The coronavirus pandemic is affecting businesses large and small. Now is the time for lenders to prepare for its effect on business borrowers.
Industries Already in Distress
In February, a PricewaterhouseCoopers (PwC) report identified five industry sectors likely to see the greatest restructuring activity in 2020:
- Dining and food service
- Auto suppliers
- Specialty pharma
The reasons for existing distress in these industries vary. However, disruption caused by the coronavirus pandemic will ripple through these and many other industries. Additionally, an oil price war that has coincided with the pandemic will impact the energy sector.
Know Your Borrowers
In response to the coronavirus, lenders should determine which borrowers are likely to suffer the most. A borrower already in payment default should obviously be on the lender’s watchlist. Another factor to consider is whether a borrower is in a distressed industry. In the retail sector, for example, some businesses have ceased operations, a factor that certainly warrants further investigation.
After developing a watchlist of potentially troubled borrowers, a lender should investigate each business’s financial condition. Many loan documents require borrowers to provide reports and maintain financial covenants. This information can sometimes be dated, so lenders should rely on provisions in loan documents requiring borrowers to provide further financial information upon the lender’s request.
When requesting updated information, lenders should focus on information that is readily available and demonstrates the borrower’s financial health. Useful information includes:
- Daily receipts
- Inventory levels
- Locations that are closed to business
- Aging reports for accounts payable and accounts receivable
Can Your Borrowers Withstand the Coronavirus?
A lender must triage the borrowers on its watchlist. Even among borrowers in distress, lenders must consider the borrowers’ relative financial strength or weakness. A lender should ask: Can this borrower withstand the initial economic shock caused by the coronavirus?
Some borrowers will have the financial wherewithal to withstand even a temporary shutdown in their business, and others will not. The availability of liquid assets is key. Lenders should also consider the short-term and longer-term projections for the borrower’s industry. Monitoring the availability of government assistance for borrowers will also be important because such assistance could sustain a borrower until business picks up.
Consider Your Options
Many borrowers are in default. Payment defaults are easy to identify. Businesses that are not in payment default may be in covenant default or subject to material adverse change provisions that are included in many loan documents. Financial information gathered from a borrower can assist a lender in determining whether defaults have occurred.
Everyone hopes that borrowers can weather the current storm. Healthy borrowers whose businesses have experienced a temporary ripple will likely be candidates for loan extensions or forbearance agreements. This is a useful time to review loan documents. As part of an extension or forbearance, a lender may be able to correct errors or oversights from earlier loan documents or strengthen a lender’s collateral position.
Less healthy borrowers may leave lenders with no option other than to take action to preserve value. Remedies available to lenders include receiverships, direct collection of receivables, foreclosure or litigation.
We Are Here to Help
Bradley attorneys have helped clients work through many previous economic downturns. Our team stands ready to answer your questions and help you analyze your portfolio.