Home >Industry >Banking >Companies revisit loan contracts to seek concessions as covid-19 hits earnings
Experts believe most lenders will take a accommodating stance on covenants given the market conditions.
Experts believe most lenders will take a accommodating stance on covenants given the market conditions.

Companies revisit loan contracts to seek concessions as covid-19 hits earnings

  • Many companies are in parleys with their lenders to re-negotiate loan agreements as they fear violation of financial covenants due to disruptions caused by covid-19

MUMBAI: Indian corporates are going back to lenders to renegotiate loan contracts, seeking concessions on repayment timelines and financial covenants as the covid-19 outbreak and the ensuing lockdown have led to sharp erosion in consumer demand and hit earnings.

The financial hit is being felt across sectors, as evident in a survey of 300 firms conducted in May by the Confederation of Indian Industry, which said 65% expected a nearly 40% drop in revenue in the April-June quarter. Such steep fall in topline will constrain the ability of companies to maintain financial parameters promised to their lenders.

Given these challenges, many companies are in parleys with their lenders to re-negotiate loan agreements as they fear violation of financial covenants.

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 to earnings before interest, tax, depreciation and amortization (Ebitda), debt-to-equity ratio, interest cover ratio, debt service coverage ratio, fixed asset coverage ratio, among others.

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 & 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 cure period," said Srivastava.

"If financial covenants are not cured, that is 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."

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 & sector head (financial services ratings) at rating agency Icra.

Another such breach could be in terms of debt/ Ebitda ratio that is projected to be met as part of the loan agreement. With Ebitda expected to take a hit this fiscal, companies are requesting their 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," a senior executive at a publicly listed mid-cap company told Mint, requesting anonymity.

Experts believe most lenders will take a 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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