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INSIGHT: Covid-19 and Credit Markets—Key Issues for Lenders and Borrowers

June 26, 2020, 8:00 AM

It is now clear that due in part to the Covid-19 pandemic, the U.S. is in a recession. What is less clear is how the Covid-19 pandemic will impact credit markets.

Until we can understand the scope and fallout more clearly, both lenders and borrowers should explore six practical considerations as those impacts unfold.

Significant Changes May Not Occur Until After Final Peak

Covid-19’s effects on credit markets cannot be reliably predicted and may not be apparent for some time or correlate with the pandemic’s severity. The economic fallout may not materialize until weeks or months after government restrictions are rolled back and businesses reopen due, for example, to the extent to which employment recovers and consumer confidence rebounds. While planning for the best, borrowers should prepare for a difficult road ahead in managing liquidity.

  • As borrowers examine leverage, free cash flow and their ability to manage debt over the next six to 12 months, diligent financial management is critical.
  • Borrowers should analyze whether projections they previously delivered to lenders continue to be realistic. Should a different forecasting model be utilized now that historical performance is unlikely a reliable predictor of near-term performance?
  • Borrowers also should consider initiating conversations with lenders and restructuring advisors to explore creative strategies going forward.
  • Further, borrowers should stay up to date on the latest news and regulations regarding the CARES Act and other federal programs.

Just as bankruptcy filings tend to be a lagging indicator of economic health, Covid-19’s direct impact on credit markets is likely to lag behind the pandemic. The lack of experience and transparency in dealing with a global pandemic will likely lead to a surge in defaults in credit facilities over the next six to 12 months.

Post-Covid-19 Changes to Borrower’s Business Model May Impact Financing Needs

Covid-19 and its aftermath may also engender changes in business operations and models that will necessitate more spending during a period of diminished revenues and profits for reasons that can already be identified as well as some that may emerge in the future.

  • There may be a dramatic shift in customer preferences toward transacting online, requiring major improvements in capacity and quality of online platforms and delivery services.
  • Political and market developments may continue to undermine the reliability and acceptability of overseas supply sources, potentially creating stronger demand for domestically produced products. This will drive a need for new initiatives and investments in technology, capital equipment, inventory, personnel and new and/or redundant sources of supplies and services to assure normal production volumes and to build excess capacity to respond to changes in demand and preferences and exploit market opportunities.

Borrowers should assess the probable magnitude and timing of the incremental costs they may incur due to these potential changes and adjust their financing plans accordingly.

Communication Is Critical

Borrowers need to be proactive in communicating with and requesting loan modifications from lenders to avoid defaults due to the Covid-19’s impacts and to reduce the risk of limited access to credit.

  • In this environment, borrowers should frequently evaluate their current loan facilities and assess whether modifications are needed to avoid default, provide latitude in covenants and/or increase availability.
  • Lenders are also experiencing the pandemic’s effects, requiring them to develop policies to address lending relationships and the numerous client inquiries and requests resulting from the recessionary situation. Early communication with the lender can help maximize flexibility and avoid unnecessary time pressures for resolving these issues.

Additional or Alternative Funding Sources May Provide Relief

Alternative and private direct lenders have substantial capital on hand and are open to new transactions despite the Covid-19 crisis. When considering direct lending sources, it is important for borrowers to weigh the advantages and disadvantages of direct lending.

  • Direct lenders generally offer greater flexibility in their underwriting process and shorter closing timelines for borrowers with assets to pledge.
  • Borrowers for whom traditional bank financing is not possible, who are financially distressed or seeking to add more debt to their capital structure may find direct lending sources attractive.
  • Borrowers should expect higher pricing than with traditional bank financing and be wary of “loan-to-own” strategies in which lenders enter into secured facilities with an intention or willingness to acquire the business and assets following default.

Direct lenders offer bridge financing opportunities and could fill some of the gap left by traditional lenders as they assess risks presented by the Covid-19 pandemic.

Signing issues Will Need to Be Addressed

With many working remotely, slower package delivery and leaner office staffs, it is becoming increasingly difficult to deliver wet ink signatures in a timely manner. The use of e-signatures has expanded in the current climate and will likely continue once life gets back to normal and offices reopen.

It is expected that many jurisdictions, including those that are currently experimenting with remote online notarization authorized by emergency orders, will permanently authorize remote online notarization and that its use will dramatically increase.

Preparation Is Key

Although Covid-19’s lasting effects on credit markets are not predictable, borrowers and lenders are well-positioned to prepare for the unknown.

In anticipation of the lingering economic upheaval resulting from the pandemic, borrowers and lenders should be proactive in managing their relationships, informed on the latest Covid-19 relief programs and strategic in planning for creative solutions to withstand these tumultuous times.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

David J. Naftzinger is a partner in Thompson Hine’s Commercial & Public Finance, and Business Restructuring, Creditors’ Rights & Bankruptcy practice groups in Cleveland. He focuses his practice on bankruptcy and creditor’s rights, banking and commercial law, and financing transactions.

Tarnetta Jones is senior counsel in Thompson Hine’s Commercial & Public Finance practice group and is based in New York. Jones focuses on finance transactions with an emphasis on leveraged, investment grade, asset-based, working capital and acquisition finance. She represents financial institutions, lenders, private equity and hedge fund sponsors, and public and private issuers and borrowers in secured and unsecured, syndicated and bilateral, revolving and term lending transactions. Jones also assists clients with a wide range of general corporate matters.

Jennifer Villyard is an associate in the Commercial & Public Finance practice group in Cleveland. She focuses her practice on commercial financing transactions involving banks and other financial institutions, as well as public and private companies, in connection with secured and unsecured credit facilities.