POST COVID CORPORATE DEBT RESTRUCTURING IN KENYA: LESSONS FOR BORROWERS AND LENDERS

COVID-19 has severely affected the global economy and financial markets. Significant reductions in income, rise in unemployment, and disruptions in the service, and manufacturing industries are among the consequences of the disease mitigation measures that have been implemented in many countries.

As a result, many corporate borrowers are finding themselves in a tight spot with declining revenues and reduced workflow against their payment obligations in respect of the existing facilities. Consequently, the Lenders have engaged the Borrowers in financial difficulties to have their debts restructured to avert insolvency procedures.

Post-Covid debt restructuring will benefit both the lenders and the borrowers. The impact of the Covid pandemic has affected even the most sound and well-run businesses. It is therefore not an isolated challenge and neither can it be attributed to any policies of the business or poor judgement. It is against this backdrop that lenders are required to consider restructuring when faced with such requests from borrowers. The lenders will stand a better chance of eventually being repaid in full while borrowers bounce back and continue with their business and improve productivity and ultimately revenue generation.

A.??LESSONS TO LENDERS

The highest impact on lenders is related to their loan portfolios where borrowers across different sectors are facing a sharp decline in their income, and hence the difficulty in discharging their payment obligations as they come due.

1.???Lenders are encouraged to restructure loans and use the flexibility embedded in the prudential framework to continue financing viable firms. This ensures that confidence in the lending system is maintained by ensuring that losses are not hidden and prudential standards are not relaxed;

2.???Based on an assessment of the borrower’s capacity to pay under new terms, Lenders can renegotiate terms (maturity, interest rates, and fees), moratorium policies or grace periods/payment deferrals. A grace period to repay loans could help borrowers manage the temporary impact of the crisis;

3.???In restructuring currently performing loans impacted by the outbreak, lenders should first assess the capacity of repayment and performance of the loan under the revised terms and should also follow the requirements related to restructured loans, using the flexibility embedded in the regulatory framework.

4.???Whether restructured or not, loans could become non-performing due to the effects of the pandemic. Lenders should consider provisioning which entails recognising a loss on the loan ahead of time. Depending on the terms of the restructuring, the number of provisions might be small (for example, if only the interest rate is reduced). Some performing loans may also require higher provisioning due to a significant increase in credit risk.; and

5.???Additional financing to impacted firms should be based on the firm's ability to repay and should not lead to a relaxation of underwriting standards. Lenders should review substantial changes in loan practices and assess whether these activities are consistent with the lender’s credit policies and risk profile while taking into consideration credit enhancements that might be provided.

B.???LESSONS FOR BORROWERS

Distressed borrowers should engage with their lenders to have their existing debts restructured as it provides the following benefits:

1.???This will enable borrowers to repay their loans without affecting their businesses. Reduction of interest rate has a domino effect. With reduced interest rates, a borrower will not pay as much as before, meaning that they have more money available to run the business. Once the borrower has enough cash flow, the growth of the business is inevitable.

2.????Allows borrowers to settle for more favourable terms in the loan repayment plan and with much more improved repayment terms, borrowers can rearrange their finances to ensure that they keep the business afloat.

3.???Results in the protection of borrower’s assets. Whenever a borrower takes up a loan, they have to provide collateral. Upon facing some financial constraints that make it impossible to repay a debt, lenders will realize the collateral and sell them to recover the outstanding loans. With debt restructuring, such an eventuality is unlikely to happen as the borrower is in a better position to repay the debt, thus protecting the business assets.

4.???Debt restructuring while offering relief to borrowers struggling to keep up with their debt repayments is captured in the borrowers’ records and hence affects the credit appraisals when the borrower requires new facilities. A high credit score is attractive to lenders because it indicates that one is creditworthy. However, if one takes up a loan for restructuring, lenders can indicate the purpose for which it has been availed, making future creditors get concerned about the borrowers’?ability to handle their finances. As a result, the borrowers’?credit score is negatively affected and hence diminishing their chances of securing future loans. The borrowers should therefore take advantage of debt restructuring to turn around their financial strength and hence present a sustainable business with strong indicators for any future loan requests.?

5.???A prolonged repayment period translates into payment of more interest. This will have an impact on the borrower’s bottom line and therefore borrowers are advised to repay their debts soonest possible.

Conclusion

Lenders could still face additional losses due to COVID-19 and should identify vulnerabilities and look ahead to their financing products. Borrowers on the other hand if concerned about a potential breach should approach lenders as soon as possible to notify them of the potential breach and request for a restructuring of the debts. With the decline of the containment measures brought about by the pandemic, many businesses will bounce back and the revenues will grow. The lessons picked from the pandemic will therefore ensure that borrowers provide adequate safeguards for their business through innovative offerings and the use of technology to reduce their overheads. This will also provide flexibility in the financial sector where the lenders are faced with limited choices in the face of declining or non-existent revenues and hence the need for the stakeholders to continue engaging to develop robust practices that safeguard the interests of both the lenders and the borrowers.

Authors: Isaiah Mungai Kamau , Judy Guandaru , Joy Murugi Omulele and Vivian Namisi