Time To Revisit Your Loan Arrangements

Now that the recession has hit, banks will be scrutinising the terms of loan arrangements, so now would be a good time to review your documentation.

We are now officially in the grips of a recession, which is likely to continue for a sustained period of time. Despite the massive bail out by the Government, the banking crisis continues to escalate, with banks announcing record losses of billions of pounds, and the Royal Bank of Scotland making the biggest loss in UK corporate history.

Therefore, it is not surprising that banks are taking every measure to mitigate these enormous losses. One of the easiest ways to do this is from their existing customer base. In our experience, banks are using every trick in the book to alter the terms and conditions with customers to favour their interests. There is more incentive to do this for loans made to the RP sector, as margins achieved on RP lending traditionally have been low. As a result, banks are paying far more attention to what is included in your loan documentation, including covenants and notifiable events. It is important for RPs to be aware of this and hopefully remain one step ahead of the banks.

Revisit Your Loan Documentation

It is well worth re-familiarising yourself with your loan documentation. We fully appreciate that it is a lengthy tome, but there may well be terms and conditions that were entered into at the inception of the loan which have been forgotten, or weren't considered relevant at the time the loan was entered into.

In particular, you may find that there are a large list of events where you need to notify the bank and obtain their consent. Such circumstances will include mergers and changes to year end, constitution, group structures and auditors. The bank's reaction to being notified to a change in circumstance may need to be factored in when making strategic decisions, as it may give the bank the opportunity to revisit the terms of the loan and the rate that you are charged. For example, we have recently seen a simple group reorganisation lead to a renegotiation of terms to a significantly higher rate of interest, even though the substance and the risk profile of the RP in question had not changed.

Covenant Compliance

Banks are looking far more carefully at compliance with bank loan covenants. This includes covenants of all types, financial and non-financial. Some organisations view non-financial covenants as 'soft covenants' and do not take them as seriously as financial covenants. For those organisations, be warned, your bank may not share this view and all covenants should be taken seriously. If the breach of covenant enables the bank to demand immediate repayment of the loan, this may provide it an excuse to renegotiate the terms of the loan and achieve a higher rate of interest and charges.

An example of a non-financial covenant would be the provision of management accounts within a certain deadline.

However, aside from the action that the bank might take if a covenant is breached in these circumstances, there is further bad news within the financial reporting standards (FRS).

If an organisation does have the misfortune of breaching its covenants during the year, FRS 25 paragraphs 50A to 50E apply. These paragraphs provide guidance on the split of loans between current and long-term liabilities and prescribe that the accounting treatment is dictated by the position at the year end. FRS 25 dictates that if a covenant is breached prior to the year end, the loan is classified as a current liability. This is unless the lender agrees prior to the year end to a waiver or to a period of grace beyond 12 months from the balance sheet date. This applies even if the lender agrees to a waiver or grace period after the year end. Therefore, the only way to avoid this re-disclosure is to receive written confirmation from the bank prior to the year end.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.