As COVID-19 continues to stir economic uncertainty, businesses are concerned about possible defaults under their credit facilities and some businesses may want to consider how they are using credit vehicles to support ongoing operations. OFP Shareholder Michelle DiCintio discusses some factors businesses may want to weigh in the coming weeks.
OFP COVID-19 Response Team: Clearly, the current health crisis is having a significant impact on “normal” business operations. If businesses are concerned about breaching their current loan documents or even being able to make their monthly payments, what do you recommend?
MSD: As the impact of the spread of COVID-19 unfolds, a fresh read of terms negotiated in pre-COVID-19 times is warranted by both borrowers and lenders, including the following:
- Breaches of financial covenants
- Cross-defaults to other indebtedness or material agreements
- Deterioration in financial condition resulting in material adverse effect, insolvency or payment default
If there is an impending event of default caused by COVID-19-related disruptions due to breach of financial covenants or otherwise, borrowers would be well advised to be proactive and discuss adjustment to covenants or other relief with lenders now.
Furthermore, on Sunday evening, federal financial and state banking regulators jointly issued an interagency statement encouraging financial institutions to assist borrowers impacted by COVID-19. The agencies are promoting the use of loan modification programs to provide temporary relief to borrowers affected by COVID-19 and, ultimately, to mitigate credit risk. Suggested modifications include “payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant.”
To alleviate concerns from lenders relating to reporting requirements, the agencies stated that:
- Lenders are not required to automatically categorize COVID-19-related loan modifications as troubled debt restructurings (TDRs);
- Good faith, short-term loan modifications in response to COVID-19 are not TDRs, provided the borrowers were current prior to any relief;
- Lenders, in general, will not be expected to designate loans with deferrals granted to impacted borrowers “as past due because of the deferral”;
- Loans to stressed borrowers “generally should not be reported as nonaccrual” during the pendency of these “short-term arrangements.”
The Agencies comprise the Board of Governors of the Federal Reserve System, Consumer Financial Protection Bureau, Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, and Conference of State Bank Supervisors.
Again, our advice is for borrowers and lenders to start talking now. Our hope is that open communication by the parties avoids surprise and buys time to permit an orderly restructuring, refinancing or alternative transaction to raise capital.
OFP COVID-19 Response Team. What about smaller organizations? Are there different actions that small-business owners need to take to manage their economic viability?
MSD: In addition to talking to their lenders, there may be additional resources available to small businesses. The Small Business Administration has relaxed requirements for small businesses whose operations have been disrupted by COVID-19. SBA Disaster Relief loans may be used to “…pay fixed debts, payroll, accounts payable and other bills that can’t be paid because of the disaster’s impact. The interest rate is 3.75% for small businesses. The interest rate for non-profits is 2.75%.” Small business owners in all U.S. states and territories are currently eligible to apply for a low-interest loan due to COVID-19. Click here to apply and for more information.
OFP COVID-19 Response Team: If businesses have available lines of credit, should they consider drawing down on those credit lines, and how should the COVID-19 situation inform such business decisions?
MSD: With regard to market trends, we have seen some companies draw down their available credit, creating more liquidity and increasing reserves as COVID-19 plays out. However, you must understand your finances to the greatest extent possible before you make the decision to tap any unused availability.
We’re advising clients to take a fresh look at their cash flow predictions and budgets for the next 12 months and make revisions where necessary. Also, as stated above, you need to be aware of all the representations, warranties and covenants contained in your current credit facilities because a draw down may cause an inadvertent breach. It’s important to know, however, that this is a highly fluid situation, so it’s a good idea to involve your legal and accounting professionals before making a decision regarding your business’ financial future.
For further reading:
The OFP COVID-19 Response Team is available to help your organization manage uncertainty and keep your business afloat.