Whilst most registered providers (RPs) have a robust stress testing process, each business faces different issues, has varying pressure points and most importantly each RP’s funding agreements, whilst likely to be similar, will have been subject to negotiation and are likely to be subtly different.
So how do you continue to operate – and, in particular, ensure compliance with your loan obligations?
Delivery of information
Several regulator bodies, including Companies House and the Regulator of Social Housing, have confirmed extensions to the time period for delivery of financial accounts or other important information.
However, this will not automatically result in an extension of the contractual time period permitted under a funding document. It depends on the wording of the clause and whether a hard deadline is set, or whether it is tied to delivery in accordance with regulatory requirements.
In particular, older loan agreements have more detailed financial information clauses that may be more restrictive. There is also usually a requirement to deliver annual budgets and/or business plans at the same time as the financial accounts, which may also not be available. It is important to review documentation to ensure compliance or to request a waiver or amendment.
Changes to business
Whilst many businesses are adapting the products or services they deliver - such as gin makers now producing hand sanitiser, RPs are unlikely to experience such fundamental changes. However RPs may be altering the way they run their business, such as furloughing staff, reducing non-emergency repairs and maintenance, putting development sites on hold or office closures.
With no end to the COVID-19 emergency for the foreseeable future, more fundamental changes may become necessary in businesses. Finance executives need to be aware that most funding agreements have a cessation of business clause, whether in the default provisions or as a stand-alone covenant.
It may also be framed by reference to a “substantial” or “material” part of the business. Neither of these phrases is legally defined, although there is some case law that may give guidance. Many people are surprised that even a 10 percent change could be considered “substantial”.
The other area where greater caution is required is the provision of additional financial support in these extra-ordinary circumstances, whether to tenants, employees, subsidiaries or other members of a group. Many loan agreements don’t just restrict the making of loans, but also the giving of guarantees, granting of credit, investment by way of shares and the transfer of assets between subsidiaries. They will include carve-outs based on the normal situation, but the provision of greater financial support may not have been anticipated and dealt with at the time the provisions were drafted.
Any significant change in the way that an RP carries out its business is worthy of a review of the loan documentation to ensure it would not inadvertently trigger a default.
Increased default risk
Increases in rent arrears and bad debts or falling property values could trigger compliance issues with financial covenants. Most covenants are tested by reference to audited annual accounts and the information may therefore not yet be available.
In some cases, they will also be tested or possibly just monitored by reference to the quarterly accounts, but it is worth bearing in mind that the figures in these management accounts may be significantly more volatile than in recent times and could be an early indication of potential problems meeting covenants.
Whilst we have not heard of any lenders making use of their right to request a covenant compliance certificate outside of the normal cycle, borrowers are required to notify their lender at any time of any potential default situation and failure to notify will in itself be an event of default.
It is also important that RPs know their cross default and insolvency clauses. Whilst the majority of clauses in a standard facility will relate to the borrower, these events of default are usually drafted more widely to encompass group members and could pick up negotiations in relation to extensions of time or rescheduling with creditors of a commercial subsidiary. Often these have a material adverse effect test applicable, but again it is important to carefully review the wording.
Another area of increased risk relates to litigation and the likelihood of third parties taking court action in relation to the enforcement of contracts and or employing aggressive debt collecting methods, such as issuing statutory demands. It is important to have policies in place to identify these situations and to escalate them within the treasury team to ensure visibility for those monitoring compliance with loan covenants or confirming repeating representations on a new drawdown.
Need more information or advice?
The banking and finance team at Bevan Brittan can analyse your financing arrangements to help you identify any areas of risk as a result of current circumstances.
For further support relating to the impact of COVID-19, please view our COVID-19 Advisory Service page