Discussion With Richard Katzman
A Turnaround Professional
by Neil (Dima) Berdiev
This is a reprint of an interview by Neil (Dima) Berdiev of DNB Advisory LLC that was originally published in his newsletterRichard Katzman and I got together to talk about the overall environment and how we as commercial bankers can better prepare ourselves for what lies ahead.
First, we talked about the most common missed opportunities and mistakes by commercial bankers when it comes to credits deteriorating and turning around those situations.
As Richard has been largely focused on companies up to $15MM in revenue during his career, frequently with one business owner or a small ownership team, he’d seen again and again that business owners are eternal optimists. (With all the pressures of running a company, you may not survive if you don’t have this attitude.) However, optimism is of course good in moderation; it can’t be blind to challenges a company is facing. As commercial bankers, when you get a picture of the business from its owners, you are likely getting the brightest possible view.
To make things worse, Richard noted that commercial bankers typically want to hear what they want to hear. (Generally, as an industry insider I’d agree with that.) They (RMs) are often on the side of the business owner and don’t think of a possibility of a workout. Unless things are really dire, commercial bankers tend not to ask hard questions, don’t keep going at it until the answer makes sense. They’d just take what they are being told at face value, log into a CRM / file the notes, and move on. Richard often referred to his own experiences of running a company that his father originally built, focused on leather goods’ production, until that industry went overseas. He remembered getting a very large order from a customer (in a declining industry), revenues were up, therefore borrowings were up and the bank did not call to ask questions for 3 months. Once the RM learned of the reasons, he never followed up with additional questions that should have been asked.
Another point is that RMs and other commercial bankers do not think about the cost of workouts. Let’s forget for a moment loan losses, as many workouts do not lead to material losses. Before you get to a “full-blow” workout, there is a tremendous cost to a lending organization in the loss of productivity within lending and credit teams. Even a light workout will take 2 to 3 times and even longer to manage than an average credit. During some stretches of time, you may need to say good-bye to servicing other clients properly. Also think about the opportunity costs of prospecting and booking new money. Now convert all this into dollars. You will be appalled at resource waste. It is wrong to think of this as overhead. Two overheads are not meant to be equal. It is your opportunity to run your overhead as profitably as possible.
Suppose you have to spend two half weeks understanding the situation, meeting with the client, putting a presentation together for approval, designing the strategy and getting internal and client buy-in. How much could you have done in a 40-hour equivalent? I’ve actually been there as an RM. I am sure you have too. You know what the fun part st? That’s just the beginning, and it is not money or profit-generating resource waste. Eventually your workout team will take over a credit but, before you get there, it is your and your colleagues’ valuable time on the line that can and should be used much more productively. At this stage you are trying to prevent a loss. Depending on how this stage and other stages are being handled, you may still be able to rehabilitate the credit and send it back to the line.
Then we talked about the reasons for RMs and other fellow commercial bankers may not be asking questions. We talked about several like reasons:
- too many accounts to manage when there is just no time and it is not a priority to understand customers;
- not having credit knowledge and experience in what to do, how to it, and not seeing the benefits of asking questions;
- too focused on sales than portfolio management; and
- team and organization not having a culture of understanding clients’ businesses (and growing sales through this better understanding – i.e. selling solutions as opposed to pushing products or services).
Richard asked me how much time I thought RMs spent on business development versus portfolio management. We agreed that 50% x 50% or 60% x 40% is perhaps the preferred workflow, depending on the team and set up. However, it is probably wishful thinking. The reality is likely 70% x 30% to 80% x 20% and up.
He asked another important question: What are your RMs compensated for, really? This is where you will likely find that disconnect you are looking to explain the lack of motivation and encouragement to stay close to borrowers, dig in, ask relevant and at times tough questions. That is likely your answer. They are largely not paid and measured for understanding and servicing clients. They are paid for bringing in new accounts.
Speaking of asking tough questions, I worked with a colleague who is very well-known in workout circles in New England. He used to share his impression of sitting at large syndication meetings with very sophisticated banks and bankers in the room (we are talking BofA, Chase, Citi, etc.). You’d think that if you are in a smaller business area, especially at smaller commercial lending organizations, you do not have the kind of bench strength these larger organizations have. Yet, during bank calls, my colleague would often be asking management again and again to go over some answers because they did not make sense to him, to the annoyance of his peers. In his words, he could see facial expressions of looking at him as if he is the dumb guy in the room. But when he started raising questions, other bankers in the room would gradually begin jumping in with a nod of approval and would also want to know the answer. Why? Nobody but my former colleague wanted to appear non-smart by not understand something. In doing so, those other organizations appeared quite unintelligent because management knew that they could blow smoke in their faces and people would not ask questions. Something we all can learn from this example. Do you want to appear smart or get to the bottom of thing? Choose your side.
We also talked about the flow of an average turnaround engagement, if there is such a thing as an average turnaround. Specific to Richard, when he goes in, he does emergency analysis. He needs to figure out quickly where the problems lie, severity of the situation, what turnaround paths can be and their timing. Is there cash and/or access to cash? Which products and services does the company offer? Which ones are making money and which ones are not and their margins? He also works to under management’s situation and that tends to be a tough nut to crack. Typically, management allows for the problem to happen and get out of control. Then he needs to figure out who on the management team is the weak link. If managers and employees have negative attitude, that can’t always be fixed and people may need to be let go. Richard remembered a particular tannery manager. Everything was a problem, and he was not used to thinking from the perspective of solutions. After all this information intake, he makes a determination if he can keep the management team or if they need to be replaced.
When Richard goes into a workout situation, he is typically going into a crisis or they would not need him. The next step is business restructuring. His goal is to figure out where he can fix a business and how to drive profitability, if the company can pivot, and start negotiating with long-term and short-term creditors to win time for the business (when directly representing the company and not the lender). What’s essential is to set reasonable goals that can be met! One turnaround professional compared workout of a company to a living creature that’s been badly wounded. His goal is to ensure that the wound is not too deep and that the creature can actually survive. Then, he needs to take the creature into surgery and then to the ICU. If it lives, then he will take it into recovery, eventually.
I am sure as a commercial banker you are trying to figure out how to find the “right” turnaround professional to engage with a particular borrower. Each may bring a different perspective, different approach, different style, and different value-add, even if they work toward a similar goal to rehabilitate your client and help it manage through a critical situation. They can also help you avoid lender liability by your not directing or advising your borrower on how to run the company. First, interview potential candidates prior to the initial engagement. It is critical to create a list of what you’d consider to be common goals and to get on the same page day one. Alignment is one of your primary goals. Your turnaround professional of choice has to agree on the goals. Then, you will need to establish timelines and check regularly how performance compares to the goals that have been set. Regular updates, meetings, and check-ins are critical. If you are not on the same page with you turnaround professional and do not have regular direct communication, things won’t go well.
Richard’s words for commercial lenders to work most effectively with turnaround professionals:
- Have very clear and regular communication
- Be on the same page at all times
- You can’t have any misunderstandings
- Detailed engagement parameters have to be set up front
- Get regular updates and compare them to goals
- Finally, the most essential questions of them all: What’s the real value of a turnaround professional? What’s the real ROI and how does one measure possible results and outcomes?
If Richard works for a lender, ROI is in the lender’s ability to collect its debt and ongoing interest and other return that’s contractually due. I’d add to that that in addition to principal and return preservation, a) helping a borrower to weather a downturn, b) strengthening loyalty and profitability, c) retaining in the portfolio, and d) minimizing as much as possible workout resource costs are what makes incredibly successful commercial lending organizations.
As Richard continued, don’t look at a turnaround professional as an expense but rather an investment that needs to generate a certain return (that really applies to all your service providers). If he works for a business, they (Richard and the owners) set goals from the beginning. Do they want profitability, in how many months, where they want revenue, profits, and CF to be, etc.? If the job is done right, it is an investment, not an expense. With a successful turnaround, a company should be able to make back the turnaround professional’s fee in multiples. Depending on the company size, it should expect to see double or triple value return in terms of ROI on a turnaround professional’s work. Here again, turnaround is not an expense. It is an investment!
With thanks to Richard Katzman of On Call Leadership who can be reached at Richard Katzman firstname.lastname@example.org
Neil (Dima) Berdiev – email@example.com