A primary treasury objective is to maintain and maximize access to the capital and debt markets at the lowest cost – which means consents before the fact rather than waivers after the fact. And since “stuff happens,” treasury needs to pro-actively talk to the lenders about current problems, issues, or potential events that might affect access to those markets.
This can only be accomplished by a thorough understanding of all credit agreements, their ancillary documents, and all of their covenants. To mitigate default risk, a process to identify and determine any issues, both during the quarter and at quarter-end, is paramount – it allows treasury representatives to proactively talk with lenders regarding the issues, while keeping access to lower market rates.
A borrower has a legal obligation to review its compliance with all of the requirements of its financings, including the ancillary documents. That’s a tougher task than you might think given compliance staff turnover and usually the person responsible for compliance was not involved in the original negotiations, and never given time to fully read and understand the covenant complexities. Add to that, the increasing out-year risks of default per S&P and the SOX/ACS 470-10 requirement to justify classifying its debt as long-term by verifying that there are no covenant violations.
All these moving parts – multiple staff members, hundreds of technical documents, many covenants, requirements, and deadlines – make default risk much higher than people think – S&P default data, for BBs, the 5-year hard and technical default risk is 8% and 18%.
Any default, including a technical default, results in public disclosure, stock price hits, loss of control to the lenders and auditors, and customer, vendor and employees concerns. The PCAOB has caused the auditors to more actively test management assertions and internal controls in areas of high materiality risk. Ultimately, a surprise default is an unequivocal treasury mistake.
While Treasury is not responsible for poor operating results, Treasury is responsible for managing lenders and senior management about these high probability covenant issues to maintain the company’s access to funding at the lowest possible cost. Treasury can only do this if it has a strong debt compliance process that comprehensively manages the current quarter, gathering information about existing and potential covenant issues so that they can be monitored, managed and mitigated in future quarters.
There can be only one debt compliance objective: no surprises to your CFO, CEO and lenders! Download the Checklist now.