In 2009, a community bank in the Western U.S. had over $100 million in troubled commercial real estate and construction loans. With a net loss of $82 million from operations in 2009, the CEO was removed and the incumbent CFO was appointed as “caretaker” CEO to work on recovery and to find new capital or a buyer. The caretaker engaged a seasoned interim turnaround executive to urgently direct the correction of the loan portfolio, resolve loan related regulatory criticisms, improve underwriting and policies, and create a stronger foundation for recapitalization of the bank. Hiring of the interim executive freed the “caretaker” CEO to concentrate his time on pursuit of new capital or a buyer.
The Crisis Situation:
• Banking regulators placed the bank under a broad enforcement action, requiring recapitalization of bank, re-establishment of sound banking practices, hiring of a qualified credit administrator / crises manager, overhaul of policies, and establishment of a recovery plan for the troubled loans. All of this, with limited time to cure before the regulators would potentially seize the bank.
• Many potential buyers, and new investors had completed diligence but no meaningful offers were received. In fact, some potential suitors were leaving after only brief diligence. Management was unable to determine the underlying reasons for the lack of offers.
• There was a lack of significant progress on curtailing the problem loans. Prior management had not meaningfully addressed problem loans, employing “extend and pretend” credit actions, prolonging problems which were simultaneously sapping earnings. Negotiation inertia was prevalent on many larger relationships.
• The loan portfolio was shrinking due to normal attrition of good loans, at a time the bank needed to generate new loan growth to exceed attrition and new income to offset losses.
• An ineffective integration of an earlier regional acquisition failed to assimilate dissimilar credit cultures, leading to a large non-performing portfolio in the acquired bank.
Interim Executive’s Findings:
• Insufficient Management Reporting: Despite over $100 million in problem/non-earning assets, progress reports for resolving each asset were flimsy or non-existent. Determining what the engaged curing strategies were was a slow process. The lack of suitable reporting meant that both regulatory examiners and potential buyers couldn’t efficiently determine the direction of the portfolio.
• Misallocation of Human Resources: The bank was using its production lending team to workout many of the problem loans. These team members were neither trained nor motivated to effectively deal with problem borrowers, resulting in slow progress and considerable inertia. Moreover, this absorbed and redirected the bank’s key revenue producers’ time away from generating new client transactions or servicing existing customers. Further, the bank’s imbalance of real estate lenders vs. commercial & industrial (non-real estate) lenders needed to be addressed to help diversify the loan portfolio, while reducing the high real estate loan concentration over time.
• Understaffed Mission Critical Area: The loan workout team was insufficiently staffed and over-worked, contributing to the lack of good forward momentum on the troubled loan portfolio.
• Inconsistent Assimilation and Cultural Communication: The recently acquired bank was several hundred miles from headquarters. Its loan and credit team felt orphaned, as most communications from HQ were via e-mail with few face to face visits. Not surprisingly, the new bank team was not on the same operating page as HQ regarding its new loan production, handling problem accounts, or credit approval criteria. Combined with the dire bank situation, morale and new revenue production was low.
Keys to the Successful Turnaround:
Fortunately, the “Caretaker” CEO agreed with the Interim Turnaround Executive’s corrective measures which are briefly summarized below. These were the keys to the successful turnaround:
Uncover the Blind Spots
Executive management teams are sometimes so close to problems that they develop blind spots. An interim executive is not encumbered by organizational pre-conceptions and operating assumptions, and therefore does not have these blind spots. Uncovering impediments not apparent to in-house executives is a key step in a turnaround. Identifying and addressing the four findings listed above by the interim executive cleared the major obstacles to rapid recovery, and cured the impediments to bank examiners and potential investors.
Address the Culprit of the Organization’s Failure
It was no surprise that the bank’s loan portfolio was heavily concentrated in commercial real estate and construction loans (“CRE”) as the majority of the lenders were exclusively CRE lenders. When the national CRE economy went into free-fall, so did the bank’s CRE portfolio. The bank needed to hire other types of loan specialists to begin to diversify its portfolio, and become very selective in new CRE lending. Secondly, the interim executive initiated a hard review and revision of loan policy and reviewed the bank’s historical loan approvals and policy exceptions that were approved at loan origination. This revealed a pattern showing greater incidents of defaulted loans with exceptions than those loans approved without policy exceptions. Clearly the granting of loan approval exceptions needed to be more judicious. Lastly, mission critical areas needed to be sufficiently staffed. While an organization is losing money it is common to cut staffing costs. However, cutting or limiting the specialists needed to recover from losses and return to profitability should be avoided.
Re-energize the Production Staff
Removal of problem loan servicing from the loan production team improved morale, as this sales oriented staff was now free to generate new transactions in the new credit culture, and spend more face time with valued customers. The introduction of fresh new hires of non-real estate lenders into production teams, better company wide communication, and improved understanding of the new credit culture driven by the interim executive enabled the loan production team to focus outwardly on growth opportunities rather than inward on the bank’s problems.
Establish an “Emergency Room” Type Triage Process
When faced with a large component of under-performing or non-income generating assets an effective interim turnaround executive (a/k/a “Crises Manager”) will employ a multi-layered prioritization approach, simultaneously dispatching management personnel where their efforts will have the greatest positive impacts (I cover this approach in more detail in other case studies). Here is a brief example of dispatching one layer of management to address a specific problem segment. Again, this may differ from many management teams’ practices, but in my turnaround experience it has been most effective. Top bank lending approval executives (CEO, President, or CCO) should NOT spend their face-to-face efforts trying to salvage non-accruing loans. Frankly speaking, most of these are already past executive management’s ability to help, and are best left to professional workout specialists and legal counsel. But larger early-stage delinquencies and new customer problem developments are the most salvageable “ER” situations. Executive immersion here hopefully can prevent more serious issues from forming, and in doing so also build stronger, and more loyal customer relationships. This approach also stems the tide of further portfolio deterioration.
Typical approaches bank management may take tend to be maturity date and past due status driven. Without giving away too many trade secrets, simply put, a more strategic approach first addresses the problem assets that will have the largest positive impact on the institution regardless of maturity or their past due aging.
Develop Strong Internal Reporting that Addresses “What if” Strategies
This labor-intensive step was the greatest confidence builder for bank examiners and with potential buyers of this struggling community bank. Detailed criticized asset reports must indicate not only the individual troubled account causes, history, collateral value and the current workout plan, but also the short and intermediate term strategies, and alternate strategies if the primary workout strategy fails. Brief non-opinionated comments about the quality of the borrower’s behavior under duress are important to determine if a borrower’s promises and intentions are reliance worthy. These reports not only are the foundation of discussions during the credit triage management process, but also serve as a basis for bank loss probability forecasts. More importantly, they serve to build both regulatory and investment examiner trust that management has mapped valid recovery plans and back-up strategies.
Never Lose Sight of the Mission Objective
In a multiple crisis situation is it easy for executives to get pulled aside by lower priority distractions. Remember the emergency-room-like triage example. Interim executives can maintain focus on the issues with the largest impacts, effectively delegate mission tasks to personnel with the proper skill sets, and frequently communicate progress and setbacks to stakeholders. They are most effective in maintaining an intensive face to face follow up regimen, and when progress is made to elevate morale by enlisting management to praise and recognize success after each turnaround hurdle is cleared.
After 8 months of this process, in late 2010 a group of investors led by Goldman Sachs purchased the bank, recapitalized it significantly, and put a seasoned management team in place. The bank made a small profit that year. The troubled portfolio continued to shrink rapidly and new customer growth resulted from proper staff allotment and tasking. Through 2011 and 2012 the bank recovered completely, posting net income of $16 million and $74 million, respectfully, and the interim executive went on to complete diligence of the bank’s first four acquisitions. Total engagement of the interim exec in this successful effort was 12 ½ months.