Home News & Insights Is Refinancing Really the Answer?
November 6, 2023
Is Refinancing Really the Answer?
By James E. Harney, CTP

During the last forty years, first as an asset-based lender and later as a restructuring professional, I have observed many economic cycles and seen the impact those cycles have on the lending and restructuring environments.  While each cycle exhibited its own peculiarities, bank liquidity was the common denominator in every cycle I have witnessed.  I have always felt that what happens in the banking community is the canary in the coal mine when it comes to predicting a recession, and bank liquidity is the barometer of all other factors impacting the economy. Currently, the canary is on life support and the barometric readings indicate storms on the horizon.

Factors affecting the current economic landscape

The multifaceted impact of the global shut down in the face of the COVID-19 pandemic, including the significant infusion of government monies into the US economy from mid-2020 through the end of 2022, has yet to be quantified.  These monies masked underlying distress and precipitated a false sense of economic security.  Similar to the impact of the infusion of cash, the likely permanent change in work habits is causing a decline in the need for commercial real estate—the repercussions of which have yet to be fully realized.  Although not yet fully realized, the commercial real estate crisis is causing serious disruption in many regional banks as well as some multinational institutions.  There may be a mark to market mandate coming from the Federal Reserve and some major commercial properties may need to be repurposed precipitating a decline in operating profit and consequently, value.  The question is, “How many office buildings can you profitably repurpose?” Consumers are feeling the pinch as demonstrated by increasing credit card delinquencies and rising default rates on car loans.  Middle market companies are struggling under the combined weight of higher debt service brought on by increased interest rates and substantial increases in the cost of raw material prices.  Armed conflicts in Eastern Europe and the Middle East, as well as political unrest at home and abroad, only serve to exacerbate the economic instability.

In my experience, over the past decade, the lender waited until the event of default before making the hiring of a turnaround consultant a requirement. The addition of this expertise provided for a thorough review and often, a complete restructuring of the business. The restructured business was then able to cure the default and remain with the incumbent lender—or find new financing providing a satisfactory resolution for the bank.

More recently and partially because of the factors identified above, I have noticed a new trend in middle-market banking. Lenders are proactively purging loans from their portfolios in advance of an actual default. Banks are advising borrowers credit lines will not be renewed and indicating the borrower should seek replacement financing elsewhere. I am now receiving calls from lenders requesting I assist in refinancing the credit out of the portfolio rather than providing a financial review and potential restructuring.

So, what is the takeaway here?

The increased interest rates, coupled with the decreased asset values, particularly if the Federal Reserve mandates further mark to market adjustments, will make it difficult for the bank to achieve the satisfactory resolution of the past decade. With increasing frequency, banks seeking to dispose of troubled loans will be faced with at minimum a restructuring of the borrower. As the economic situation declines, resolving the credit may require the forced sale of the asset or an insolvency proceeding.

To sum up, a confluence of economic and political factors has given rise to an environment of business stress the likes of which we have not experienced in a very long time. Although banks are moving to dispose of difficult credits earlier than in the past, their efforts may not be as successful as previous endeavors. As middle market companies are feeling compression from higher interest rates and the higher cost of raw materials, so too are lenders feeling the squeeze between developing issues in the portfolio and tighter liquidity in the marketplace. As a result, the go-to strategy for exiting a difficult credit – refinancing it out of the portfolio – may be a thing of the past. As the barometer continues to fall, banks will need to address portfolio issues with creative credit structures or be willing to face the storms on the horizon for insolvent borrowers.

If you would like to further discuss how Harney Partners can assist with a distressed business situation, please contact us today.

jim harney
James E. Harney, CTP

Jim has a 20-year career as a commercial lender in Chicago and New York, followed by another 20+ years of consulting after founding Harney Partners in 1991. He is a recognized industry leader in the turnaround and crisis management field providing management and advisory services to companies facing complex situations. His successes have been recognized by his industry peers through numerous regional and national awards from the Turnaround Management Association and the M&A Advisor.