There is an asymmetry information problem that exists within special assets groups (SAG) across the country. SAG groups focused on small and medium-sized credits at the nation’s largest banks are at a stark disadvantage by not having a capital markets resource.  Believe it or not, most banks have no national capital markets function at the business and middle market banking level to help special assets executives exit credits. This means, each regional SAG group, even within big banks, must develop their own relationships or rely upon favors to get introductions. This means billions of dollars of criticized assets are dealt with highly inefficiently. This translates into many clients being limited in terms of their take-out options because their respective lender is limited in terms of being able to provide introductions. There is a clear information asymmetry problem when the take-out partner has a clear advantage over the incumbent bank due to limited options due to no national database.

For the most part, special assets work, even within the largest banks, is still conducted on a local and regional basis with the practitioners being limited to their respective region. The SAG executives will have some knowledge of the markets they are serving, but the flip side to that is that they are often limited to local contacts for help in those same regions. This might sound controversial, but the bigger the bank the more disadvantaged the special assets executive when dealing with smaller credits. This is true even at the nation’s largest and best capitalized banks. Why, might you ask? – too many companies to manage within mid-market and business banking groups and too few people to handle them. The large corporate credits get very focused/specialized senior attention due to the absolute dollar risk, importance and complexity of credit, but the same cannot said for the smaller credits typically defined as below $20 million or $30 million in facility size. This translates into understaffed groups managing a lot of disparate credits without having direct access to a large pool of take-out lenders.

Here is the real reason: The bigger the bank the more segregated each region is, which means there is no capital markets function or national database to help each region. There is no room in the budget for these folks to travel to conferences or even expense trade journals. That’s right, the nation’s biggest banks in their efforts to cut costs have not created a capital markets function or conference budget to build more non-bank lender relationships. It is worth noting that for bigger credits an investment bank is often hired either by a directive from the special assets group or by a proactive owner. In these situations, a full process is run, and many more options typically arise that often benefit the incumbent bank rather than the client. More options will certainly arise rather than just ABLs being sourced, as most investment banks now have many more options including distressed equity and credit funds. In these cases, the asymmetry equation gets equaled, but not always as most funds look to get their return from the bank’s side rather than the entrepreneurs.

The nation’s biggest banks, and even most regional banks, have big capital markets syndication groups for new deals in search of deploying billions of dollars of capital. However, ironically, they don’t have this same function to help the many folks tasked with salvaging par on their criticized assets. So, every region is left on its own to come up with three referrals in each instance that the majority of the time are local and not always the best fit as a take-out partner. Firstly, they are almost always ABL groups and only as good as the latest appraisal, which not surprising always come back conservative. The bank is then left with the choice of exit now at a discount or continue to have the banks’ capital tied up. This happens frequently as SAG executives typically enter each situation with primarily the same group of regional lenders who use the same set of appraisers. The term “hope note” was trademarked for a reason – the bank often must decide to deal with large reserves or take discounts to free up reserves.

This approach has been the norm for decades as the reasoning has been that special assets is a cost center, and it is not worth investing in to send these folks to tradeshows or otherwise invest in a capital markets function. The result is carrying high reserves longer or taking discounts to free up capital. This is, of course, done as a result of the local and regional executives not knowing or having access to a national database of lenders who might be applicable take-out partners. It is reasonable to conclude that the special assets executives are on the wrong end of the asymmetry information paradigm given they have appraised assets, tough credits and very limited take-out options.  

The solution seems simple, which is for banks to form or designate a few folks to develop national relationships with non-bank lenders and provide more options for the client to exit. Interestingly, most non-banks have their portfolio management and work-out teams centralized so they typically have an inherently strong capital market function to deal with their problem clients. It will be telling to watch what changes, if any, come out of this next cycle once the PPP wears out. Now is the time for bank executives to start thinking about innovative ways to provide their SAG executives with more capital market options. If they don’t, they might find themselves on the wrong side of the asymmetry equation with limited power to do anything about it.