ASHBURTON INVESTMENTS: Expert Opinions: Edition June / August 2020

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When defaults occur

Ways for lenders to protect themselves are discussed by Corneleo Keevy,
head of credit risk management at Ashburton Investments.

Following the announcement by the Land & Agricultural Development Bank of SA (Land Bank) on 24 April, that an event of default (EoD) occurred on its notes, there has been rising concern around such events occurring on the debt obligations of other issuers.

In the current economic environment, the revenue of counterparties is likely to have been materially reduced due to limited trading during the lockdown. They are also unlikely to have sufficient scope to reduce costs to the same extent as the decline in revenue, therefore ultimately impacting the profitability and liquidity of counterparties. The result is that counterparties could trigger EoDs.

What happens when an EoD occurs?

Upon an EoD, a lender has the right to demand immediate repayment of all outstanding amounts owing. In practice, lenders or creditors rarely enforce this right, as it could result in the triggering of a crossdefault on other obligations of the counterparty and cause a material part of a counterparty’s debt obligations to become due and payable on demand.

As a result, if all creditors exercise their rights to demand immediate settlement of their obligations, the counterparty is likely to have insufficient liquidity to honour all claims. This could result in the counterparty applying to be placed under business rescue, administration or curatorship and/or ultimately being liquidated. Therefore, instead of demanding settlement of their obligations, lenders and creditors will likely commence a formal debt-restructuring process to increase the likelihood of full debt recovery.

Can an EoD be avoided?

Counterparties are often aware of potential financial covenant breaches before the relevant measurement dates. In such cases, counterparties will pre-emptively engage with lenders in an attempt to secure a waiver for the potential EoD before it occurs or to reset the financial covenants. In the event that the counterparty can satisfy the specific lenders that the causes of the EoD have not impacted the long-term sustainability of the counterparty, or that the credit risk on the debt obligation has not fundamentally changed from when it was entered into, it may well be able to secure waivers or amendments from lenders.

What takes place under debt restructure?

The initial phase is characterised by engagements between the counterparty and its debt funders. During the restructuring period, there are many actions to which a counterparty can agree in order to reach an agreement to restructure its debt obligations. These actions may include but are not limited to the cessation of dividends, deferral of non-critical capital expenditure, cost reduction measures, disposal of assets, or an equity rights issue. The ultimate goal of the restructure process is for the counterparty to be returned to a position where it has a sustainable capital structure (solvent) and sufficient liquidity to continue operating and pay its debts. From experience, the debt funders in SA have mostly approached debt restructuring in a responsible and measured manner. We believe this will continue during and after Covid-19.

Conclusion

The corporates which raised funding in the SA debt capital markets were generally well-capitalised with sufficient liquidity to trade through the initial stages of the Covid-19 lockdown. This does not mean that all the borrowers will not seek relief from their funders to avoid potential EoDs. But given their standing, many are likely to receive support from funders.

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