When considering corporate lending applications, banks have always dealt with the assessment of a corporate borrower’s creditworthiness retrospectively. This is now set to change, creating new challenges for both borrowers and lenders.
Germany’s Minimum Requirements for Risk Management (“MaRisk”) applying to banks are about to be amended. The post-consultation version of the 7th MaRisk Amendment is scheduled for publication this summer – the final published version of the amendment is expected towards the end of the year. As well as incorporating the European Banking Authority’s guidelines for the inclusion of ESG (environmental, social, governance) factors in credit institutions’ risk assessments (“EBA Guidelines on loan origination and monitoring 2020/06”), the 7th MaRisk amendment will also cover the requirement for sensitivity analyses in future creditworthiness checks by banks.
In the course of assessing the creditworthiness of and “granting of credit to medium-sized and large enterprises”, the EBA expects credit institutions to evaluate a corporate borrower’s current and future ability to meet their obligations under the loan agreement. This assessment should take multiple factors into account, among them the borrower’s financial position, corporate structure, business model and business strategy, as well as all their financial commitments.
Along with the company’s current and projected financial position, capital structure, net operating income, dividend distribution policy and source of repayment (= debt servicing) capacity, banks should focus particular attention on their analysis of the borrower’s “free cash flow available for debt servicing”.
These analyses must take account of the impact of potentially adverse conditions. These may include, on the one hand, “market events” such as a macroeconomic downturn, changes in political, regulatory or geographical risk, or an increase in the cost of funding (that could be plausibly predicted on the basis of current capital market trends). On the other hand, “idiosyncratic events”, meaning credit-related events including but not limited to a decline in the company’s revenues or profit margins, an operating loss, failures of key trading partners, or an increase in balance sheet leverage, should also be taken into account. Both types of events may have an impact on the borrower’s viable financial position – hence also creditworthiness – over the term of the loan agreement, and in particular, may negatively impact the borrower’s ability to make repayments. When accepting collateral, which should not in itself be a “predominant criterion” for approving a loan (so should only ever be considered, according to the EBA Guidelines, as “the institution’s second way out”), the value of the collateral should also be included in the sensitivity analysis as a function of the company’s cash-flow situation.
A meaningful and consequently plausible sensitivity analysis based on the abovementioned market and credit-related (“idiosyncratic”) events – hence capable of accurately predicting the company’s future debt servicing capacity – requires the existence of a solid, resilient business plan. The analysis should also include scenario-based analyses of the key planning parameters, including: (a) cash flow from operating activities, (b) working capital requirements, (c) capital expenditure and (d) dividend distribution/withdrawals. Business projections should always be realistic, reasonable, and in line with economic and market expectations. If the bank has serious (material) doubts about the reliability of the company’s projections, it should draw up its own projections. Depending on the bank’s current approach, this may have significant consequences for its lending commitments to medium-sized and large enterprises.
These more stringent requirements for granting credit mean that banks are becoming much more demanding, which in turn is making the preparation of new financing applications a more laborious process for medium-sized and large companies. The changes mean that banks are increasingly moving into line with other providers of debt capital such as debt funds, for whom such documentation requirements – and in particular, analytical scrutiny of business planning scenarios – have always been standard practice.
This means that from a corporate perspective, it is now necessary to be proactive in drawing up a well thought-out, resilient business plan, and to implement systems and processes that facilitate the creation of the documentation required to apply for credit so that the company is as well prepared as possible for potential emergencies. When lending to companies, banks have always assessed their creditworthiness retrospectively – now this is expected to change, creating new challenges for borrowers and lenders alike. Both perspectives are covered in detail in our two certification courses Corporate Banking Professional (for banks) and Corporate Finance Professional (for companies), based on real-world examples that encapsulate the key concepts of corporate financial management.