — professionals skilled in workouts.
Rather than one proverbial satellite, the nation’s banks are dealing with the equivalent of a watchlist of marginal credits and a bunch of space cowboys — professionals who are at or nearing retirement or worse have been downsized as part of cost cutting. Try calling the workout departments of big and small banks and ask them off-the-record whether they are prepared for the next downturn. The answer is no. It’s a hard job that requires on the job training and a unique set of qualifications — knowing when to use the hammer versus the velvet glove; knowing when to exercise remedies versus judgement and patience. Banking is at the end of the day a local and regional business — meaning whatever experience a borrower has on the way in or out will surely be communicated to their respective communities.
It’s a unique job that demands a high level of mental acuity. There is a daily/weekly/monthly grind to dealing with the hardest credits. It’s tantamount to getting a new multi-dimensional puzzle to solve each week with problems ranging from uncontrollable commodity price swings/tariffs, to bad or entrenched management. Neither is easily solvable and these are real time problems as liquidity will be challenged during these situations. There is a toll this takes when the hardest problems are put on your desk and success is defined as getting par and moving on. In addition, the time spent on regulatory and general reporting requirements makes an already time-consuming job more arduous.
Another factor to consider is that the job has become eminently more complicated over the past ten years for two critical reasons: The proliferation of complex uni-tranche and split-lien deals, and growth in capital markets. Stated differently, deals are not only more complicated, but there are many more multi-lender deals that will surely create court fights… and the take-out options are much different. The ABL market exploded during the past decade and there are now options from distressed private equity to bulk loan sales. The non-bank lenders have provided liquidity that was limited in the past. Knowing capital markets is also becoming a critical component.
It does not take crystal ball to know the direction we are heading and that it can’t be that far off on the horizon. According to the New York Times, loans to companies with large amounts of outstanding debt — known as leveraged lending — grew by 20 percent in 2018 to $1.1 trillion, according to the Fed’s twice-annual Financial Stability Report.” There is no arguing that credit standards have loosened (both bank and non-bank) over the past few years and banks have fought bitterly for assets. The result is that while the economy is by all means still thriving, the banks have just booked significant assets with higher risks, looser standards and lower rates.
There is going to be a real leverage epidemic in the next downturn and the resounding theme seems to be that management seems to think allocating staff with commensurate experience will be easy to do when many of their most experienced staff have been downsized, are on the verge or retirement or have found more lucrative consulting work. Each bank should be asking themselves what their plan is for their workout department and start checking where their space cowboys are today.