In the immediate term, most Lenders are considering modifications that offer (usually on request only and subject to normal underwriting and credit review) a 60–90 day deferral of payments for principal reductions or both principal and interest. These modifications are typically being enacted only to give the parties (and everyone else) an opportunity to better assess how the COVID-19 outbreak evolves and what impact the government’s response to the outbreak may or may not have on the Borrower’s business going forward. To avoid establishing a course of dealing, Lenders should be clear in communicating that this accommodation is (as of right now) a one-time event and that future accommodations may not be granted. Lenders should consider (a) developing a standard/formal communication to Borrowers which explains the context in which and why the accommodation is being granted and (b) implementing policies to prevent loan officers from over-promising to Borrowers via informal communications such as phone calls, social media, emails, and texts. It is certainly okay (and natural) to empathize with a Borrower’s challenges, but individuals dealing directly with customers should avoid over-committing to another round of accommodations if the outbreak lasts longer than anticipated.
Dealing with Deferred Payments and Interest Accrual
Lenders should consider how interest will be treated during any period of deferral. Will interest continue to accrue during the deferral period? If so, when will that interest be due for payment and how? How will deferred payments be repaid? At maturity? Will the maturity date itself be extended as part of the accommodation? If interest will be accruing during the deferment period, representations that the number of payments being deferred will be added to the maturity date should be avoided, unless the amortization in the loan supports the ability to make such promises. Regardless of how the Lender decides to manage deferred payments and interest accrual, the Lender should take the time to clearly explain the same to the Borrower to avoid any confusion down the line. Additionally, once payment accommodations have been made and clearly documented, Lenders should ensure that their internal accounting/payment systems are set up to properly track the terms of any modification.
Covenant and Reporting Requirements
In the intermediate term, another important consideration Lenders are grappling with is how to manage covenant and reporting requirements going forward. For instance, if a Borrower agrees to payment deferrals for its customers, what impact will those deferrals have on the Borrower’s borrowing base? What about inventory or accounts that become aged and are not replenished due to a longer than expected shutdown? Most Borrowers will have a difficult time complying with their financial covenants going forward as well due to the economic impacts of the crisis. Lenders will need to re-think how to measure a Borrower’s financial health during this crisis. In anticipation of these issues, modifications done in the immediate term should contain standard reservation of rights language. Additionally, Lenders should consider developing a form reservation of rights letter that can be used (as needed) to document covenant and reporting defaults during the crisis when enforcement action may not be desired and/or may be legally prohibited.