CFO – September 23, 2021

The pandemic has affected many businesses. Fortunately, at the request of the federal government and with the relief of regulators, many secured lenders have refrained from taking action against borrowers who default on their loan terms. However, lenders are now becoming less patient and more focused on law enforcement. When requesting an additional forbearance or loan modification, what information should borrowers provide to their lenders? What should lenders be accommodating about? How can a borrower best prepare for relief?

To begin with, the books and records must be up to date. Lenders will look at whatever their borrowers provide them. Lenders will only make informed decisions, which means they will need up-to-date results.

Lenders will also require realistic financial projections for ongoing operations. Pre-pandemic financial projections should be linked to actual results during the pandemic and also to current financial projections. They should show the line items that have changed since the original forecast.

You should be able to identify what happened during the pandemic which caused poor operating results. Identify the things over which you had no control. Has there been a decline in sales due to reduced foot traffic, an inability to obtain sufficient raw materials, an increase in the cost of raw materials, loss of operational efficiency, or a labor shortage? Additionally, identify any operational issues that existed before the start of the pandemic that you had control over. Rather than denying that there is a problem, acknowledge the problem and explain how it was resolved and how the pandemic hampered the implementation of the solution.

You should also adjust the actual operating results using historical data and percentages (like gross margin). Use reasonable leading numbers consistent with your actual performance before the pandemic. It should show results “without the pandemic” to convince the bank that the company is still worth supporting for an unprecedented time.

You should be prepared to discuss any assumptions made when preparing for the projections. Each assumption will be carefully checked by the lenders. Lenders will compare your assumptions with industry standards as well as those used by other bank clients. You don’t want to be an outlier. Assumptions should be cited in industry journals, in your prior period operating results, or both.

The goal is to demonstrate that the business was operating satisfactorily before the pandemic, that the business suffered only (or mainly) from the pandemic, and that the business will return to its pre-pandemic performance.

When reviewing your forbearance or loan modification application, lenders will want to know what you have done to help. So, be prepared for issues like spending cuts, downsizing, production line idling, lease terminations or concessions obtained from lessors of equipment and concessions from landlords. Lenders are more likely to abstain if their borrower has done everything possible to help themselves. The bank should not have any suggested action that management has not already thought of.

Most importantly, you need to convince the bank that there is no need to cancel the loan and that it is in the bank’s best interest to give relief. Therefore, a borrower should check the following:

  1. The liquidation value of the bank guarantee;
  2. How it should be liquidated in the event of foreclosure (eg by public auction or private sale);
  3. How weak or strong is the market for bank collateral;
  4. If the bank’s collateral is of the type that the bank would not want to take possession of because of environmental concerns;
  5. If the bank will be bombarded with consumer complaints if it closes the borrower;
  6. Whether the bank’s guarantee can be easily sold separately from other assets over which it has no privilege;
  7. Administrative costs; and
  8. Whether the warranty can be easily sold locally or will need to be dismantled and moved.

For on-site sales, there is rent, insurance, security, etc., in addition to the auctioneer’s fees and costs. In addition, some large machinery must remain in place at the borrower’s premises so that potential buyers can witness the operation.

Lenders also like to see managers have a skin in the game. Credibility boosting elements are pay cuts and executive perquisites. If dividends have been paid to shareholders or insider loans have been repaid, the bank will consider the clawback of those payments as a source of working capital. Of course, nothing impresses a lender more than shareholders who invest more of their own money in the business, even if it’s structured like a loan.

Most lenders appreciate thoughtfulness and honesty. Be prepared to have an open and honest conversation about any difficulties encountered and how management is approaching each issue. It is very important to offer solutions, not just to reveal problems for which you do not have answers.

Analyzing your own business in depth, knowing what the bank will need in the negotiations, preparing the information on a solid basis and having everything ready at the start of the negotiations will make the negotiations easier and facilitate a faster and better outcome.

Reprinted with permission from the September 23, 2021 issue of CFO. © 2021 Chief Financial Officer. All rights reserved.

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