Sometimes, some things just have to be said. And I, being on the front line of distressed commercial real estate loan workouts, find myself compelled to say it.
There is trouble afoot. A fundamental miscalculation is being made, sending bankers, senior officers, directors, troubled asset advisors, special asset committees, and their respective attorneys, down the wrong path.
Blame it on Wall Street. Blame it on the FDIC. Blame it on regulators generally. Lord knows we have been blaming it on evil real estate developers, investors and borrowers for this entire economic down cycle.
We are bankers. The pure at heart. Protectors of the American dream. Providers of the fuel that runs our economy. [Never mind that the fuel tank exploded a few years ago.] We are the righteous. We are the strong.
Troubled assets [we like to call them “Special”]: The shopping centers, office buildings, industrial properties, senior housing projects, multifamily and condominium projects, and other real property that serves as collateral for our loans.
The borrower said the asset was worth $20 million. Today it is worth barely $10 million, if even that. We must have been defrauded!
Our guarantors gave personal financial statements reflecting a net worth of $15 million when they obtained their loan. Today, they claim to be broke. They are evil thieves who must be hiding their treasures off shore, or in their back yards. [Oh wait. We foreclosed on their back yards – it must be in their mattresses!] Where else could it have gone?!!! Never mind that it was comprised of equity interests in commercial real estate developments, with revenue from fully occupied centers, whose values have plummeted, or been lost in foreclosure to others.
They promised to pay us off by selling-out their condominium project in 36 months. That was six years ago. Liars… Liars! Their pants must surely be on fire!
So now, here we are. We have a huge number of defaulted loans. We are on the Troubled Bank List. [Shouldn’t it be called the “Special” Bank List?] We are one of the FDIC’s problem banks. Or, perhaps, we are a “fortunate” successor bank – with a loss sharing arrangement with the FDIC.
We have a boat load of “Special Assets”. What do we do now?
One choice would be to make the best of a bad situation. Recognize the virtual certainty, in many cases, that the loan is going to result in a loss. Detach from the blame game. Use prudent commercial business sense and sophisticated business acumen to analyze the situation and take steps to recover as much as we reasonably can from these troubled loans. Behave as prudent bankers. Pursue the loan workout objective pronounced by our banking supervisors in their joint Policy Statement on Prudent Commercial Real Estate Loan Workouts issued October 30, 2009 (available on the FDIC website): “Loan workout arrangements need to be designed to help ensure that the institution maximizes its recovery potential.”
There’s a novel idea. Take steps designed to MAXIMIZE RECOVERY POTENTIAL. What do you suppose that means?
Do you suppose that means putting blinders on, declaring every default, and mindlessly enforcing each and every remedy provided in our loan documents? Pushing real estate collateral to a trustee’s foreclosure sale or sheriff’s sale, even when other potential purchasers have expressed concrete interest in purchasing the property in an “ordinary course of business” purchase transaction for significantly more than we can reasonably expect to realized at a forced sale? Pursuing guarantors, without compromise, to the point of effectively forcing them into bankruptcy (which may often be a “no-asset” liquidation from which we will recover nothing) instead of negotiating with a guarantor for a release of guaranty in return for cooperation in getting the highest possible price for the collateral – or for even a moderate payment from funds the guarantor may be able to borrow from friends or family to avoid bankruptcy – and which we will never receive if the guarantor must file bankruptcy?
For many years I represented banks, bank shareholders (holding company shareholders), senior officers and directors. In this down cycle, my focus has been primarily representing distressed borrowers and guarantors, but I get it. I have been on each side. These aren’t just bad loans. For more than a few, these are bad loans threatening to take down the bank. With that, is the risk that the FDIC will subsequently sue senior officers and directors, and in some cases their attorneys and advisors, seeking to impose personal liability for imprudent loans or failure to properly manage loan risks or failure to take adequate steps to maximize recovery.
In other cases, the bank has already failed, and the focus is on enforcing loans in a way that complies with our duty to the FDIC to mitigate loss to the FDIC insurance fund, and enable us to gain the benefit of loss sharing arrangements with the FDIC.
In either case, decision making is often shaded by fear of FDIC criticism. Perhaps counter-intuitively, this can lead to commercially indefensible decisions based upon simpleminded or misguided notions of what the FDIC is concerned about. More and more frequently, I am experiencing bankers, senior officers, directors, troubled asset advisors, special asset committees, and their respective attorneys, making asset recovery decisions exactly contrary to the FDIC directive to MAXIMIZE RECOVERY for financial institutions.
I have recently had bank attorneys tell me (as I have proposed loan workouts/settlements for borrowers and guarantors) that:
1. It would be better for the bank to sell the collateral through a trustee’s foreclosure sale and realize even only $5 million to $6 million instead of $9.5 million offered by an interested independent buyer seeking an “ordinary course of business” sale – for fear of the bank being “criticized by the FDIC” for selling the collateral pursuant to a “private sale” instead of public sale. [The bank acquired the loan pursuant to a reported 90/10 loss sharing arrangement with the FDIC – Question. Is this the approach the bank would be using to maximize its recovery if the bank stood to suffer 100% of the loss? Is this a little bit of gambling with other people’s [the FDIC’s] money?]
2. It would be better for the bank to actively litigate a foreclosure and guaranty action [against a virtually insolvent guarantor], with two sets of lawyers, in two states, [seriously increasing the bank’s costs and depleting available borrower/guarantor resources] even though the borrower was willing to fully cooperate with the bank in devising a cooperative marketing plan to sell the property at the best possible price, or give a deed in lieu of foreclosure, or agree to a consent foreclosure, [the choice being the bank’s] in return for a release of guaranty.
3. It would be better for the bank to pursue the guarantor and receive nothing following the guarantor’s personal bankruptcy, than it would be for the bank to accept a payment of funds the guarantor would be able to gather by borrowing from friends and family, because a bankruptcy with no recovery from the guarantor would be “cleaner”, reasoning the FDIC could not criticize the bank for not pursuing the guarantors.
Objectively, the obvious question that needs to be asked is – how are any of these courses of action designed to maximize recovery for the financial institution?
The truth is, they are not. There is no objective commercial analysis that can justify any of these positions – at least not in the particular cases to which I am referring, and for which I have personal knowledge. These decisions can only be explained, objectively, as smoke and mirror efforts to create a plausible defense to criticism from the FDIC.
And what criticism is trying to be avoided? Criticism against doing exactly what these banks, bankers and their attorneys are, in fact, doing. Pursuing recovery strategies that are NOT designed to maximize recovery for the financial institution (and avoid loss to the FDIC insurance fund).
On a very simplistic level, I get it. The FDIC, as Receiver for various failed banks, has taken to suing senior officers and directors, and in some cases their attorneys and professional advisors, seeking to impose personal liability for mismanagement resulting in loss. Often there are questionable loans to friends or cronies of bank insiders that have resulted in millions of dollars of loss to the financial institution, and ultimately the FDIC insurance fund. [None of the loans referred to above were to borrowers/guarantors who had any relation to any bank insider.] A recurring allegation, in support of the FDIC’s claim that these senior officers, directors, attorneys and advisors should be personally liable for the loss is that they breached fiduciary duties owed to the institution by failing to take adequate steps to protect the bank from loss, and in many instances “made no effort to pursue the guarantors.”
Taking an overly simplistic view of this allegation, a growing number of senior officers, directors, attorneys and advisors appear to have developed a strategy that is essentially this: “If the FDIC is going to assert as a basis for personal liability that “no effort was made to pursue the guarantors,” then we will just simply NEVER release a guarantor, and will always pursue the guarantor, come Hell or high water, even if we could improve and maximize recovery for the bank by working out a compromise that includes a release of the guarantor from personal liability.”
The underlying justification seems to be: “If I have to choose between the bank [or the FDIC] losing more money, or me being potentially personally liable for not pursuing a guarantor, I am going to protect myself every time. Damn the guarantor – and damn the bank’s balance sheet [and damn the FDIC insurance fund]. I am going to pursue the guarantor to the ends of the earth so the FDIC can never allege in a complaint that I “made no effort to pursue the guarantor.”
To the non-critical eye, this approach may appear to make some sense. Recognize, however, that the legal theory underlying the FDIC allegation of personal liability for failure to pursue the guarantor is that these litigation targets breached their fiduciary duty to the financial institution by failing to take adequate steps to mitigate loss and maximize recovery. It is the purest form of breach of fiduciary duty to sacrifice the best interests of the bank – by declining a workout plan that maximizes recovery – just so you can be in a position to say to the FDIC: “But I pursued the guarantor!”
In the three circumstances I described above – and there are many, many more of the same ilk – how difficult is it going to be for the FDIC to recast the allegation in support of personal liability of senior officers, directors, attorneys and advisors, that they breached their fiduciary duties to mitigate loss and maximize recovery by declining viable workout plans that did just that.
This truly has become the “March of the Mindless“.
The legitimate way to avoid criticism from FDIC regulators, and to avoid exposure to personal liability for breach of your fiduciary duties to your financial institution (and, under loss sharing arrangements, for breach of your duty to mitigate loss to the FDIC insurance fund) is to genuinely act in a prudent manner to maximize recovery, and thereby mitigate loss.
There is no mechanical formula. Each loan, and each workout scenario, must be evaluated based upon its particular circumstances. The objective, always, must be to maximize recovery for the financial institution. Actually maximize recovery. You may not avoid all losses, but you can mitigate loss by pursuing a workout plan that, in fact, is objectively designed to maximize recovery.
My approach on behalf of distressed borrowers and guarantors in loan workouts for seriously distressed loans is, and always has been, to help you maximize your recovery, in return for you releasing the borrower and/or guarantor from further liability so bankruptcy and financial ruin can be avoided. It is not a pretty circumstance for either party – but prudent cooperation all around will give the best possible result for all concerned. This is not a zero sum game. Maximizing loss for the guarantor is not the same thing as maximizing recovery for the bank. The first rule of successful negotiations is to focus on the benefit you receive, not the benefit the other party receives. Why would it be bad for the bank that the guarantor avoids complete financial annihilation? Just do what is right for the bank. Comply with your duty to maximize recovery; by genuinely maximizing your recovery – and move on to the next troubled loan. I’m sure you have plenty.
Thanks for listening,