When things go wrong
Executing a workout
status: draft
Executing a workout
A workout has three phases: assessment, negotiation, and execution. Moving too fast in any phase creates problems. Assessment without enough data leads to bad decisions. Negotiation without clear alternatives wastes time. Execution without preparation leads to value destruction.
This guide provides the playbook for each phase from the capital provider’s perspective.
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Phase 1: assessment (days 1-14)
The goal of assessment is to understand your position, value the collateral, and identify your options before negotiating.
Legal position review
Have counsel review all credit documents before any substantive negotiation.
| Document | Key Questions |
|---|---|
| Credit agreement | What Events of Default exist? What are cure periods? What consents are needed? |
| Security agreement | What is the collateral? Is perfection complete? |
| Intercreditor agreement | What are your rights relative to other creditors? |
| Guarantees | What credit support exists? Is it still valid? |
| Amendments and waivers | What has been modified? What precedents exist? |
Document review checklist:
- All defaults identified and categorized
- Cure periods calculated
- Required consents identified (majority lender, etc.)
- Enforcement procedures mapped
- Notice requirements understood
- Timeline from default to remedies estimated
Collateral valuation
Value the collateral under multiple scenarios. This is your negotiating framework.
| Scenario | Assumption | Recovery Range | Timeline |
|---|---|---|---|
| Orderly run-off | Originator services to maturity | 90-100% | 2-5 years |
| Accelerated run-off | Backup servicer takes over | 80-95% | 1-3 years |
| Bulk portfolio sale | 30-60 day marketing process | 75-90% | 2-4 months |
| Forced liquidation | Immediate sale to highest bidder | 60-80% | 1-2 months |
The gap between orderly run-off and forced liquidation is your negotiating room.
Valuation methodology
| Method | When to Use | Key Inputs |
|---|---|---|
| Discounted cash flow | Performing portfolio with predictable cash flows | Default rate, prepay speed, loss severity, discount rate |
| Comparable transactions | Portfolio sale likely | Recent trades, broker quotes |
| Liquidation analysis | Hard asset collateral | Auction values, recovery rates |
| Going concern | Originator may survive | Enterprise value, coverage ratio |
Servicer capability assessment
Can the current servicer manage a wind-down? Do they have the infrastructure, licensing, and incentive to perform?
| Factor | Assessment Questions |
|---|---|
| Operational capacity | Do they have staff to manage collections? |
| Licensing | Are they licensed in all required states? |
| Technology | Can systems handle modified servicing requirements? |
| Motivation | Do they have incentive to perform well? |
| Experience | Have they serviced through distress before? |
Backup servicer readiness:
| Readiness Level | Transition Time | Risk Level |
|---|---|---|
| Hot standby | 30-45 days | Low |
| Warm standby | 45-90 days | Medium |
| Cold standby | 90-120+ days | High |
Creditor landscape analysis
Who else has claims on the originator or the collateral?
| Creditor Type | Typical Position | Likely Behavior in Distress |
|---|---|---|
| Senior secured lender | First on collateral | May push for quick resolution |
| Junior secured lender | Below you on collateral | May delay to preserve optionality |
| Unsecured creditors | No collateral | May push for bankruptcy |
| Trade creditors | Operational | May file involuntary bankruptcy |
| Equity holders | Last | May obstruct if out of the money |
Bankruptcy risk assessment
If the originator files bankruptcy, your workout becomes a Chapter 11 case.
| Factor | Low Bankruptcy Risk | High Bankruptcy Risk |
|---|---|---|
| Liquidity runway | 6+ months | Less than 30 days |
| Other creditor pressure | Manageable | Aggressive collection activity |
| Management attitude | Cooperative | Adversarial |
| Equity value | Material value remains | Equity is underwater |
| Business viability | Restructurable | No path forward |
Exposure quantification
Know exactly what you’re owed before negotiating.
| Component | Amount | Status |
|---|---|---|
| Outstanding principal | $ | Current |
| Accrued interest | $ | Through date |
| Accrued fees | $ | Through date |
| Unfunded commitment | $ | At risk if funded |
| Indemnification exposure | $ | Potential |
| Cost of enforcement | $ | Estimated |
| Total exposure | $ | Maximum |
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Phase 2: negotiation (days 15-45)
The goal of negotiation is to reach agreement on the path forward and document the terms.
If continuing: amendment path
You’ve decided the relationship is worth preserving with enhanced protections.
Amendment negotiation framework:
| Category | Your Demands | Their Pushback | Typical Landing |
|---|---|---|---|
| Spread | +100-150 bps | Too expensive | +50-100 bps |
| Fees | 50 bps amendment fee | Reduces liquidity | 25-50 bps |
| Triggers | Tighten by 100 bps | Too restrictive | Tighten by 50 bps |
| Reserves | +3 months interest | Cash constrained | +1-2 months |
| Reporting | Weekly | Administrative burden | Weekly with threshold |
| Commitment | Reduce 25% | Need capacity | Reduce 10-15% |
Negotiation principles:
| Principle | Application |
|---|---|
| Nothing agreed until everything agreed | Don’t give concessions piecemeal |
| Get it in writing | Every agreement confirmed in email or term sheet |
| Build in milestones | Amendment includes performance tests |
| Create off-ramps | If turnaround fails, you have exit rights |
| Require representation refresh | Reps and warranties reaffirmed |
| Waiver of claims | They release any claims against you |
If exiting: wind-down path
You’ve decided to exit the position.
Wind-down negotiation framework:
| Issue | Your Position | Their Position | Resolution Approach |
|---|---|---|---|
| Wind-down period | Shortest possible | Need time to transition | Milestone-based |
| Servicing during wind-down | Maintain standards | Want to reduce costs | Performance standards in agreement |
| Advance obligations | Terminate immediately | Need continued funding | Limited advances for collections |
| Paydown schedule | Aggressive | Match collections | Collections-based with minimums |
| Discounted payoff | Full recovery | Discount for early exit | NPV of expected recovery |
Alternative exit structures
| Structure | How It Works | When to Use |
|---|---|---|
| Whole facility sale | Another capital provider buys your position | You want immediate exit; buyer sees value |
| Collateral auction | Market and sell the loan pool | Collateral is saleable; you have time |
| Originator buyout | Originator or sponsor takes out facility at discount | They have capital; want to continue business |
| Partial sale | Sell performing; retain distressed | Maximize performing recovery; work out distressed |
Discounted payoff analysis
If originator or sponsor offers to buy you out at discount:
| Factor | Analysis |
|---|---|
| Offered price | What percentage of par? |
| Alternative recovery | What would you recover through enforcement? |
| Timeline | When would you receive alternative recovery? |
| Certainty | How certain is alternative recovery? |
| Costs | What are enforcement costs? |
| NPV comparison | Which is worth more today? |
Example:
- Outstanding: $10,000,000
- Offered payoff: $9,000,000 (90%)
- Alternative: Portfolio sale at 85% in 6 months
- Enforcement costs: $200,000
- Discount rate: 10%
NPV of alternative: ($8,500,000 - $200,000) / (1.10)^0.5 = $7,911,000
In this case, the 90% payoff is better than the alternative.
Equity or warrant consideration
In severe distress, the originator may offer equity or warrants as partial compensation.
| Consideration | Pros | Cons |
|---|---|---|
| Upside participation | If turnaround works, significant gain | Subordinated to all debt |
| Alignment | Your interests align with their success | May become insider with fiduciary duties |
| Recovery enhancement | Something rather than nothing | Illiquid; hard to value |
Proceed cautiously. Equity positions can complicate future negotiations and may create regulatory issues for some lenders.
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Phase 3: execution (days 30-90+)
The goal of execution is to implement the agreed path and monitor progress.
Documentation requirements
| Document | Purpose | Timeline |
|---|---|---|
| Term sheet | Memorializes key terms | Before detailed drafting |
| Amendment/workout agreement | Comprehensive legal documentation | 2-4 weeks after term sheet |
| Compliance certificate | Confirms current status | At signing |
| Officer’s certificate | Corporate authority and reps | At signing |
| Intercreditor consent | If required | Parallel to drafting |
| Rating agency notification | If rated deal | Within required notice period |
Implementation checklist
- Amendment fully executed
- Enhanced monitoring implemented
- Reporting schedules updated
- Covenant calculations updated in tracking system
- Internal credit rating updated
- Investment committee briefed
- Rating agencies notified
- Regulatory reporting updated
Enhanced monitoring implementation
| Monitoring Item | Frequency | Responsible Party |
|---|---|---|
| Financial reporting | Weekly | Originator |
| Portfolio performance | Weekly | Servicer |
| Covenant compliance | Weekly | Originator |
| Management calls | Bi-weekly | Both |
| Site visits | Monthly | Capital provider |
| Third-party review | Quarterly | Accountant/consultant |
Servicing transfer execution
If servicing transfer is part of the workout:
| Phase | Activities | Timeline |
|---|---|---|
| Preparation | Data mapping, system setup, licensing verification | Days 1-14 |
| Parallel run | Both servicers operating, reconciliation | Days 15-44 |
| Cutover | Transfer of record, borrower notification | Day 45 |
| Validation | Post-transfer reconciliation, issue resolution | Days 46-60 |
Transfer cost budget:
| Item | Cost Range |
|---|---|
| Per-loan boarding fee | $50-$150 |
| Data migration and QC | $10-$30 per loan |
| Regulatory notifications | $5-$15 per loan |
| Parallel servicing period | 30-60 days of duplicate cost |
Collateral disposition execution
If liquidating collateral:
| Phase | Activities | Timeline |
|---|---|---|
| Advisor engagement | Select broker/advisor, negotiate terms | Days 1-14 |
| Marketing | Prepare materials, contact buyers | Days 15-44 |
| Bidding | Receive and evaluate bids | Days 45-60 |
| Closing | Negotiate final terms, execute sale | Days 60-90 |
Disposition approaches:
| Approach | Typical Recovery | Timeline | When to Use |
|---|---|---|---|
| Negotiated sale | 85-95% | 60-90 days | Performing portfolio, known buyers |
| Competitive auction | 75-90% | 30-60 days | Market pricing needed |
| BWIC | 70-85% | 15-30 days | Quick exit needed |
| Retail loan sales | 80-95% | 90-180 days | Consumer loans, maximize recovery |
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Workout structures that work
Amend and extend
How it works: Reduce facility size to match actual collateral, extend maturity to allow orderly run-off, increase spread to compensate for risk, tighten covenants to limit deterioration.
When it works: Collateral is performing, originator has a viable path forward, the relationship is salvageable.
Key terms:
| Element | Typical Terms |
|---|---|
| Commitment reduction | 10-25% |
| Extension period | 1-2 years |
| Spread increase | 50-150 bps |
| Trigger tightening | 50-100 bps |
Pay-down and release
How it works: Originator or third party injects cash to partially pay down facility, you release collateral proportionally.
When it works: There’s a willing cash source (sponsor, new investor), and partial exit makes sense for both parties.
Key terms:
| Element | Typical Terms |
|---|---|
| Paydown amount | 25-50% of outstanding |
| Release ratio | 1:1 or collateral-based |
| Remaining terms | Improved economics |
Facility sale
How it works: Sell your position to another capital provider at a discount.
When it works: The buyer sees value you don’t, you need to exit for portfolio reasons, or workout costs exceed sale discount.
Key terms:
| Element | Typical Terms |
|---|---|
| Purchase price | 80-95% of par |
| Representations | Limited or none |
| Assignment | Subject to credit agreement |
Management change
How it works: Require new management as a condition of continued support.
When it works: The problem is execution, not fundamentals. The current team got you here; a new team can get you out.
Key terms:
| Element | Typical Terms |
|---|---|
| Personnel changes | CEO, CFO, or Head of Credit |
| Timeline | 30-90 days |
| Consultation rights | Approval of replacements |
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Cross-references
- Waiver, amendment, or acceleration - Choosing the workout path
- Enforcement and liquidation - If workout fails
- Intercreditor dynamics - When other creditors are involved
- Servicers and backup servicers - Servicing transition details