Tripped Up

More companies are violating loan covenants, but there are ways to avoid taking a hard fall.

In the first quarter of 2009, lenders charged an average 204 basis points in interest and 56 basis points in one-time fees in exchange for easing loan terms, according to S&P. Arrangers are asking for fees of up to $1 million just to consider a loan amendment, says AMN Healthcare’s Dreyer, and consent fees — payments to the members of a loan syndicate — are up three- and fourfold. “The pricing is the most shocking thing right out of the gate,” Dreyer says.

Banks need to reprice risk, but there are other reasons why customers are paying more. When borrowers come to KeyBank wanting a covenant amendment, there is now both a credit decision and a capital decision to be made, says Mack. “As the credit quality deteriorates, we’re required to keep additional capital, so we have to be compensated for that,” he explains. “Our capital costs have increased — the bank market is charging more for everything.” Even if the lead bank in a syndicate has a solid relationship with the borrower, it has to give other participants “market terms,” says Mack.

Penalties are increasing partly because the market will bear it, says John Walenta, a director at Oliver Wyman, but partly for legitimate reasons as well. Deteriorating corporate credits force banks to spend more time managing loan portfolios. “There’s an opportunity cost for the banks — they’re not out cross-selling,” Walenta says.

Still, Walenta can see why escalating fees and price increases drive CFOs mad. “The bank is concerned about the company’s liquidity, but at the same time it’s extracting fees and rate hikes,” he says. Generally, CFOs who haven’t been to the loan markets recently are in for a surprise, says James Moran, head of corporate lending for Credit Suisse’s investment-banking arm. “There is an element of sticker shock in terms of what the market requires to amend a financial covenant,” he says.

Can We Talk?
It’s best not to run from the shock. On the positive side, a loan-covenant violation can be resolved with some-thing less punitive than an asset seizure or liquidation. “It’s an opportunity to have a dialogue with the company,” says Greg Becker, president of Silicon Valley Bank. “There is a serious violation only 1 out of 10 times.”

What’s more, the lack of liquidity in markets takes away some of banks’ leverage. If a lender did seize a company’s assets, it could have trouble selling them. “Nothing is off the negotiating table,” says Vanessa Spiro, a partner in banking and finance at Jones Day. “That’s the most interesting part of this downturn.”

Still, if a company is going to trip a covenant, the CFO should give the bank plenty of warning. Borrowers need to be transparent with their lenders and explain why they’re missing projections, says Mack, as well as give lenders time to process the information. The amount of lead time depends on the seriousness of the breach. Nine months to a year is not unheard of. At minimum, give the lending group a couple of weeks, advises Mack.

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