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June 24, 2020

Lending Considerations in the COVID-19 Environment

Lending Considerations in the COVID-19 Environment header.

While the business interruption impact of the COVID-19 pandemic hit virtually all companies in the second quarter, the financial impact from the coronavirus will still be felt through the third quarter. The economy is starting to reopen, but the pace of returning to business as usual is going to be slow and bumpy, particularly in the parts of the country that experienced a high number of COVID-19 cases.

The financial repercussions of the COVID-19 pandemic will have an impact on your overall financial condition, mostly negative, which, in turn, may affect your relationship with your lenders. Being prepared for how your lending arrangement could change in this environment can help you mitigate your risks related to debt covenant violations and/or the effect of payment deferrals or modifications that are about to expire.

The Immediate Effect COVID-19 Had on Lending

The COVID-19 virus hit quickly, and there was little time to prepare for the effect that the shuttering of the economy would have on your business operations. Many entities received Paycheck Protection Program (PPP) loans from their banks (which had a 100% guarantee from the Small Business Administration (SBA)) and a forgiveness feature, drew down on any availability under lines of credit and/or may have had to request 90 day payment deferments from their lenders (most lenders were willing to accommodate the deferment requests because the COVID-19 pandemic affected everyone).

This leniency during the first wave of COVID-19 pandemic may not be around should the need to continue to defer payments for another 90 days be necessary. Your company may be in need of additional liquidity that your bank may not be willing to provide if you cannot demonstrate that profitable sales and the longer term outlook is positive. It may also be interesting to see how your banker responds to your request, whatever it might be, as lenders will undoubtedly be overwhelmed with an increase in requests for payment modifications and/or deferments.

Changes to Expect

The accommodations made in the second quarter were short-term solutions, and moving forward, lenders will likely be taking a much more conservative approach.

If you rely on working capital lines of credit and term loans to support sales growth, either for liquidity or fixed asset purchases, your lender may be less willing to fund new borrowing requests moving forward, especially if your lender has seen a significant uptick in problem loans. It is also important to understand that not all lenders are financially sound.   Understanding the financial strength of your lender and where you fit in terms of importance to their portfolio is very important.

Your company should be prepared for the possibility that once the initial 90-day payment deferral ends, another may not be offered, even though lenders can go up to 180 days without having to classify the loan as a Troubled Debt Restructure (TDR).

At some point, if your company is struggling financially, your lender may ask you to seek financing elsewhere. Generally, the lender will issue a formal letter notifying you that you are in default and that the line or loan currently outstanding will not be renewed or extended.

After the 2008 financial crisis, banks became very aggressive in exiting credits, and the same thing may happen during this financial crisis.

Previously Relaxed Credit Arrangements May Become More Structured

Some companies may have been borrowing with an unsecured lending structure and/or an unmonitored secured line of credit. But if your company is showing financial weakness (negative trends), your lender may require additional collateral, a borrowing base certificate arrangement and possibly a collateral audit or some other third party financial review. For example, a 13-week cash flow projection is a very common requirement made by lenders when they are concerned about the short-term viability of their borrowing customer.

Forbearance Agreement Risk

Forbearance agreements are a first step in dealing with covenant violations. Generally, when a company violates a covenant with the bank (the terms of the lending agreement), the bank may offer a forbearance agreement whereby it agrees to postpone taking any adverse action during the forbearance period. Generally, forbearance agreements can be costly, as the company receiving the forbearance agreement could incur additional lending and legal fees.

What Your Company Can Do

One of the first steps you should take would be to evaluate second quarter results and consider what your third-quarter numbers would look like. This analysis should consider how your sector is doing as a whole. For example, businesses in the hospitality sector might still be financially challenged in the third quarter, but medical device manufacturers might not be. Knowing that lenders may be requiring additional, more frequent and better quality financial information, and offering this in advance of your lender having to ask for it, can help to provide your lender with a better feeling about the overall health of your business and also allow you to better understand what options may be available.

If You Are on Shaky Ground with Your Lender

Determine whether you are in default with your lender, and if so, what you are doing to “comfort” the lender. Can your company provide the 13-week cash flow and projections to demonstrate when recovery is expected? Consider what steps you have taken to address any liquidity issues you’ve been experiencing and whether additional measures might bolster your standing with your lender.

If you know your company is going to fail a covenant test, you may need to look at alternatives, such as a smaller bank or a non-bank. Non-banks, for example, are not as highly regulated and have historically been more willing to provide a more relaxed or dynamic lending structure. However, if your company is too financially unstable, you may have a hard time placing the loan elsewhere, because both bank and non-bank lenders are going to approach credit risk in similar fashion.

Would a COVID-19 Lending Relief Meet Capital Needs?

While Congress acknowledged that the financial disruption in the wake of the COVID-19 pandemic would  affect many companies negatively, and created the CARES Act, the PPP was primarily designed for smaller entities. Larger companies, or companies that need additional credit in order to sustain operations may want to consider the Main Street Lending Programs, which offer lending terms designed to help businesses that were financially healthy before the pandemic, but it is not a forgivable loan. Keep in mind that the details surrounding the Main Street Lending Program are still evolving, although banks can now register to participate. 

Final Thoughts

Many companies will weather this financial disruption without jeopardizing their lending arrangements, but it is still advisable to request a complimentary consultation on the impact of these challenging times on your lending relationship. Meeting with your lender now can also set the table for a future conversation in the event your company’s lending situation needs to change.

For more information about the impact COVID-19 may have on your lending relationship, please contact Michael Caron at 610-290-6468 or mcaron@cbiz.com. You may also visit our COVID-19 Resource Center for more insights.

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