While the business interruption impact of the coronavirus pandemic hit virtually all companies during 2020, the financial impact from the pandemic will still be felt in late 2021 and beyond. The economy is reopened, but the pace of returning to business as usual may be slow and bumpy, particularly in the parts of the country that are experiencing a high number of variant coronavirus cases.
The financial repercussions of the pandemic may have an impact on your overall financial condition, mostly negative, which, in turn, may affect the 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 we expect are about to expire.
One item in particular to watch is bank leniency. The national emergency that was declared on March 13, 2020, and was the basis for bank leniency, is scheduled to end on Feb. 24, 2022. Both the Office of the Comptroller of the Currency (OCC), which regulates all federally chartered banks and the Federal Deposit Insurance Corporation (FDIC), which regulates all state chartered banks permitted banks to allow payment deferrals or loan modifications during the national emergency without those modifications impacting reserves and consequently negatively impacting their bottom line. With it coming to an end, banks may be forced to take a much harder line with both existing borrowers and prospects.
A Recap of the Immediate Effect the Pandemic Had on Lending
The coronavirus hit quickly, and there was little time to prepare for the effect that the shuttering of the economy would have on business operations. Many companies received Paycheck Protection Program (PPP) loans from their banks (which had a 100% guarantee from the Small Business Administration (SBA) and a forgiveness feature). If your business had availability under a line of credit, you drew down on that availability and/or may have had to request payment deferments from your lender(s). Most lenders were willing to accommodate the deferment requests due to the national emergency that permitted the OCC and FDIC to allow it, as mentioned above.
This leniency may not be around should the need to continue to defer payments still be necessary in 2022. Your company may need additional liquidity that your bank may not be willing to provide if you cannot demonstrate that profitable sales and the longer-term outlook are positive. Even if you can demonstrate a positive outlook, your bank may not be in a good financial position itself and may not be able to extend additional credit to some clients.
Changes to Expect in 2022
The accommodations made in 2020 through the present 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 deferrals end, another may not be offered, even though lenders have been able to modify payment structures and covenant violations without having to classify the loan as a Troubled Debt Restructure (TDR), which is not a good thing.
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 and/or an unmonitored secured line of credit lending structure. 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 (the terms of the lending agreement) with a bank, 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 most likely will incur additional lending and legal fees.
What Your Company Can Do
One of the first steps you should take would be to evaluate operating results and consider what your projections or budget for 2022 would look like. This analysis should consider how your sector is doing as a whole (one of the 5 Cs of credit – Conditions). For example, businesses in the hospitality sector might still be financially challenged, but medical device manufacturers might not be. Knowing that lenders may be requiring additional collateral, more frequent and/or 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. It may also buy needed time for you to explore other financing options.
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.
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 borrowing requirements change.
For more information about the impact coronavirus may have on your lending relationship, please contact Michael Caron at 610-290-6468 or [email protected].
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