Home Finance & Investments Businesses at risk of breaching covenants, debt advisor warns

Businesses at risk of breaching covenants, debt advisor warns

Phil Tarimo, Partner with DSW Debt Advisory

A toxic combination of rising costs and falling consumer demand and property values could put many businesses at risk of breaching their banking covenants in the coming months, a leading debt advisor has warned.

Phil Tarimo, Partner with DSW Debt Advisory, which helps firms to raise debt funding and negotiate with lenders, says it is important that businesses which are unable to meet their obligations take action to reassure their lenders and maintain their support.

“Many businesses will be suffering in the current climate but those with debt facilities will generally have covenants in place which specify minimum levels of performance,” says Phil. “If performance declines, for example if their costs rise or profitability falls, or in some cases if asset values fall, they risk breaching those covenants which could give the bank the right to call in the loan.

“However the actions of the business leadership team will have a major influence on the bank’s decision. With careful management, they can stay in control and maintain the confidence of lenders.”

He has the following advice:

1. Understand what covenants are in place
Covenants fall into two categories. Financial covenants relate to financial performance such as the level of profitability, costs or cashflow. Where a property or other assets are involved, there may be a loan to value (LTV) ratio specifying, for example, the property must be worth at least 40% more than the loan.

Other covenants relate more to operational issues but often require the company to provide monthly management accounts within a certain time frame. “Businesses should have absolute clarity about what covenants are in place and what is required of them,“ says Phil.

2. Create forecasts and monitor them closely
Projections covering all the key business metrics will provide early warnings of any problems, giving management more time to take action and also to plan how to communicate them to the bank.

3. Alert the bank to any problems
Avoid surprises by telling lenders at an early stage, Phil advises. “If the bank discovers the business has breached its covenants and management have failed to tell them, it will undermine your credibility. By being open and transparent, you will tick the right boxes.”

4. Explain the causes
A lender will want to understand why problems have arisen and this could influence their decisions. “It is important to convey the right messages,” says Phil. “If the business was robust before and the issue was due to a one-off event, or a temporary setback due to the current business environment, it is critical to get this across.”

5. Provide the solution
Explain the steps you are taking to tackle the issues and what, if any, actions the bank could take to help. In some cases lenders will agree to amend covenants if they are persuaded it is the best course of action. A professional debt advisor can help with any negotiations.

Phil concludes: “The last thing a lender wants to do is to call in a debt. Banks are not set up to run businesses or liquidate assets – they have to rely on third parties to do that for them at great expense. So if there is a fundamentally sound business with a proactive management team doing everything expected of them, lenders will generally be supportive.”