Curing “Term Loan-itis”

An aversion to term loans permeates the finance marketplace

Many lenders have “term loan-itis” today. A challenged US economy has sent lenders reeling and caused them to tighten up credit approvals for borrowers in need of term loans, both new applicants and existing borrowers alike.  Revolving credit lines secured by accounts receivable and inventory are much easier for lenders to approve.  Banks have difficulty getting repaid by replacement lenders on the term loans sitting within bank loan portfolios, making it even more difficult for new transaction requests.

Symptoms of “Term Loan –Itis”

Borrowers have paid down their term loans and are asking for you to re-advance (sometimes called “re-load”) the term loan back up to a percentage of liquidation value of the equipment. Lenders say no because equipment values have dropped precipitously.

Borrowers seeking to leave their current lender find that replacement lenders are unwilling to lend enough dollars to fully repay the existing loan because the amount necessary to pay the exiting term loan is too high.

Borrowers requesting capital expenditures facilities to acquire new machinery and equipment for business expansion are being declined by their current lender and/or new lenders.

Lenders are re-appraising machinery and equipment during the middle of the term of a loan and security agreement only to find that appraisal values are coming in lower than the amount of loans outstanding. The result – lenders are foreclosing on borrowers that are making all of their payments on time to the lender, forcing these companies into bankruptcy or liquidation.

The issue is the appraisal of assets – particularly machinery or equipment.  The slowing economy, declining valuations and increased scrutiny on financial statements means that lenders who appraise collateral today based on credit issued over the past 24-36 months have found that otherwise good loans are suddenly unsecured. Auctioneers are reporting that machinery and equipment appraised at high auction values two and three years ago are now often bid at 20% -30% of the original auction value and sometimes do not even fetch a bid at auction.

Unlike receivables and inventory that can be liquidated in the short term, lenders are nervous about underwriting a credit on long term assets whose values may not hold up over time.

The immediate result of these economic trends is that lenders have significantly tightened their credit standards:

• Many lenders will no longer lend at a percentage of Orderly Liquidation Value. Now lenders are looking at a percentage of Forced Liquidation Value, a much lower value.

• Lenders’ tolerance for Companies coming out of a turnaround or any situation impacting cash flow is much lower than ever. Lenders prefer not to provide term loans to Companies without uninterrupted cash flow over historical periods.

• Lender appetites for capital expenditure financing is at an all time low as lending officers prefer to deal only with the term loans already in existence, and not increase term loan exposure to borrowers.

• The percentage of term loan on a total credit facility that lenders are willing to offer to borrowers is dropping, now closer to 25% than 50%. Capital intensive businesses are being forced to look at equity alternatives to finance growth.

The Cure For “Term Loan-Itis” 

There is, unfortunately no quick fix for this problem. It will take many years for the US

economy to turn around and for lenders to compete aggressively for term loan facilities. There are however, some steps that can be taken to help in certain situations.

 Divide and conquer By far, the most efficient means by which to combat this issue is to finance the term loan with a specialized term loan lender, and leave the revolving credit facility with the current lender. Lenders that may ask borrowers to leave their institution and repay the entire loan are often comfortable with allowing the term loan portion to be refinanced elsewhere, and even increase the remaining revolving credit facility to encourage the borrower to stay.

 Due Diligence As An Art Form Take control of your due diligence process by demonstrating adjusted EDITDA by giving rise (and credit) for non-recurring items and pro-forma restructuring results can often convince lenders that your company’s cash flow is under control, and that you have the ability to service term loan debt based upon the historical results of operations.

 Alternative Communication Channels Lender liability limits the counsel that can be given by lender to borrowers, and sometimes even their accountants and lawyers. Choose someone in the finance industry that is recognized by lenders and can speak their language. This can often make the difference between a borrower being forced to leave a lending institution at great expense, and really understanding what the lender wants and is willing to accept.

Primagency can work with Borrowers, their representatives, and the lending community to effect solutions to address the problems associated with Term Loan-Itis”. No doubt, these are difficult and challenging issues for all parties. Primagency has a broad view of the marketplace, and as Agency of Record to middle market companies, can often successfully re-structured loans to the benefit of both the lender and the borrower.