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We can work it out … maybe


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Steve Jacobs is conducting a lot of triage these days on patients whose ailments are largely defined by an ailing economy.

He is not alone. The floundering economy and the reluctance of once-eager lenders to bankroll risky ventures is creating a rush to what amount to financial emergency rooms where lawyers and lenders and workout specialists such as Jacobs struggle to preserve businesses and please their bankers.

“I liken it to a corporate illness,” said Jacobs, who entered the financial world during the financial crisis of the 1970s at Bankers Trust Co.

Since 1990 he has been a principal at BCC Advisers, a Des Moines company that specializes in mergers and acquisitions, business valuations and corporate finance.

These days, he tries to cool hot nerves that flare when businesses begin to fail.

“In this kind of environment, it occupies well more than 50 percent of my time,” Jacobs said. “It takes a lot of time; it’s always an emotional process because you’re typically helping family-owned businesses.”

Jacobs is referred to as a workout specialist. He is the contact made before businesses and their lenders let their differences lead them to court.

The fact that his company’s services are in high demand these days is an indication that the recession is causing lenders to take a second look at the businesses they help finance.

Lawyers representing prospective borrowers say that otherwise creditworthy clients are encountering stubborn negotiators when they attempt to renew operating lines of credit.

A banner year, of sorts

This year, they say, their practices have been consumed with representing “mom-and-pop” operations that are suffering because of low sales, a decline in asset value and, consequently, a potential loss of credit.

“They are seeing a drop in income, a loss of asset base, so their loans are not getting renewed,” said Jerrold Wanek, a Des Moines attorney who sees clients after workouts have failed.

Wanek said the current situation is unlike previous downturns because the economic pain is widespread.

“The difference in this one is that virtually every industry is getting hit,” he said.

If Wanek’s caseload is any indication, there is a lot of acrimony in the Greater Des Moines economy.

Wanek estimated that he has between 650 and 700 cases pending in state court, with the majority of those being foreclosures and debt collections involving businesses and commercial real estate.

And for his 26-year career, he is headed for a personal record this year for filings in the U.S. Bankruptcy Court for the Southern District of Iowa, where business bankruptcies overall also are on a record pace.

Wanek has filed 27 bankruptcy cases so far this year, with the trend being toward reorganizations in which large companies try to satisfy creditors while staying in business, rather than liquidations in which they close shop and sell all of their assets.

“It’s not just the number of cases this year, but the size of cases,” Wanek said. “Bigger things are falling.”

Still, he would rather avoid court.

Wanek said he attempts to determine whether a bank is willing to trim value from a defaulted loan in order to avoid going to court, where the value is likely to drop much further, especially in a foreclosure action.

Once a case goes to court, he examines loan documents for omissions that might make the loan unenforceable.

That maneuver has worked, so far, on a lawsuit that resulted from the far-flung business dealings of the late Ed Boesen, who committed suicide July 15, 2008, as his business dealings were unraveling.

Wanek argued successfully that Omaha-based Great Western Bank violated federal lending laws when it required Boesen’s wife, Maureen, to sign a loan document after it had accepted a stockbrokerage account – later proved to be bogus – that he offered as security on a $3.5 million loan. The Iowa Supreme Court has refused to hear Great Western’s appeal of the ruling. The bank is attempting to claim proceeds from a $2.5 million life insurance policy. That issue is scheduled for trial Aug. 10.

That is an extreme case that possibly arose due more to Boesen’s overly ambitious business schemes than a tough economy. But it does illustrate Wanek’s efforts to protect clients, good economic times or bad.

Wanek said that he rarely refers clients to a workout specialist, such as Jacobs, if his own efforts or those of others are unsuccessful.

“If the workouts were successful, I wouldn’t see them,” he said.

Honest people, honest differences

Des Moines lawyer Steve Zumbach said workout specialists such as Jacobs play a crucial role in preserving the value of a business and taking the emotion out of a tense atmosphere that can tend to cloud thinking.

“It’s a stressful period for the borrower and the lender,” he said.

The outcome of workouts are “across the board and unpredictable,” with the one constant being that both sides will lose some money.

Zumbach, who also holds a Ph.D. in economics, said he entered the legal profession hoping to work on elaborate corporate deals, but virtually right of the box began “dismantling things” during the farm crisis of the early 1980s.

It was a time that left an impression of damaged lives and a dramatic loss of value in the state economy.

Without the help of workout specialists, Zumbach sees lenders and business owners stepping into the same downward spiral.

For the most part, many of the business owners who come to Zumbach for help represent family-owned enterprises that may have survived multiple generations.

“The added dimension is that the entire net worth is tied up in the business; other family members are involved, other generations,” he said. “Getting a passive manager or investor involved is a problem; you have mushrooming personal complications.

“The best outcomes are when emotion and passion are left at the negotiating room door.”

By the time those owners arrive at Belin Lamson McCormick Zumbach Flynn, where Zumbach is a partner, “it is clear that the loan can’t be worked out. The question is, how do you get to a positive outcome?”

Zumbach said there are two paths in such situations. One is to “take the keys and liquidate.”

“The fire sale is the least desirable,” he said. “Even an orderly liquidation leaves little for the borrower.”

The other option is to restructure the business, possibly by getting a group of lenders together and determining how each can get the maximum value from their loans.

“Few deals get to that point,” Zumbach said. “But, they can maximize more of the loan if they work together and try to capture the going-concern value, maybe find new equity partners. Still, it’s difficult because of the emotion and passion by both parties.”

Zumbach said lenders tend to look at the “sanctity of the note.” If they abandon it, they diminish the value of the loan and the assets securing it, and then “the lending culture is being ruined.”

Nonetheless, it is possible to keep a business in operation, providing it is viable to begin with.

Zumbach recounted an experience in which a third-generation farm was being sought by lenders. The farm was lost to lenders, but the farmer managed to keep enough implements to continue the operation by leasing back some of his land.

By simply rushing to court or foreclosure, the current generation of lenders and business operators “don’t understand the depth of the seriousness they’re going to get into,” Zumbach said.

Though passion and personalities play a large role in the workouts, Zumbach also believes the current stress in the lending dynamic has been created by lenders and entrepreneurs who became overly dependent on computer models that were used to determine the viability of loans.

“I think boards and management were seduced by the math,” he said. “Instead, at that point we have dumbed down the process. It’s connecting two dots that no one has seen before.”

The computer models – such as the sophisticated programs that guaranteed the viability of complicated packages of securities based on certain market assumptions – have proved shaky, at best, during the recession.

“Some assumptions would have us blow up the models,” he said. “My advice is not to fall in love with the eloquence of your financial model. Humans can see the connections that computers can’t see.

“In terms of financial analysis capability and sophistication, more ended up being less.”

The human touch

Jacobs, the president of BCC Advisers, knows he is walking into a volatile situation when he gets a call from a lawyer, banker or business owner trying to resolve a lending crisis.

His first task is to assess a company’s financial position and let those cold facts take emotion out of the equation.

That isn’t an easy thing to do, because he often is working with a family-owned operation, where as Zumbach noted, emotions are heightened.

BCC Advisers also makes it clear that it does not want to run a financially troubled company, although some workout specialists will play that role.

“At the point we get involved, there are a variety of creditors, from unsecured at the low end to secured at the high end, that we have to work with,” Jacobs said. “Lenders sometimes are ready to call in a loan or they are getting to that point. They want to know whether there is a possibility the company can turn around. They want to know whether there is a light at the end of the tunnel.”

Owners also must be willing to change management practices or allow a third party to operate the company. In that case, BCC Advisers will supply legal and technical support to management.

It also will provide legal support if the lending crisis leads to a court case.

It is important that business owners understand that lenders are not in the business of taking excessive risks, even though the lending practices leading into the current economic crisis seemed to indicate otherwise.

“They’ve gone from being risk-averse to risky and back to risk-averse,” Jacobs said.

Adventuresome lending practices have led regulators to place increased requirements on banks. It is an oversimplification to blame lenders for suddenly pulling in credit lines that have kept businesses afloat, he said.

When loans are unavailable, Jacobs will search for other forms of credit, including asset-backed lenders and factors, to help a business pay its bills.

“Our job is to help the business owner execute a variety of strategies at the same time. They’re not all going to work,” he said.

Private equity can play a role in some cases, but it is not common to find an angel investor when a company is struggling.

For the most part, a workout can succeed, Jacobs said. Few creditors want to push a borrower into bankruptcy, where both creditors and debtors typically suffer losses.

Jacobs said he is not certain that the workout side of his business has reached its peak.

“I hope the economy has hit bottom, but nobody knows for sure,” he said.

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