While the business interruption impact of the pandemic hit virtually all companies during 2020 and 2021, the financial impact from the pandemic is still present in 2022. The economy has reopened, and business as usual may not feel so familiar, but we’re now learning to adapt to our new normal.

The financial repercussions of the post-pandemic world and the new effects of the Great Resignation may have an impact on your overall financial condition, which, in turn, may affect the relationship with your lenders. Being prepared for how your lending arrangement could change in this environment can help you mitigate your risks related to debt covenant violations and/or the effect of payment deferrals or modifications.

One item in particular is bank leniency. The national emergency that was declared on March 13, 2020 was the basis for bank leniency. Both the Office of the Comptroller of the Currency (OCC), which regulates all federally chartered banks, and the Federal Deposit Insurance Corporation (FDIC), which regulates all state chartered banks, permitted banks to allow payment deferrals or loan modifications during the national emergency without those modifications impacting reserves and consequently negatively impacting their bottom lines. With that coming to an end, banks have been forced to reassess with both existing borrowers and prospects.

The After Effects of Post-Pandemic Lending

The coronavirus hit quickly, and there was little time to prepare for the effect that the shuttering of the economy would have on business operations. Many companies received Paycheck Protection Program (PPP) loans from their banks (which had a 100% guarantee from the Small Business Administration (SBA) and a forgiveness feature). If your business had availability under a line of credit, you drew down on that availability and/or may have had to request payment deferments from your lender(s). Most lenders were willing to accommodate the deferment requests due to the national emergency that permitted the OCC and FDIC to allow it, as mentioned above.

In 2022 you may need to continue to defer payments. Your company may need additional liquidity that your bank may not be willing to provide if you cannot demonstrate that profitable sales and the longer-term outlook are positive. Even if you can demonstrate a positive outlook, your bank may not be in a good financial position itself and may not be able to extend additional credit to some clients.

Changes to Expect in 2022

The accommodations made in 2020 through the present were short-term solutions, and lenders are looking to take a much more conservative approach moving forward.

If you rely on working capital lines of credit and term loans to support sales growth, either for liquidity or fixed asset purchases, your lender may be less willing to fund new borrowing requests, especially if your lender has seen a significant uptick in problem loans. It’s also important to understand that not all lenders are financially sound. Understanding the financial strength of your lender and where you fit in terms of importance to their portfolio is essential.

Your company should be prepared for the possibility that once the deferrals end, another may not be offered, even though lenders have been able to modify payment structures and covenant violations without having to classify the loan as a Troubled Debt Restructure (TDR), which is not a good thing.

At some point, if your company is struggling financially, your lender may ask you to seek financing elsewhere. Generally, the lender will issue a formal letter notifying you that you are in default and that the line or loan currently outstanding will not be renewed or extended.

After the 2008 financial crisis, banks became very aggressive in exiting credits, and the same thing may happen during this financial crisis.

Previously Relaxed Credit Arrangements May Become More Structured

Some companies may have been borrowing with an unsecured and/or an unmonitored secured line of credit lending structure. But if your company is showing financial weakness (negative trends), your lender may require additional collateral, a borrowing base certificate arrangement and possibly a collateral audit or some other third-party financial review. For example, a 13-week cash flow projection is a very common requirement made by lenders when they’re concerned about the short-term viability of their borrowing customer.

Forbearance Agreement Risk

Forbearance agreements are a first step in dealing with covenant violations. Generally, when a company violates a covenant (the terms of the lending agreement) with a bank, the bank may offer a forbearance agreement whereby it agrees to postpone taking any adverse action during the forbearance period. Generally, forbearance agreements can be costly, as the company receiving the forbearance agreement most likely will incur additional lending and legal fees.

What Your Company Can Do

One of the first steps you should take is to evaluate operating results and consider what your projections or budget for 2022 looks like. This analysis should consider how your sector is doing as a whole (one of the 5 Cs of credit — Conditions). For example, businesses in the hospitality sector might still be financially challenged, but medical device manufacturers might not be. Knowing that lenders may be requiring additional collateral, more frequent and/or better quality financial information and offering this in advance of your lender having to ask for it can help to provide your lender with a better feeling about the overall health of your business and also allow you to better understand what options may be available. It may also buy needed time for you to explore other financing options.

If you’re on Shaky Ground with Your Lender

Determine whether you’re in default with your lender and, if so, what you’re doing to “comfort” the lender. Can your company provide the 13-week cash flow and projections to demonstrate when recovery is expected? Consider what steps you have taken to address any liquidity issues you’ve been experiencing and whether additional measures might bolster your standing with your lender.

If you know your company is going to fail a covenant test, you may need to look at alternatives, such as a smaller bank or a non-bank. Non-banks, for example, are not as highly regulated and have historically been more willing to provide a more relaxed or dynamic lending structure. However, if your company is too financially unstable, you may have a hard time placing the loan elsewhere because both bank and non-bank lenders are going to approach credit risk in similar fashion.

Final Thoughts

Many companies will weather this financial disruption without jeopardizing their lending arrangements, but it is still advisable to request a complimentary consultation on the impact of these challenging times on your lending relationship. Meeting with your lender now can also set the table for a future conversation in the event your company’s borrowing requirements change.

For more information about the impact coronavirus may have on your lending relationship, please connect with Michael Caron at 610-290-6468 or [email protected].

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