In commercial lending, and especially in asset-based lending (ABL), where loans are backed by collateral like inventory, receivables, or equipment, managing risk is important. According to the Secured Finance Network, the total value of asset-based loans increased by 1.3% in the first quarter of 2024. However, new commitments with new clients dropped by 36.5%
While ABL remains a valuable option for businesses with significant assets, the stakes for lenders are high. If a borrower defaults, the lender must rely on the liquidation value of the collateral to recoup losses. This underscores the importance of proper loan portfolio management to minimize loan losses. A proactive approach is needed to identify and address potential risks early. This is where external consultants come into play.
In this article, we’ll explore how external consultants contribute to managing portfolio risks in a commercial loan portfolio, including ABL.
Identifying Signs of Distress in Loan Portfolios
Effective loan portfolio management begins with spotting early signs of distress, which signal that a borrower may be facing financial challenges. Addressing these red flags can significantly mitigate losses and protect assets.
Recognizing Early Warning Signs
Several key indicators can reveal potential distress in a borrower’s financial profile:
- Cash Flow Issues: A decline in cash flow may signal difficulties in paying bills or repaying debt. Close monitoring of cash flow enables lenders to detect these issues early.
- Declining EBITDA: A consistent drop in earnings before interest, taxes, depreciation, and amortization (EBITDA) often indicates operational challenges. Lenders should track EBITDA to assess a borrower’s financial health.
- Covenant Breaches: Loan covenants impose financial conditions on borrowers. When these are breached, it can be a sign of broader financial problems. Covenant breaches require swift action to address the underlying issues.
Identifying these signs early allows lenders to take preemptive action through regular financial reviews and Key Performance Indicators (KPIs) that track borrower health.
The Need for Specialized Intervention
In more complex cases, internal teams may lack the resources or expertise to fully manage distressed borrowers. This is where external consulting firms become invaluable.
Consultants bring specialized knowledge in financial restructuring, operational improvements, and strategic turnaround planning. They often leverage advanced analytical tools and sector-specific expertise, providing lenders with the insights they need to make informed decisions.
How External Consultants Help Lenders Manage Loan Risks
External consulting firms, such as NYC Advisors, LLC, provide services that significantly enhance the effectiveness of loan portfolio management strategies in asset-based lending.
Risk Assessment and Management
When a lender identifies potential issues with a loan, they may introduce an external consultant to assess the borrower’s financial situation. Consultants evaluate cash flow, KPIs, process efficiency, and operational performance. Their insights allow lenders to address issues before they escalate.
By preparing detailed plans to restore borrower profitability and ensure compliance with loan covenants, consultants help improve the debtor’s financial health—thereby reducing the lender’s risk. You could check out our Due Diligence Checklist—it’s a valuable resource that can help lenders make sure that they’re well-prepared when assessing borrower situations.
Performance Improvement
Consultants work with borrowers to enhance their financial performance through detailed analysis and strategic planning. This involves optimizing operations across the board—from marketing and sales to product/service delivery—improving cash flow and achieving operational efficiency.
While consultants focus on stabilizing the borrower’s business, their efforts also protect the lender’s interests, leading to better loan portfolio outcomes and reduced default rates.
Unbiased Reviews and Recommendations
An external consultant’s impartial perspective is invaluable when assessing a borrower’s financial and operational health. This fresh viewpoint can lead to:
- Improved Communication: Consultants facilitate better communication between lenders and borrowers, helping both parties align on recovery strategies and collaborate effectively.
- Creative Solutions: Consultants often introduce refined strategies that a borrower’s management may have overlooked or been hesitant to try.
This objective perspective allows consultants to address operational inefficiencies and financial challenges more effectively, benefiting both lenders and borrowers.
Mutual Benefits for Lenders and Clients
Hiring an external consulting firm to support loan portfolio management benefits both lenders and their distressed clients.
Stabilizing Client Businesses
Consultants help clients stabilize their operations by addressing the root causes of distress. They implement strategies such as:
- Operational Enhancements: Streamlining processes to eliminate inefficiencies and improve profitability.
- Cash Flow Management: Establishing a 13-week cash flow forecasting model and new KPIs to allow both borrower and lender to closely monitor recovery progress.
For example, NYC Advisors, LLC helped a 75-year-old family-owned toy distributor, facing serious financial challenges and they were asked by their lender to find another lender.
Our intervention led to:
- Assisting the third generation in buying out the company from their parents.
- Creating a three-year business plan that restored profitability within 12 months.
- Implementing a 3PL warehouse, improving inventory management, installing a new ERP system, and relocating the business.
- Securing a new credit line from the same lender.
Within a year, the company achieved a 1.2% profit margin, saw a 50% sales increase in the second year, and reached an 8.2% profit margin by the third year. The business later moved to a new bank with a larger credit facility at a lower cost.
This case study demonstrates how consulting firms like ours can help struggling businesses recover while benefiting lenders by improving loan portfolio performance.
Risk Mitigation for Lenders
By hiring external consulting firms, lenders can mitigate risks within their loan portfolios, reducing defaults and safeguarding their financial interests. This leads to:
- Lower Default Rates: Early intervention and tailored solutions help prevent defaults, protecting the lender’s loan portfolio.
- Long-Term Client Relationships: Once a borrower’s business stabilizes, lenders can maintain strong relationships and offer further financial support as the business grows, creating long-term value.
External consultants provide essential support in managing the risks associated with asset-based lending. By focusing on improving borrower performance and offering unbiased assessments, we address issues that might otherwise lead to defaults. This collaboration not only strengthens client businesses but also leads to better outcomes for lenders.
If you need help managing your loan portfolio risks, NYC Advisors, LLC is here to assist. Contact us today to learn more about how we can support your lending operations.
