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  • Overview

    The financial impact of COVID-19 is impossible to quantify at this moment but the magnitude of it should not be underestimated, especially in certain sectors, including tourism and hospitality, retail and manufacturing.   Although the effects of the COVID-19 outbreak are likely to reverberate for months or years, there are short term financial challenges, such as diminished cash flows and increased demand for working capital, that both borrowers and lenders face and need to address.

    Borrowers

    There is a range of financial challenges and consequences that businesses may encounter as a result of temporary disruptions to supply chains and weaker activity:

    • Liquidity

    The most obvious consequence is the impact on liquidity.  If there are not sufficient cash reserves, robust business interruption insurance or access to working capital lines then companies need to seek out sources of liquidity that are sufficient to enable them to cope with disruption.  

    Borrowers should consider both their positions with regard to cash income and outgoings and proactively engage with their lenders in order to negotiate short term breathing space.  Outgoings (payments to lenders) can be reduced by negotiating with lenders with a view to asking for payment holidays, changes to payment terms or changes to mandatory prepayment clauses.

    Another way to improve cashflow is to use tailored working capital facilities.  But, of course, negotiating a new facility might take time and time is tight in the current climate.

    In leveraged finance transactions it might be possible to draw undrawn facilities in order to ensure some flexibility going forward.  However, financial covenants testing (and timing of testing) needs to be kept in mind.

    • Existing contractual obligations under any banking/lending arrangements

    Liquidity and solvency concerns can be aggravated if existing contractual obligations under any finance arrangements are breached.  Here companies need to be mindful of any events of default occurring, financial covenants being breached or working capital facilities being blocked.  The company needs to be clear on what the termination clauses are with their existing banking contracts.  Also, an important question is whether any cross defaults would be triggered.  

    As above, the first port of call is existing creditors and other stakeholders.  It may be possible to ensure the business is able to continue trading through careful negotiations and contractual waivers.  Borrowers should be aware that when banks’ clients are in default the banks face increased reporting obligations and they may need information in order to be able to grant concessions.  Lenders would therefore welcome open dialogue if borrowers are (or suspect they might be) in breach of obligations.

    • Impact on derivative contracts

    Businesses that have existing derivative contracts need to check their exposure and whether volatility of markets and currencies would have any impact on derivative contracts.  In times of turbulence, exposure to derivatives might magnify problems.

    Lenders

    Lenders are unlikely to be in a position to agree long term solutions and to commit to any substantive restructurings at this point.  This is likely to happen only once the worst of the crisis is over, when long term restructurings may need to be implemented.  For the time being, lenders will likely want to focus on short term arrangements which are necessary to stabilise the affected business and to ensure it can continue trading but also to protect the lender’s own position.  

    The issues that lenders are likely to encounter are breaches of financial covenants, material adverse change clauses, valuation of assets (affecting security) and payment defaults.  All of these are likely to cause a breach of banking documents.  In addition, borrowers may ask for additional help to assist with liquidity.

    Lenders may take the view that there is no point in accelerating loans or enforcing security when asset values as low.  There will often be sound business reasons as well as political pressure, to support borrowers by refraining from taking any enforcement action during this period.

    Government measures

    Borrowers

    The government has announced a £330bn government backed loans and guarantees scheme which will be available for large businesses and SMEs.  The scheme for large companies will operate through the Bank of England, and the second as an extension to the COVID-19 Business Interruption Loan Scheme (CBILS).  For more specific information on this, please see our article dedicated to CBILs  The government extended the maximum loan for small business from up to £1.2m per business to £5m with no interest payable for sixth months.

    The intention is that lenders will be prepared to make loans to businesses in reliance on guarantees issued by the government.  This will make lenders more willing to lend from a credit risk perspective as well as allowing them to allocate less regulatory capital on the basis of sovereign risk.  If in the future borrowers default on these loans the banks will be able to claim against the government to make good any losses and the government will likely to be subrogated to the lenders’ interests and would likely to manage the long term consequences of any default or work out.  It is unclear at this stage how this process would be administered.

    In addition, the government has committed to £20 bn of business rate support and grant funding by giving all retail, hospitality and leisure businesses a 100% business rates holiday for the next 12 months, increasing grants to small businesses to £10,000 and providing further £25,000 grants to retail, hospitality and leisure businesses. 

    The Bank of England has also introduced the COVID-19 Corporate Financing Facility, which is a new facility intended to help support liquidity among larger firms.  You can read more about it in our dedicated article. Note that this facility will provide funding to businesses by purchasing commercial paper of one-year maturity, which is issued by non-financial firms where those firms make “a material contribution to the UK economy”, and had, prior to being affected by the COVID-19, a short term rating of investment grade, or financial health equivalent to an investment grade rating.  This test would not – at first sight – appear to be something which many small or medium sized businesses will be able to satisfy; however there are indications that this requirement could be varied, and companies without credit ratings may be able to access the facility if they apply to the Bank of England.  In addition, the Bank of England has announced that it plans to increase its holdings of sterling non-financial investment grade corporate bonds issued by similar firms.

    Lenders

    The UK government has also taken a number of steps to ensure that the financial system has the funds to supply credit to the real economy.  For example, the Bank of England has announced an expansion of its Term Funding Scheme, which allows banks and building societies to access Bank of England funds with the aim of increasing lending to businesses at an interest rate close to the Bank of England base rate.  In addition, the Bank of England has launched a Contingent Term Repo Facility, which is essentially a liquidity insurance tool that allows eligible participants to borrow cash in exchange for other, less liquid, assets.  All of these measures are intended to maintain liquidity within the banking system which should then – in turn – be able to support the individual businesses which are their customers.

    Furthermore, in order to ease restrictions on banks, regulators have been prepared to relax some of the more recent regulatory requirements which had been imposed after the global financial crisis, reducing the countercyclical capital buffer to 0% and cancelling the 2020 stress test.

    These changes mean that - temporarily - banks will be able to conduct more lending business for the size of their balance sheet.  The Bank of England and the FCA have also identified a number of other measures that will be adapted or delayed in order to alleviate operational burdens on lenders.

  • Related Services

    Banking & Finance

    Our banking and finance lawyers can assist in your business securing funding for expansion or development.

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