The Day the Music Died in Special Assets
2010 is the day the music died in special assets departments around the country. That’s the day that the Office of the Comptroller of the Currency (OCC) descended upon the big banks, especially special assets groups, and changed the rules by literally re-writing the playbook. What playbook you ask? Today each special assets group within banks with at least $50 billion in assets has an extremely specific policy manual that was re-written after the Great Recession in 2008. This policy drastically changed modern-day special assets professionals and essentially transformed America’s best fighter pilots from entering dogfights to becoming drone commanders. Prior to this change, the heart and soul of a workout was an intimate brawl and many of the weapons previously utilized were taken away. As a result, being a proverbial modern-day fighter pilot or special operative in special assets has changed dramatically in the past decade.
The proverbial F-16 stick was taken away from Maverick and every procedure was made by the book – or more specifically, by the OCC’s book. Special assets, historically, is a “by the seat of your pants” role, which is why you get the talented folks to do it – change is constant. You want uniquely talented professionals who want to solve puzzles whether it be credit or owner psychology. Today the process is fraught with red tape, and when you make the credit policy manual-driven, it can unknowingly give an advantage to the borrower. You should never take control away from the pilot, but that is what has happened. Since the last recession, the OCC has lived inside the big banks and thoroughly invested in re-writing the rules. The rules being applied to C&I lending and when a credit should be classified as criticized and reserves set aside.
The earlier the reserve, the faster the kick-out and less of a work-out is required. By virtually living inside banks, the OCC certainly did its homework and like all banks had to make rules on a portfolio basis. This means setting policy on a portfolio rather than on the individual recommendation of credit or special assets executives. Workouts are typically conducted on a case-by-case basis, or said differently, house-by-house, street-by-street warfare rather than city-by-city, which is how policy makers work. That is not the way it works in the theater of war, just asks the folks doing the work. More often than not, banks do come out whole, but nowadays all too often banks are incented to take the discount and move on, and we are talking pre-COVID-19. This is a major change from the past and again it should be noted that smaller banks without OCC monitoring face drastically different oversight. Too small to fail is an enviable position if you are at a larger bank.
After the last recession, the government came down hard on the biggest banks by increasing capital bases and forcing banks to reserve sooner. If you ask work-out executives off the record they will tell you that their own law firms conspired against them to make life more complicated as the credit approval list got longer. This created more paperwork, legal involvement, and of course more oversight. This definitely helped make banks sounder, but it had an unintended consequence by reducing the number of skilled workout professionals. Said differently, the problem credits were forced out earlier so the need for big work-out groups diminished. The actual workout work became more administrative. This change of taking power away from the operators in the field is a big deal. The pioneers that modernized special assets within banks trained for battle rather than paperwork – this is a real change from past practice. Being a workout office is tantamount to being a great fighter pilot. You cannot be afraid to engage and you need to know how to engage in a good dog fight.
Try doing that with no weapons! What the OCC changed was not only the rules of engagement, but the process to be even able to engage. Meaning, it became harder to enforce or even threaten enforcement because the policy behind enforcement at the big banks has become very bureaucratic. It is the point where trained professionals are more incented to take a discount than to engage in a real workout as the approval process and documentation process is more work than the actual workout. The author would encourage each reader to do their homework when it comes to the big banks.
It should be noted that there were of course positive changes from the OCC as their rules caused the banks to push out clients more quickly thus reducing the need for large workout departments. These changes fundamentally put the banks in very good capital positions, but it also made them weaker in key departments. Special assets is a pure expense until once a decade or so when a very unexpected event occurs that causes a major economic issue – whether it be economic or health related. Then, just like war, you need to recruit and train an army quickly. Here we stand today with banks having depleted their best tier 1 loan workout operators, and major write-offs are coming with a 10-year-old workout policy that was not meant for today’s economic environment. It is not hard to think back to the day when the music died.
The art of a workout comes down to hand-to-hand combat and knowing you have the skills and weaponry on your side. We are entering a whole new world that was clearly not expected and are going to ask professionals to go into battle with a legal manual rather than weapons. This needs to be examined immediately as there is an entire non-bank world at the ready.
What the OCC needs to do right now is unleash the tiger and let these tier 1 operators do what they do best, which is hand-to-hand workouts. Previously written handbooks were for a different time versus right now.
Don McLean said it best when he sang his famous song “American Pie,” but in the vein of today’s special assets world. Because the OCC tried to take the field, the special assets executives refused to yield. Do you recall what was revealed when the OCC showed their shield? The day the music died is the day the OCC arrived! Bye-bye Miss American Pie…
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