Our thinking Quick reads “Knock, knock” – how to approach negotiations with your lender: 5 top tips
Credit and private debt
June 2020
7 min read

“Knock, knock” – how to approach negotiations with your lender: 5 top tips

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Our previous article covered aspects of a company’s third-party credit facilities that could cause concern in light of the hardships caused by COVID-19.

In this piece we provide practical tips on how a borrower might approach discussions with third party lenders to refinance or adjust the terms of its facilities

1. Engage early and decisively

It is clear that many borrowers have immediate issues to address. Typical (solvent) borrower behaviour since lockdown has been characterised by diligent and conservative cash management together with an unprecedented drive to secure liquidity for the near term, with widespread drawdowns on existing revolving credit facilities, utilising permissible baskets and where possible, deferring interest or capital payments.

Experience shows that in most cases, lenders have been supportive of existing borrowers that were performing before Covid-19, particularly where other key stakeholders such as shareholders and sponsors also play their part (i.e. provide additional finance).

There are two main reasons for this from a lender’s perspective – first, lenders recognise that many inherently sound businesses have been affected by the crisis and therefore should be helped through the current difficulties and second, the recent guidance from Prudential Regulation Authority and Financial Conduct Authority encouraging lenders to support businesses during this time, and not enforce their debt, means there is now a regulatory onus on lenders to act in this way.

However, if borrowers do not comply with their obligation to inform lenders of a breach, lenders find themselves in a difficult position – on the one side not wanting to risk wrongful enforcement, and hopefully achieving a better return by keeping the borrower trading and avoiding a formal insolvency process, while on the other side needing to reassess credit risk and protect their position.

A key aspect in keeping your lender onside and maximising liquidity for the near term is therefore to engage with them early. Borrowers should maintain an honest and open dialogue with their lenders throughout this period, implement a structured, regular communications schedule and, if necessary, work with them and advisers to agree waivers, extensions and adjustments where possible. The reality is that most companies and institutions alike will, for some time to come, be adversely affected in some capacity by the current situation, so an upstream party such as lender will likely be accommodating, not least to leave it sufficient bandwidth to deal with ‘true’ crisis situations. Cooperating in the search for constructive solutions provides the best chance of avoiding surprises and maintaining credit lines.

2. Financial covenants

As a result of COVID-19, many companies are experiencing a material deterioration in cashflow, asset values or other measures of financial performance, thereby affecting their ability to adhere to the financial covenants included in loan documentation.

But the recent – or at least pre-Covid 19 – trend for ‘covenant lite’ structures has resulted in the removal of early warning signs for lenders – in particular, a lack of financial maintenance covenants and loose restricted payment provisions.

Where significant covenant protections are lacking but lenders’ “risk-on” temperament is in reverse, and refinancing activity is becoming more challenging, the onus is really on management and financial sponsors to be sensible in identifying situations where they need to engage with their lenders to shore up liquidity, pre-empt issues and preserve long-term economic value.

The advice is therefore for management teams to engage with their lenders pre-emptively in advance of an immediate credit catalyst.

3. Seek out new, alternative financing solutions

A fall in revenue will make it more difficult for businesses to make new investments and service their existing debt obligations. But liquidity will also be required to return to normal once the lockdown eases. Questions such as do you need to fund working capital to re-open or ramp up activities, or have you deferred payments that will need to be unwound, will need to be addressed at some stage.

External support may however be a short-term solution and, in response, the UK government has introduced the Coronavirus Business Interruption Loan Schemes. In summary, eligible SMEs can receive up to £5 million in the form of term loans, overdrafts, invoice finance and asset finance and, larger enterprises, can receive up to the lower of 25% of turnover or £200m, subject to appropriate accreditation checks[1].

This is certainly a positive development in helping to improve market confidence and bolster liquidity, but one of the mistakes we have seen from borrowers is not having a clear enough “ask” when trying to access these government schemes. It is sometimes forgotten in the current crisis that lending decisions across the board will remain economically rational, so finance parties need to be confident that your business is sound and viable in the longer term.

The latest guidance in all cases advises businesses to prepare basic details of the loan proposal (amount, purpose and period for repayment) but also further, more detailed evidence likely required by any lender in normal times such as management accounts, cash flow forecasts, business plan and details of assets.

In these times, it is no doubt challenging to bring together the above into a comprehensive package and on an accelerated basis. However, the benefits to preparing a robust and comprehensive proposal with strong supporting documents could be the difference between a business staying afloat and not. And good advisers should be on hand to assist with this…

[1] Firms borrowing more than £50m through the large enterprise scheme will be subject to restrictions on dividends, senior pay cash bonuses and share buy backs during the period of the loan, unless they were previously agreed.

4. Asset-based borrowing

Borrowers should consider carefully whether they can utilise the assets they hold on their balance sheets in order to raise capital, as this may be a good alternative option by which a company can inject liquidity while the pandemic’s effect remains. There are hurdles to overcome of course – getting a proper steer on asset values or return on assets is harder for a lender when things are in a state of flux. But whether it’s a supplier or receivables financing facility at one end to shore up supply chains, or sponsors looking to increase PE fund fire power through structures such as NAV debt structures (facilities secured against a fund’s underlying assets and the returns on its investments) at the other, borrowers and lenders may find it easier to structure loans based on the value of assets rather than against future cash flows, which are inevitably even more uncertain at this time.

5. New insolvency and restructuring measures… to the rescue

Finally, much has been written recently about the Corporate Insolvency and Governance Bill (the “Bill”) which was introduced in Parliament on 20 May 2020. The Bill introduces both permanent reforms to corporate insolvency law, including the introduction of a stand-alone moratorium and a new restructuring plan to help business rescue and also short-term measures stemming from the COVID-19 crisis, including the suspension of wrongful trading legislation and restrictions on the use of statutory demands and winding-up petitions.

We will be writing further about the impact of the Bill and its finer detail in future newsletters, given that the precise form and time of implementation of the Bill remains uncertain (we anticipate late June or early July). However, from a borrower perspective, it is apparent even at this early stage that the new legislation will implement a series of ground-breaking measures to enable companies to be efficiently restructured and support financial recovery. Value co-creation through borrower and lender collaboration is a major theme of these latest reforms!  So watch this space….

Is this brief too brief? Expert legal advice is on hand from MJ Hudson’s Finance and restructuring law team.

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