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Key Priorities for Borrowers in a Bear Market

Tracking the financial covenants in loan documents is a key priority for borrowers in a bear market.

Breach of a financial covenant ultimately may lead to acceleration of the outstanding loan(s). The more likely scenario, however, at least in the short term, is a cash trap (when rent income, which would otherwise have been available for the borrower’s use, is (temporarily) trapped into a blocked account and under circumstance may even become subject to a mandatory cash sweep) and a waiver process, whereby the latter almost by definition means more restrictions (for example, on distributions) and payment of a waiver fee as a quid pro quo for waiving the default as a result of the breach and, if necessary, either resetting the covenant and/or invoking a covenant holiday.

Two of the most common financial covenants in real estate loan documents are Loan-to-Value (LTV) and Debt Service or Interest Cover Ratio (DSCR or ICR).

  1. LTV: an LTV breach can be projected based on internal desktop valuations, but – in the absence of (possibly) significant prepayments – it is difficult to prevent. The timing of the valuation and, hence, the breach is, within limits, under the borrower’s control. This could provide an opportunity to discuss an anticipated breach without having one’s back against the wall.

  2. DSCR / ICR: benchmark rate increases are unlikely to cause an ICR or DSCR breach as a result of lenders being required to enter into hedging arrangements to fix the floating limb of the applicable interest rate. However, a single tenant or material tenant’s financial difficulties in a multiple-tenant property may cause rent income to decrease significantly. Headroom in the covenant, for example based on a sufficiently high vacancy rate when drafting the budgets and agreeing on the ICR levels, or indexation provisions in lease agreements to offset loss of rental income, may provide a cushion for a decrease in rental income. Reevaluating tenants and/or the sector in which they operate may warrant borrowers initiating a discussion on the correct(ion of the) DSCR or ICR.

When it comes to tracking financial covenants, if you’re on time, you’re late. This saying is (also) true for discussing financial covenants with your lender(s). By the time a breach is imminent, a borrower is no longer in the driver’s seat, and the credit may no longer sit within the relationship team. Being aware of financial covenants so as to address potential breaches and have a commercial discussion with the relationship team will be key in navigating these uncertain times.

©2023 Greenberg Traurig, LLP. All rights reserved. National Law Review, Volume XII, Number 335
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About this Author

 David van Dijk Amsterdam Real Estate Attorney Greenberg Traurig
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David van Dijk is one of the Netherlands’ most prominent real estate lawyers and heads Greenberg Traurig's Dutch Real Estate Practice. He focuses his practice on commercial real estate, with emphasis on investments, project development, as well as real estate-related litigation. David joined Greenberg Traurig with his team in December 2020 from a leading Dutch firm, where he headed the Real Estate Group. He has more than 20 years of experience handling international real estate matters.

David is ranked in tier 1 by Chambers in the...

31-20-301-7321
 Thijs Elseman Amsterdam Finance Attorney Greenberg Traurig
Shareholder

Thijs Elseman is a member of Greenberg Traurig's Finance & Restructuring Group. He focuses his practice on corporate finance, restructuring and insolvency. Thijs advises corporates, investment banks, financial institutions and private equity investors on a wide range of corporate finance transactions, including bilateral and syndicated loans, acquisition and asset financing and debt and equity capital market transactions. He is regularly involved in complex, distressed financing transactions and cross-border restructurings. Before joining Greenberg Traurig in 2022,...

31-20-301-7406
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