By Kathy Lonowski, Senior Advisor at Pivot >
As economic uncertainty, elevated interest rates, and pressure in sectors like commercial real estate continue to challenge financial institutions, banks are placing greater focus on how they identify and manage credit risk before problems escalate.
Kathy Lonowski, Senior Advisor at Pivot >, and former FDIC Regional Director, has spent decades overseeing institutions through periods of economic stress. Here, she shares why strong special assets and workout teams are more essential than ever — and what separates banks that weather a downturn from those that don’t.
Q: From your perspective, why is a bank’s special assets or workout group so critical — especially in today’s environment?
KL: Banks are operating in a complex, volatile environment right now. Borrowers are dealing with pressure from higher interest rates and refinance risk. Initially, tariffs drove elevated operating costs, and now geopolitical tensions are creating supply chain bottlenecks. Consumers are feeling pressure at the grocery store and the gas pump, and those rising costs affect consumer demand across industries.
Another unique factor today is the rise of AI. While AI is creating efficiencies, it’s also introducing new cybersecurity risks that financial institutions need to understand and manage. We’ve also seen several prominent companies announce large layoffs. If that trend continues, banks need to consider the impact unemployment could have on borrower cash flow and repayment ability, especially in industries dependent on certain types of jobs that may no longer exist.
All of that can lead to credit stress. And when borrowers start having liquidity problems, that’s where a sophisticated workout team becomes critical. The goal is early identification of credit weakness. It’s much easier to: refinance, restructure, or work through a problem in the early stages before a relationship deteriorates to nonperforming.
Specialization matters too. Relationship lenders are trained to originate and grow loans — that’s their job, and they’re good at it. But those same bankers aren’t always the right people to manage a distressed credit. They may be too close to the relationship to make the tough call, or they simply don’t have experience with legal remedies, bankruptcy, or liquidation analysis. That’s what workout groups are built for.
Q: What are the earliest warning signs that a loan portfolio may be heading toward trouble, and how should institutions respond before issues escalate?
KL: Banks need to monitor for patterns in the markets where they operate, not just individual loans. Rising unemployment, a softening housing market, and property values disconnected from rental income are broader trends that usually show up before the problems land in your portfolio.
At the institution level, watch for rising delinquencies in the 30-to-89-day range, increased overdraft activity from borrowers who’ve never done that before, more loans migrating to watch status, and an uptick in covenant waivers or exceptions. Loan modification patterns can also be telling. Repeatedly extending maturities, granting interest-only periods without solid support, or rewriting loans based on optimistic future assumptions are potential signals that something is brewing under the surface.
Commercial real estate deserves its own attention. Rising vacancy rates, declining collateral values, falling absorption rates, aging inventory, and weakening guarantor support are all signs banks should take seriously. Concentration monitoring is equally important. If a bank has significant exposure to a particular loan type or industry, leadership may need to reduce concentration limits to get ahead of the downside risk.
Sometimes the earliest warning sign is behavioral. When borrowers stop communicating, delay providing financial statements, or avoid conversations with the bank, that’s often an indication something may be wrong — or at least a signal that the institution needs to engage more proactively. The key is identifying problems early and acting before issues escalate.
Q: In your experience, what separates banks that successfully manage problem loans from those that struggle during periods of economic stress?
KL: Most loan portfolios show signs of deterioration months before serious losses occur. Those warning signs usually appear in financial trends, policy exceptions, covenant issues, or market conditions. Strong institutions react early while problems are still manageable. They promptly downgrade risk ratings, get updated appraisals, require additional collateral or equity, and increase reserves. Critically, they’re transparent with their board and regulators, and they’re willing to take real steps to de-risk even when it’s uncomfortable.
The banks that struggle tend to wait and hope conditions improve. I saw this play out firsthand during the Great Financial Crisis when part of my FDIC territory covered Las Vegas. At the time, many bankers insisted the market was unique and that the downturn wouldn’t affect them the way it affected other areas. But the bottom eventually fell out, and many Nevada banks failed. The institutions that acted quickly — downgrading credits, working with borrowers early, and aggressively managing risk — were the ones that minimized losses and ultimately survived.
Sometimes institutions hesitate because they don’t fully understand the severity of the risk within the portfolio. Other times, they’re simply too close to borrower relationships and overly confident in their underwriting history. But when external forces shift fast enough, good underwriting history isn’t enough if you’re not paying attention to what’s happening around you.
Q: Many institutions may not have deep in-house workout expertise. Where can outside advisors add the most value in helping banks manage distressed assets or special situations?
KL: Outside advisors don’t replace management — they supplement it. They become especially valuable when problems multiply quickly. A performing loan that pays on time every month doesn’t require much attention. A problem credit is an entirely different story. When several of them surface at once, most banks simply don’t have the bandwidth or specialized expertise to manage them well.
Outside firms can step in for loan file reviews, borrower financial analysis, covenant tracking, workout strategy development, and specialized legal guidance — bankruptcy, foreclosure, lien preservation, creditor disputes. The other big advantage is objectivity. Independent advisors don’t have longstanding borrower relationships influencing their judgment, which makes it much easier to be proactive and avoid hesitation.
For smaller community banks especially, it’s unrealistic to have deep restructuring and legal expertise in-house. Having a firm like Pivot >, with experience across industries, restructuring backgrounds, and familiarity with court processes, can save significant time and headache, and get to a resolution faster.
Q: Looking ahead, what should financial institutions be doing now to prepare for potential stress in commercial real estate, credit markets, or other areas of concern?
KL: Today it’s less about predicting the next crisis and more about building resilience before stress surfaces. That means staying focused on early warning signs, monitoring concentrations, and paying close attention to loans with near-term maturities — especially anything that will need to refinance at today’s rates.
Most importantly, stay disciplined about credit standards and evaluate loans based on current conditions, not what the market looked like when the loan was written. Regular internal and external loan reviews keep the portfolio accurately risk-rated, which means reserves and capital are in the right place if things deteriorate.
The banks that navigate downturns well aren’t the ones who predicted them — they’re the ones who knew where the cracks could appear before the cracks showed up.
