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Article :: Guidelines for Managing Customer Negotiations

Category: Finance
By: Zoran Miljkovic





In today's turbulent economic environment, providers of credit, particularly commercial banks, are under considerable pressure to balance the demands of revenue growth with the need to protect and preserve shareholders' capital.  The purpose of this article is to help lenders (i) standardize and memorialize certain best practices when dealing with clients and (ii) to establish a framework for productive and proactive negotiations when fielding customer requests for increased credit and/or acquisition financing.  By respecting the guidelines articulated below, banks and other lenders can utilize their intellectual resources in the most efficient and cost-effective manner possible by focusing their energies on what is important and not merely reacting to what is "urgent".


Over the past several months as the credit cycle has dipped into the trough, banks and other lenders have entertained numerous customer requests for, among other things, increased credits facilities, waivers of covenant breaches, extraordinary distributions of shareholder capital (especially germane for U.S. borrowers incorporated as Sub Chapter "S" corporations), and acquisition financing.  In response to these types of requests (particularly for covenant waivers), banks have discretion as to whether they demand something in return, which could take the form of increased pricing, work fees, additional security, more stringent credit structures, or any combination of the foregoing.  Acknowledging that revenue growth is usually an enterprise-wide imperative, banks must nonetheless balance the demands for increased revenues with the overarching requirement to protect shareholders' capital, particularly within the context of the deteriorating credit environment.  Fortunately, these competing goals are not mutually exclusive and can be achieved through fidelity to the following principles:

  1. Customers are bound by the terms of their credit agreements. Banks have every right to expect customers to abide by their contractual obligations and to pay a price for failing to honour those obligations;
  2. Most customers understand that exceptional requests will not be granted unconditionally and that something must be given in return;
  3. Some customers may need to be educated to the fact that banks, in addition to being suppliers of capital, are subject to national and international rules and regulations.  When banks put their capital at risk, they should expect a fair and reasonable return for doing so;
  4. By acceding to customer requests without receiving due consideration, banks establish a course of dealing that is not only difficult to reverse, but may actually be detrimental, from a legal standpoint, to their interests in the long term; and
  5. A bank's credit appetite is not unlimited, nor should it be.  Therefore, a bank should always negotiate from a position of strength, comfortable in the knowledge that it can offer higher credit limits (capital permitting) if it so chooses, but always remaining cognizant of the multiplicity of stakeholders to whom it is accountable.

Questions to Ask in Response to Requests for Facility Increases

A bank should never agree to a customer request for increased credit availability (nor give the customer the impression that approval for such is certain) without first asking the following questions:

  1. Why does the customer need the increase?
  2. What is the customer's financing need for the next twelve months?
  3. How is the customer performing financially?  Are current financial statements available so that the merits of the request can be assessed?
  4. If advances are subject to a borrowing base, are there sufficient assets documented in the latest borrowing base to support the request?  If not, how quickly can a new borrowing base be provided?
  5. If aggregate advances are limited by a letter of credit (or parent guarantee), will the letter of credit (or guarantee) still provide the stipulated overcollateralization necessary after the increase in credit is granted?  If not, has the customer made arrangements with its letter of credit issuing bank (or with its guarantor) to increase the level of credit support?

Questions to Ask in Response to Requests for Acquisition Financing

Acquisition financing poses unique challenges and requires that substantially greater due diligence be performed.  In addition to the questions above, the following issues should be addressed before any kind of expression of interest or commitment is given to the customer:

  1. What kinds of assets or businesses are being acquired?
  2. How do the assets/businesses fit into the customer's current business model and long-term strategy?  To the fullest extent possible, banks need to determine whether the assets or businesses to be acquired are of good quality and worthy of being financed.
  3. Is the acquisition accretive to enterprise value?
  4. Has the customer prepared a business plan, and has its Board of Directors approved the plan?
  5. How does the customer propose to finance the acquisition?
  6. How much of its own capital (i.e., equity or subordinated debt) does the customer intend to contribute?  Banks should expect a minimum of 25-30% of the purchase price to be contributed by the customer.  This contribution percentage, of course, will necessarily change depending on the overall economic cycle.
  7. How advanced are the customer's negotiations with the seller?
  8. How much diligence has been completed and what further diligence still needs to be done?  Is the customer prepared to share its due diligence?
  9. Is there a Purchase and Sale Agreement in place between the customer and the seller?  If not, when will one be executed?  The answer to this question will help determine the customer's commitment to the target acquisition.
  10. Are there any liens on the assets being acquired?  This is particularly important if the target assets will become part of the lender's security, especially in borrowing base structures.
  11. What liabilities or other unfavourable agreements will the customer be assuming from the seller?

Information Required to Consider an Acquisition Financing Request

Once the foregoing questions have been asked, and it is determined that the customer's request merits further consideration, the bank must receive the following information in order to perform a reasoned credit analysis:

  1. Historical (2-3 years) financial statements of the target company;
  2. Projections: at least two years of proforma historical (i.e., combined historical statements of the customer with the historical results of the target) and 2-3 years of projections for the combined entity on a going concern basis;
  3. Proforma borrowing base at closing, if applicable, and demonstrated compliance with the borrowing base for the duration of the projections;
  4. Proforma balance sheet at closing; and
  5. Proforma covenant compliance at closing.

Conditions Precedent to Financing

At the outset of negotiations with the customer, a bank must establish its position as no less than an equal counterparty to the transaction by conveying clearly that the following conditions may be imposed:

  1. In order to consider an increase, or to provide acquisition financing, the bank may need additional security;
  2. If the bank is financing specific assets, such as inventory or accounts receivable, the bank may need to conduct a field exam or perform other due diligence;
  3. Increased pricing may be imposed to ensure that the bank meets its internal return requirements;
  4. If the request for an increase is sizeable, or if the bank is asked to consider acquisition financing, a work or upfront fee may be considered; and
  5. Additional or new financing will be subject to the bank's completion of satisfactory due diligence and the requisite internal credit approvals.  A lender should never commit itself to a transaction, or imply that approval is assured, until this condition is satisfied.

Taking Action

Once the lender's relationship officer has discussed the request with the customer and conveyed the lender's requirements as detailed in the preceding sections, he/she should then discuss the proposal with the appropriate credit officer. The relationship and credit officers should determine those items that are essential to considering the customer's request.  Once these conditions are agreed upon, the relationship and credit officers should conduct a joint call with the customer to articulate the lender's needs.  Depending on the complexity of the request, this can be done on a conference call and/or with a joint visit to the customer's place of business.

Once it is determined that a financing request is worthy of consideration, the credit officer should have the authority to conduct further due diligence, and to be able to freely contact the customer to obtain additional information and details, as needed.

Every lending institution should determine its comfort level with each client and develop a strategy to remain relevant to the customer without overextending itself to any particular name.

Zoran Miljkovic

February 2009

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