The future of lending in a post-coronavirus landscape

LENDING IN A POST-CORONAVIRUS LANDSCAPE

The inability of borrowers to produce reliable forecasts, and of valuers to make site inspections, has led many funders to refuse all new loan applications while the current lockdown continues.  When restrictions are eventually lifted, however, we are likely to see a renewed appetite to lend to certain businesses, particularly given the availability of government assisted lending.  It is not difficult to spot those business sectors, such as logistics, pharmaceuticals and e-commerce, which will benefit from the current crisis and are likely to source finance for expansion.  While COVID-19 may well have stalled most buy-to-let conversions, funding for social or supportive housing projects is likely to increase.  Lenders and borrowers will, nevertheless, need to adapt to the new social and economic reality.  In our previous blog post we considered the impact of Coronavirus on existing debt facilities; we now explore the issues likely to be faced by prospective borrowers and lenders.

Outmoded formalities

The severe global restrictions imposed on businesses have served to highlight the inadequacy of many current practices.  Paper-based identity checks, still hitherto used by the majority of lenders and their advisors, are unlikely to be viable for so long as there is a prevailing concern over the risk of contamination.  We envisage a more widespread transition to online forms of verification.

Property lenders currently require receipt of wet-ink signatures on security documents due to the Land Registry insistence on the filing of originals or certified copies thereof.  Following the temporary measures introduced by HM Revenue & Customs to accept e-mail filing of stock transfer forms executed by electronic signature, it is surely only a matter of time before similar relaxations are introduced more widely.

It is current best practice for deeds to be witnessed in person, and most lenders will require independent advice to be given to guarantors and third party chargors at a face to face meeting.  A number of our lender clients already accept independent advice by video conference, and even by conference telephone if the advisor has taken prescribed measures to verify the identity of the client.  One hopes to see a movement towards the acceptance of witnessing by video and, in the longer term, the valid execution of deeds through electronic verification of signatures, rather than witnessing in person.

Asset-based lenders

Property lenders are currently hampered by the reluctance or inability of valuers to undertake site visits.  Some lenders continue to make offers based on desktop valuations.  In our experience this is fraught with difficulty; often, an inspection will identify critical issues such as unauthorised occupation (jeopardising the unregulated status of a bridging lend to an individual borrower if the occupier is the borrower himself or a related person).  Furthermore, desktop valuations are likely to be heavily caveated, with the reportedly increasing usage of “material uncertainty” clauses; even without such blanket qualification, any desktop report is likely to be inherently limited by reference to historical sale prices.  This is perhaps the most serious problem facing our lender clients, for which there is no obvious solution other than waiting for the current restrictions to end.  In the meantime, lends based on desktop valuations are likely to be subject to low LTVs.

Invoice discounters will be particularly keen to investigate the solvency of the debtor book, and any so-called “force majeure” clauses which may allow customers to delay payment, thereby frustrating enforcement on default.  One expects to see requirements for lower debtor concentration, and more widespread exclusion of specific debtors.

Due diligence and Conditions Precedent

Lenders are likely to undertake more detailed, targeted due diligence on particularly vulnerable aspects of a borrower’s (or, on acquisition finance, target’s) business; for example, supply chain issues, key contract terms, the ability of the workforce to adapt to remote working, and business continuity and data protection challenges.

Historically, where regulatory approvals and third party consents are required for specific aspects of a funding project, many lenders have been content to allow drawdown to proceed on the basis of so-called “conditions subsequent”, with a requirement for the borrower to obtain such consents within a stipulated period of completion.  Such conditions are usually agreed on the assumption that any such approvals are likely to be a rubber-stamping exercise.  Given the uncertainty over the ultimate duration and severity of the disruptive social distancing measures, lenders are unlikely to adopt this approach on future transactions. Borrowers will need to ensure that the conditions to completion of a property, share or business acquisition are fully aligned with the more extensive conditions precedent to any acquisition funding.

Covenants

Lenders should look afresh at financial and other covenants, the templates for which will probably not have altered materially for some time.  For example, compliance with financial reporting and project monitoring obligations is largely taken for granted.  Common sense dictates a more proactive investigation of the robustness of the borrower’s finance department, and the business continuity procedures of third party professionals and agents.

More stringent covenants are inevitable; borrowers should therefore negotiate grace periods where possible and carefully consider the practicalities of any contractual ability to remedy default.  The power to cure a loan to value default on a particular property within a security portfolio may, for example, be frustrated by restrictions on the borrower’s freedom to dictate the application of any prepayment of the facility.

Conclusion

High volume lending on standard, largely non-negotiable terms frequently encourages complacency by both borrowers and lenders, and the incentive to conclude a transaction within an unrealistic timescale sometimes results in a failure to appreciate exactly how covenants mechanisms will work in practice.  Our most successful lenders have adopted a flexible and commercial approach to loan structures, while not compromising on due diligence.  The current crisis may at least give everyone pause for thought and, by necessity, result in an approach to finance transactions that is more critical and pragmatic.

If you or your business require information regarding debt facilities, please call our Banking and Finance Partner, Philip Round, on 07826 906849 or e-mail him at pround@georgegreen.co.uk for advice and assistance.