At the recent Insolvency Insider's Toronto Lender Conference, an out-of-the-box analogy was
presented during a session on lender perspectives of market trends and challenges. Arif
Bhalwani, Managing Director of Third Eye Capital Management, reframed the role of a
restructuring advisor—not just as an expert in distressed situations, but as a critical tool for
preserving a lender's capital.
He compared the lending business to being the counterparty of a put option. The analogy
emphasizes the contingent risk lenders assume when borrowers encounter distress and the
fundamental reliance on the value of the underlying collateral as the ultimate protection of the
lender's position.
In this analogy, the loan-to-value (LTV) ratio functions like a strike price in a put option contract,
with the underlying asset's value serving as the effective strike price. As long as the asset’s
value remains above the loan balance, the put option is out-of-the-money, and the lender's
exposure remains unchanged. Conversely, as the underlying asset value declines and
approaches the effective strike price, the lender's exposure increases sharply. Once the loan is
no longer fully covered by the asset, the borrower’s position becomes in-the-money, and the
lender is left holding the downside.
This prompts an important question for lenders: How long should they absorb increasing levels
of risk before engaging a restructuring advisor to help preserve value?
The answer is twofold: First, knowing which early warning signs matter and how they are being
managed. Second, understanding how a restructuring expert can help preserve collateral value
before it declines to the point of serious risk to the lender. In other words, before it hits the strike
price.
The lending business is more than extending credit—it is about actively monitoring and
preserving collateral value. Just as pricing a put option involves balancing a complex set of
variables, determining the value of collateral is more art than science. Deterioration is rarely
sudden; it begins subtly, showing up as liquidity pressures, missed filings, or erratic
management behaviour, often well before any decline is reflected in formal financial reporting.
One of the easiest signals to miss is when a borrower regularly hovers under covenant
thresholds. If results always land just one decimal point away from a breach, beware. It may
indicate financial storytelling rather than sound management. The chart below offers lenders a
starter's guide on where to look for early warning signs of asset deterioration and what actions
management may take to preserve or mask value.
| Category | Document to Review | Early Warning Signs to Watch For |
|---|---|---|
| Financial Health | • Monthly financial statements • 13-week cash flow • Forecasts | Covenant breaches, liquidity stress, declining margins, cash shortfalls |
| Collateral Valuation | • Real estate appraisals • Borrowing base certificates • Inventory aging reports | Collateral value decline, surplus/obsolete inventory risks, shrinking borrowing capacity |
| Tax & Compliance Health | • HST/GST remittance confirmations • Payroll source deductions status • Corporate tax filings and arrears notices | Unremitted source deductions or HST (CRA super priority claims), risks of non-compliance penalties or enforcement action |
| Operational Indicators | • Aging reports for payables and receivables • Changes in supplier terms (e.g., moved to COD) •Outstanding vacation • Pay/severance liabilities • Insurance certificates | Slowing collections, supplier stress, strained liquidity, risk of uninsured losses, growing employee liabilities |
| Municipal & Environmental Compliance | • Property tax statements • Environmental reports/Phase I audits | Municipal arrears, risk of municipal enforcement, environmental contamination risk lowering collateral value |
Beyond this list, what may need further investigation are any undisclosed related-party
transactions, new financing arrangements, unrecorded liabilities, management bonuses, and
inflated or fraudulent accounts receivable.
Delaying action until the collateral value has eroded to or below a lender’s loan balance is akin
to waiting until an option is in-the-money and alternatives become limited, painful, and costly.
Preserving value—avoiding the strike price—is an active process. It is also where restructuring
professionals provide critical support before formal proceedings become necessary.
Licensed Insolvency Trustees can help lenders find undisclosed super-priority exposures to
value erosion, such as unremitted payroll and HST, supplier claims under the 30-day goods
provision and pension contribution shortfalls. Restructuring advisors offer a clear-eyed view of
hidden liabilities in addition to assessing liquidity, cash flow stability, and regulatory compliance.
Most importantly, restructuring professionals help chart a path forward: clarifying lender options,
evaluating formal and informal restructuring options and finding practical strategies to preserve
collateral value.
For lenders, recognizing these early signals and engaging the right professionals can mean the
difference between value preserved and value lost. While not a perfect correlation, thinking of lending like a put option reframes the borrower-lender relationship at the moment when their interests start to diverge, with the borrower walking away from the asset and the lender walking towards an asset that may now be worth less than the original loan.
Margarita Cargher is a manager at TDB Restructuring Limited. She can be reached at
mcargher@tdbadvisory.ca
