The Big Picture: Bank Workouts and Opportunities Created by Bank Failures

The recent bank failures, finance regulations, and an ever-changing economic climate are impacting lending practices all across the country.  Lending from U.S. banks and other traditional financial institutions has contracted significantly indicating a tightening of lending standards. This has resulted in more bank turn-downs and loan workouts leaving many small to medium-sized businesses in distress as they seek out alternative business funding solutions. For financial brokers and ISOs looking to help their clients manage these issues, one practical strategy is invoice factoring.  

Commercial Loan Workouts

In the banking and finance sense, the term “workout” is given to the special process implemented by a bank or other traditional lender in order to keep close monitoring of a borrower’s financial situation.  It occurs when an account or commercial loan is classified as nonperforming and a lender does not believe their customer will be able to repay the debt.  

When a borrower is late on payments or misses them completely, the workout process is triggered.  The lender will first attempt to figure out why the borrower’s payments were late or missed.  If necessary, the lender will default the borrower and attempt to come up with a resolution through a Workout Agreement that includes restructuring of the loan, renegotiating terms and covenants, temporary forbearance, taking of additional collateral, and so forth.  

The purpose of doing this is to accommodate the borrower and provide some measure of relief so that the lender has a better chance of collecting out on the loan and interest without needing to foreclose.  It mitigates the risk of loss and is mutually beneficial for both parties.  Commercial loan workouts can be challenging as issues can be complex so lenders will carefully need to consider the impact of the proposed strategy.  Should this fail to remedy the situation, the lender may then begin to foreclose and enforce rights under the financing agreements.  The lender will close the loan facility and have their customer find financing elsewhere.

The Driving Force Behind Failures, Bank Turn-Downs, and Loan Workouts

Starting in 2022, the Federal Reserve’s campaign to reduce inflation included large and rapid increases in interest rates which drove the yield on money market funds, two-year U.S. Treasuries, and CDs from near zero to over 4.00% in one year, triggering a massive shift of deposits out of low-yielding accounts at banks into money market instruments and U.S. Treasuries.

Prior to the start of the Fed’s interest rate hikes, many banks had invested a large amount of their low-cost deposits in longer-term U.S. Treasuries and mortgages. When interest rates increased, these investments lost value leaving the banks with large unrealized losses on their balance sheets.

When depositors withdrew large amounts of money to take advantage of higher yields available on short-term instruments, the banks had to sell longer-term assets and realize the losses on their balance sheets. The outflows accelerated when depositors became aware that some banks were having difficulties. Many banks will now be constrained in their ability to make new loans and have less flexibility in situations where a loan is classified as in workout. They will be forced to turn down loan applications, call loans and reclassify riskier loans as workout loans in order to meet stress test requirements and avoid sales of investments at a loss that could jeopardize their solvency.

What This Means for Your Clients

For many small and medium-sized companies, this means they will need to find alternative funding sources for working capital until banks loosen their credit requirements again. 

Finding a replacement lender may be difficult because most banks are tightening their credit criteria, and taking on a borrower in a workout at another bank will only make it more difficult to pass stress tests. Banks and other lending institutions can be unhelpful with providing guidance on other forms of financing.  It can prove to be a difficult time as it’s easy for borrowers to fall prey to predatory financing. These business owners need support and professional financial advice from someone skilled in these situations. 

In these cases, placing a borrower with an alternative funding source, such as an invoice factoring company, which is not subject to the same restrictions as banks is a more viable solution. Invoice factoring facilities are an excellent solution for transitioning clients through a period of tight credit or those in need of assistance while in workout.

Invoice Factoring with Capstone is the Solution

Invoice factoring can be a mutually beneficial solution for banks and loan-workout customers. Valuable banking relationships continue with reduced risk, while the customer benefits from the cash flow generated from factoring their accounts receivable. With a factoring facility, bank loans or lines of credit can be paid off, and the customer will have the cash flow to stabilize their business or sustain operations.  Invoice factoring also provides businesses with immediate access to the cash flow they need, without a lengthy application and approval process. 

As a financial broker or ISO, you can work with local banks in your area and provide them with a valuable service by removing troubled loans from their portfolio while at the same time keeping the client in business.

Capstone has originated many new factoring facilities to refinance loans from banks that were being classified or in workout and restated them as factoring facilities. Typically a borrower stays with Capstone for two to three years until bank credit requirements loosened up, which allowed them to go to another bank for an asset-based loan.

You can help the many small and medium-sized businesses that are being cut off from bank lending and scrambling to remain solvent until the Federal Reserve reverses course and begins to lower interest rates. If you would like to discuss invoice factoring for your client’s business, please contact us at your earliest convenience.