A primary treasury objective is to maintain and maximize access to the capital and debt markets at the lowest cost – which means consents before the fact rather than waivers after the fact. And since “stuff happens,” treasury needs to pro-actively talk to the lenders about current problems, issues, or potential events that might affect access to those markets.
This can only be accomplished by a thorough understanding of all credit agreements, their ancillary documents, and all of their covenants. To mitigate default risk, a process to identify and determine any issues, both during the quarter and at quarter-end, is paramount – it allows treasury representatives to proactively talk with lenders regarding the issues, while keeping access to lower market rates.
A borrower has a legal obligation to review its compliance with all of the requirements of its financings, including the ancillary documents. That’s a tougher task than you might think given compliance staff turnover and usually the person responsible for compliance was not involved in the original negotiations, and never given time to fully read and understand the covenant complexities. Add to that, the increasing out-year risks of default per S&P and the SOX/ACS 470-10 requirement to justify classifying its debt as long-term by verifying that there are no covenant violations.
All these moving parts – multiple staff members, hundreds of technical documents, many covenants, requirements, and deadlines – make default risk much higher than people think – S&P default data, for BBs, the 5-year hard and technical default risk is 8% and 18%.
Any default, including a technical default, results in public disclosure, stock price hits, loss of control to the lenders and auditors, and customer, vendor and employees concerns. The PCAOB has caused the auditors to more actively test management assertions and internal controls in areas of high materiality risk. Ultimately, a surprise default is an unequivocal treasury mistake.
While Treasury is not responsible for poor operating results, Treasury is responsible for managing lenders and senior management about these high probability covenant issues to maintain the company’s access to funding at the lowest possible cost. Treasury can only do this if it has a strong debt compliance process that comprehensively manages the current quarter, gathering information about existing and potential covenant issues so that they can be monitored, managed and mitigated in future quarters.
There can be only one debt compliance objective: no surprises to your CFO, CEO and lenders! Download the Checklist now.
We’ve done the work and developed a 12-Step Checklist Treasury can take to mitigate its risk of causing default. Follow this Checklist and sleep better at night.
- Fully understand what is expected and comply with all Loan Documents.
- Always conform affected documents for amendments and update checklist and calendar.
- Develop a central repository of all debt agreements, lender comments and interpretations, and internal comments and interpretations by writing them as a memo to file.
- Compare and understand differences in all critical definitions among agreements and amendments.
- Compare similar covenants across all financings and identify the covenants with the stringent requirements and tightest dollar limits.
- Ensure that additions and dispositions to the collateral package are reported as they occur.
- If relevant, ensure that all cash receipts and disbursements are routed through the accounts managed by the Depositary.
- Provide pre-notification of any material changes to the Guarantor that could negatively impact the validity of the Guaranty.
- Make sure that the managers of each Material Contract promptly provide information of any adverse event or action.
- When a new subsidiary is created or acquired, make sure that the Joinder Agreement is signed as soon as possible.
- Understand the protocol under the Intercreditor Agreement that the Creditors will follow if there are any issues.
- In a comprehensive Indenture Checklist, each Supplemental Indenture should be “combined” with its Base Indenture.
- For indentures, understand the impact of the Trust Indenture Act (TIA).
- When relevant, confirm that the Registration is effective within the 6 month and, if not, make sure that the Additional Interest is paid when due.