In the 1st half of 2020, a surprising majority of distressed loan relationships we’ve reviewed involved borrowers whose optimistic expansion plans pre-COVID resulted in significant increases in fixed expenses and leverage (financial and operational).
These debt-funded investments – whether it’s equipment purchases, strategic acquisitions or real estate expansion – were intended to facilitate forecasted growth that never materialized pre-COVID and largely exacerbated by the economic shutdown in 2Q2020.
Given the uncertainty surrounding demand and its return, specific analysis of borrowers in this similar position that have leveraged over the last 12-18 months may stave off further credit deterioration.
A few suggestions for your underwriting:
- Projected operating cash flow: Borrower projections realistic given current revenue levels and general demand in Borrowers’ specific industry? How much deterioration can borrower experience while maintaining break-even cash flow?
- Liquidity: Current liquidity comprised of PPP funds? Did Borrower utilize operating cash and/or its working capital line availability for capital investment? Historical RLOC usage vs current availability? Other sources of liquidity (guarantor) that can support operations?
- Fixed overhead: Fixed expenses as a % of total expenses? Trending as a % of revenue? What reductions can be made/have been made?
- Asset utilization analysis: Where does under-utilization exist? What would overall impact be to ‘right-sizing’ operations via disposition of assets?