Finweek English Edition – August 15, 2019

By Simon Brown

marketplace invest DIY

COMPANIES

When a business is too indebted

Be wary when a company breaches its debt covenant and the bank needs to step in.

t

hey say a banker lends you an umbrella

when it’s sunny and then wants it back

when it’s raining. But this cliché isn’t really

fair. Bankers often come in at the worst time

in a company’s life, having to try and save it.

Sure, they’re protecting their own business

interest – in most cases loan advances. Let’s

be fair, protecting their business interest is not

a bad thing. If they didn’t, the company and the

bankers would go out of business and there

would be no bankers left to lend us money.

Currently, many locally listed stocks are

getting into trouble with debt and breaching

their debt covenants. These covenants are

essentially conditions imposed at the time of

the loan and require certain financial ratios be

maintained, otherwise the debt is in breach.

In good times, covenants are no problem.

But when things go south, they become a real

problem for both lenders and borrowers.

While a covenant breach means a debt can

be recalled immediately, this seldom happens.

When debt is recalled, the company is likely to

go bankrupt, and the lender would get very little

(or nothing) back. Therefore, with covenant

breaches, bankers often pretty much take

over the finances of the company, certainly the

bigger picture issues like asset sales and raising

cash to reduce debt.

You don’t want bankers running the

business; they’re not necessarily experts

in a specific sector. But they are experts in

debt, refinancing and other issues critical

to the survival of the business. They know

how to restructure loans and generally keep

the business afloat while waiting for trading

conditions to improve.

Bankers won’t gut the business purely for

their own gain. (Where there have been claims

of this, criminal proceedings should follow.)

Similarly, large shareholders often put

serious money in via a rights issue aimed at

saving the business. The claim is that they’re

throwing good money after bad. But they’re

also trying to save their original investment by

keeping the business alive.

Bankers try to protect the business and get

it profitable so that they can get the loan(s)

repaid. But a few important questions must be

asked. Will they succeed? Why did the business

reach such a critical state? Can management be

trusted to not almost bankrupt the business a

second time after the bankers have ‘repaired’ it?

A company going bankrupt will always be

the last resort. But even a ‘saved’ company

will struggle to regain market trust. Yes, the

business has been kept afloat, but at what cost

to the business and, ultimately, shareholders?

So, while a stock you own may be saved

• and that’s great – it is no longer a great
  investment. You’re better off exiting and finding
  a great investment. ■
  [email protected]

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