A recent survey conducted by SRS Acquiom reveals that lenders are becoming increasingly concerned about the impact of higher interest rates on their portfolios.
The survey included investment banks, law firms, bank and non-bank lenders and was completed in late September.
The survey was conducted to gauge the participants’ views on the impact of the five interest rate increases made by the Federal Reserve in 2022, on the economy, lenders’ loan activity and their portfolios.
SOME KEY TAKEAWAYS …
Some of the key takeaways from the survey include:
At least one-third of the respondents indicate that more debt facilities are becoming distressed as a result of interest rate increases- The Federal Reserve’s actions have also increased the risk profile of many debt facilities resulting in nearly 60% of respondents finding it more difficult to assess risk
- One-third of respondents (33%) indicate that they have some, but not many, credit facilities that require loan restructuring. Almost a quarter (24%) state that some loans in their portfolio require restructuring review
- Lenders are exploring a wide array of options with their borrowers to avoid bankruptcy filings, with most (69%) looking at multiple approaches including covenant revisions, more flexibility in payment options, rate adjustments and more
PAST VS. CURRENT PERFORMANCE …
While lenders are becoming increasingly concerned about the potential for rising loan losses, there is a risk that lenders are not acting fast enough to mitigate current risk.
The main concern is that lenders have a view of their borrower’s performance based on past financial results. Lenders typically receive borrower’s financial statements on a monthly or quarterly basis.
This provides a financial snapshot of their past performance, however, it does not reflect current or future performance.
With the pace and size of the Fed’s interest rate increases, along with the anticipation of likely additional rate increases to come, there is no question that the negative impact will only accelerate and impact future earnings.
SOME BETTER INDICATORS …
In order to get a better handle on their borrower’s performance, lenders should ask for financial projections for not only the income statement, but also for the balance sheet and cash-flow statements.
Some lenders receive annual financial projections at the beginning of each year, however, in the current environment, it’s extremely important to discuss the borrower’s performance with management on a quarterly basis.
Updated projections should also be requested frequently for companies that are starting to show signs of stress. If lenders are not receiving financial projections, they should start requesting them at least for companies that are showing year-over-year declines.
3rd PARTY PROFESSIONALS …
Lenders can use these projections to track current performance compared to what the borrower had anticipated and use them as a basis for a frank conversation about what is being done to improve performance.
Lenders should understand that borrowers tend to put a positive spin on the future regardless of what the numbers suggest.
Lenders should be very concerned about a borrower’s response that suggests that business will improve soon.
This typically indicates that management is not taking the operational problems seriously enough and the lenders should dig deeper.
If the borrower does not provide adequate answers consistently, the lender should consider bringing in a third-party professional to help them assess the situation.
A PROACTIVE APPROACH IS BEST …
The lender’s attorneys can also be helpful in providing advice. Attorneys are typically involved in creating loan documentation as well as preparing forbearance agreements when borrowers violate their financial covenants. 
Attorneys can be helpful in suggesting that lenders have the right to request financial projections in the initial loan documents.
If the attorney is asked to prepare a forbearance agreement, particularly if there is a history of multiple forbearance agreements, they can provide insight into what the lenders might do in the future to mitigate risk if future covenant violations continue.
Now is the time for lenders to be more cautious as interest rates increase and the high rate of inflation continues to take its toll on companies.
Taking a proactive approach in dealing with potential risk will help mitigate future loan losses and allow the lenders to retain borrowers instead of asking them to find a new lender.
Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering, a State Receivership or Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.
