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If the borrower fails to meet these targets on or before the reporting date, the lender could accelerate the loan repayment cycle or recall the loan facility. (Photo: Pradeep Gaur/Mint)
If the borrower fails to meet these targets on or before the reporting date, the lender could accelerate the loan repayment cycle or recall the loan facility. (Photo: Pradeep Gaur/Mint)

Borrowers approach banks to rework loan pacts as earnings fall

Many companies are going back to lenders to review their loan deals as they fear violation of some financial covenants

Companies in India are revisiting their loan contracts and seeking concessions from lenders on repayment timelines and financial covenants as they worry about a sharp erosion in earnings because of strict restrictions during the nationwide lockdown.

The financial impact is being felt across sectors, as evident in a survey conducted in May by Confederation of Indian Industry (CII) among 300 companies.

The survey, which was released on 2 May, showed that 65% of the companies expect revenues to decline nearly 40% in the June quarter. This will severely impact the ability of these companies to maintain the financial parameters promised to lenders.

Given these challenges, many companies are going back to lenders to renegotiate their loan agreements as they fear they may not be able to adhere to certain financial covenants due to disruptions caused by covid-19. Financial covenants in loan contracts are based on achievement of certain prearranged financial projections, which are tested on a particular date, usually on an annual basis.

These loan terms commonly include hitting financial ratios such as the ratio between net debt and earnings before interest, taxes, depreciation and amortization (Ebitda), debt-to-equity ratio, interest cover ratio, debt service coverage ratio and fixed asset coverage ratio.

If the borrower fails to meet these targets on or before the reporting date, the lender could accelerate the loan repayment cycle or recall the loan facility.

“In a loan agreement, force majeure events such as the ongoing pandemic crisis typically do not give any relief to the borrowers from their repayment obligations. Therefore, borrowers for whom the testing date is near are now approaching their lenders to request them to not call any defaults or any breach of financial covenants," said Siddharth Srivastava, partner at law firm Khaitan and Co.

A force majeure implies disruption caused by an unanticipated and chance occurrence beyond the control of either party. “While a lot of borrowers have been reaching out to lenders over extension of repayment timelines and relaxations in loan contracts, it has been observed that a breach of financial covenants is not considered an immediate default. The consequence, in most cases, is an extra penalty of 1-2% of the outstanding loan, which is levied on the borrower until the covenant is cured within the requisite period. If financial covenants are not cured, i.e., not brought to the target ratio agreed in the contract within a 60-90 day period, the lender can call an event of default. However, companies are seeking relaxations on these penalties as well, citing covid-19 as a force majeure event," added Srivastava.

For instance, in the case of non-banking financial companies (NBFCs), even if their absolute bad loans have not increased, their bad loan ratio would now look inflated due to shrinking loan assets. “Now, if these NBFCs had covenants with their lenders that the bad loan ratio should not go beyond a certain point, those would get breached," said Anil Gupta, vice-president and sector head (financial services ratings) at rating agency Icra Ltd.

Another example of such a breach could be in terms of debt/ Ebitda ratio that is projected to be met as part of the loan agreement. With Ebitda is expected to take a hit this fiscal, companies are requesting lenders to give a relaxation on such covenants.

“As our Ebitda was on track when we announced our results in March, there was no breach of covenant. But for 2021, our Ebitda will definitely be lower than our projections. We discussed this with our lenders and they were quite lenient. They may even extend our covenant period and postpone it to fiscal 2021-22," an company executive said, requesting anonymity.

Experts believe that most lenders will take an accommodating stance on covenants, given the market conditions.

“Most traditional lenders are likely to take a measured approach if requested for financial covenant waivers, keeping in mind the limited alternatives available in the current market conditions," said Abhijeet Das, partner at law firm Cyril Amarchand Mangaldas.

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