Locking down liquidity - 10 tips for a successful refinancing

• United Kingdom

• Banking and finance
• Corporate finance

07-10-2022

Against the backdrop of challenging macro conditions and with the cost of capital escalating, optimising and locking down liquidity has become a key role of the Treasury and Finance team of any business. When seeking external funding, lenders are generally well capitalised and open for business, but the bar is rising, and Borrowers need to take stock of their position in this changing environment and adapt their approach if they are to meet their refinancing aspirations. Here are our latest tips on locking down liquidity.

1. Credit story

With Brexit, Covid 19, Russia/Ukraine and now the latest fiscal and monetary events challenging the economic fortunes of many sectors and businesses, credit/investment committees are being more demanding of Relationship Directors in terms of the rigour of their credit assessments, particularly for unrated or more heavily indebted borrowers. A poorly articulated credit paper risks receiving the ‘wrong’ answer from the credit committee or making the decision to lend on required terms a harder one.

As such, in a similar way to equity investor days for institutional shareholders, borrowers should ensure their lenders are equipped with the most up-to-date information regarding performance, strategy, outlook, risks and opportunities to ensure they are represented in the best possible way.

2. Cost of capital

The cost of capital is rising as central banks look to curb the impact of the current inflation spike. Whilst the result of this has been much more visible in the public debt capital markets, recent monetary policy has bought this into much greater focus for all. Indeed, all Borrowers now need to understand where their pain points are by ensuring forecasts are updated to factor in latest medium term interest rate expectations, to have considered appropriate hedging tools and techniques to mitigate further exposure and to have ensured that their financial covenants are reviewed against latest rate expectations.

Recent interest rate volatility has meant that hedging or pre-hedging is becoming an increasingly important consideration for borrowers. Pre-hedging via swaptions (to protect against adverse rate movements ahead of a future financing) and hedging with swaps or caps (allowing borrowers certainty or the ability to benefit from capped interest rates) have increased in popularity.

In terms of margins, Covid premia - where banks temporarily re-priced risk - have now largely fallen away, with a return to pre-Covid 19 margins. That said, as credit conditions evolve, banks’ internal rating methodologies may reassess the probability of default for certain sectors and credits, and this may have an adverse impact for some borrowers.

3. Tenor

Tenor appetite reduced to three years at the start of the Covid 19 pandemic but has now largely returned to four or five years (with extension options). Some borrowers are trading tenor for price, with 4+1 becoming an acceptable compromise for many mid-market participants. Lenders may also be able to better meet their return on capital aspirations by sacrificing a year of tenor, and borrowers should consider this if the alternative is to lose a key relationship supplier of credit. That said, in sectors that are less resilient to economic headwinds, such as consumer facing, transport or those less able to pass on input cost rises, shorter tenors of 3 years may be preferred by lenders.

4. Ancillary

Whilst there are lenders whose sole interest is the underlying credit, most lenders are attracted to a particular lending situation by their ability to subsidise their cost of capital with lucrative non-risk ancillary business. As such, sharing ancillary wallet around the lending group remains a key role for a borrower and ensuring that this is distributed both evenly and strategically is key.

Communication with lenders is vital so as to understand what they particularly covet and over what time period. Equally, ensuring the right mix of lenders in a syndicate is important to ensure that each has a realistic prospect of achieving their aspirations, whether that is providing ancillary business in a certain geography or for a particular product set.

5. Geopolitics

There is clearly much uncertainty about how global events will play out - particularly the impact of sanctions, supply constraints and central banks’ ongoing reaction to rising inflation. As no-one can confidently predict what will happen with regard to Russia/Ukraine, many corporates are currently observing events and altering strategies.

Whilst capital remains relatively plentiful and inflationary pressures are largely factored into decision making, lenders will focus on understanding their customers’ exposure to sanctioned regimes, individuals, counterparties and suppliers, and what measures have been put in place to protect the borrower from the impact of any recent changes to sanctions. Lenders will definitely have questions around exposure to Russian / Ukrainian clients, counterparties or suppliers, and the borrower should be ready to provide the necessary answers.

6. ESG

As sustainability and its relationship with debt becomes better understood, many borrowers are likely to consider incorporating ESG features into their loan and bond agreements - albeit some borrowers still query whether it is justified given the time and incremental cost involved. Margin adjustments alone are not the driver of sustainable finance, however, and the more fundamental trend is a borrower's attitude towards ESG where, over time, it is increasingly likely to drive the binary decision by debt investors and lenders as to whether to lend or not.

Banks, due to increased pressures from their own stakeholders, are motivated to work with borrowers to incorporate sustainability KPIs and targets into their financing arrangements, and all borrowers should prepare themselves for this and consider ESG aspects in their forthcoming financing discussions. In club or syndicated situations, banks are also fiercely competing for the coveted ESG co-ordination role and the league table credit this brings.

7. Banking relationships

Retrenchment or scaling back by some debt providers has become a recurrent theme as banks seek to re-focus on how and where they deploy their capital. Indeed, given the current market disruption, some lenders may decide not to lend either as a result of revised credit policies or a refocus on particular sectors, currencies or territories. As a result, we are seeing increased movement in the composition of syndicates. In response, borrowers need to understand their lenders’ ongoing appetite and strategy for their credit on a regular basis and have a broad range of alternative banking relationships to call upon, if necessary, in order to drive a smooth process and achieve the best possible terms.

8. Debt advisors

With a constantly changing landscape, market volatility and evolving terms, the benefits of getting an experienced advisor on board cannot be underestimated. A good advisor will be in the market talking to lenders on a daily basis and can therefore provide a good steer as to which lenders to prioritise for a particular credit. The debt advisor can also assist with presentations and modelling as part of the selection process and can initiate and oversee the legal aspects of the transaction.

That said, it is important to keep in mind that appointing an advisor does not mean that management of, and relationship with, lenders should be delegated completely. It is the borrower who will be working with the lenders once the financing is completed and long after the advisor has moved on to their next transaction.

9. Legal advisors

The choice of legal counsel will be key to facilitating the smooth running of the transaction. A borrower should ensure that its counsel has the right expertise in order to advise on the refinancing – having advised borrowers of a similar credit and being familiar with the relevant precedent documentation and current issues in the market. The selected legal counsel should appreciate the context in which the refinancing is being undertaken, the key objectives for the borrower, and any specific areas of concern.

A borrower will want its legal counsel to be pragmatic in their advice and in their approach to negotiations, not dwelling on points of low importance from a commercial or legal perspective. If there is an overseas aspect to the transaction (for example, a set of overseas guarantors), then it can be helpful and efficient if the appointed law firm has their own offices in the relevant jurisdictions. Often a borrower will want its own legal counsel to hold the pen on the legal documentation, giving the borrower an added degree of control over the process.

10. Timing

Whilst the loan markets have tended to remain resilient throughout economic cycles, clearly there has been some impact over recent times as global events have tested funding availability and pricing, and borrowers have had to adapt their requirements and priorities to get the optimum terms available. Many have chosen to defer a full refinancing in favour of short term extensions, but with the increasing global headwinds, we are starting to see more and more borrowers looking to launch longer term refinancings. Benjamin Franklin once famously said “Don’t put off until tomorrow what you can do today”; perhaps in the loans market context that should read “Refinance when you don't have to, don't wait for conditions to improve”.