During the pandemic, it became quite common for many universities, as for all businesses, to seek financial covenant waivers from their lenders.
The ratios which lenders use to assess the financial health of their borrower are again under pressure, whether because of student recruitment not matching projections, interest rate increases or inflation impacting costs generally. With universities often having term debt that runs for decades, universities may well have covenants which were set in a very different financial environment.
As with any issue around financial sustainability, early engagement with stakeholders is key to ensuring a successful outcome. Here are our top tips for managing what can be a difficult and tense situation for any borrower:
1 Know what your covenants are and when they are tested
Universities are usually on top of the detail in their financial covenants. However, there are traps for the unwary and it is important to regularly revisit the precise wording of the covenants, and the definitions used, to ensure that they are being calculated correctly. For example, while some financial covenants are often tested on a specific date or period (e.g. year-end or the 12 months to year-end) compliance is sometimes required to be “at all times” creating the potential for breach at a point during the financial year.
Although look-forward covenants (e.g. based on projected income and projected debt service costs for a particular period) are rare in the sector, they are not completely unheard of. Even if covenants are only tested on a historic basis, if the university is forecasting a breach in future years, early engagement with lenders is essential.
2 If a breach is forecast, speak to your bank relationship manager
A large proportion of university borrowing is still traditional bank term and revolving debt. With bank debt, the university will often have a designated relationship manager to whom it can turn for any requests for waivers and amendments. Most university bank facilities are bilateral so the university is typically dealing with a single lender per facility.
4 Manage your noteholders
With private placements, the situation can often be more complex. Noteholders often have less resource to devote to managing relationships. Notes are also often freely transferable by noteholders. This means that the university may be seeking consent from an entity with whom it has had little prior interaction. Noteholders may also be based in jurisdictions other than the UK.
The documentation typically recognises these complexities with financial covenant amendments and waivers typically requiring majority consent, rather than unanimity. What constitutes a majority will vary, so the specific terms of the note purchase agreement will need to be checked carefully. Even though unanimity is not always essential, a university may wish to seek the consent of all noteholders as a matter of good lender management.
If the university does not know who to contact at its noteholders, the best place to start is with the notice provisions in the note purchase agreement or (if there has been a note transfer) in the transfer documentation. There will usually be a specified email address for queries relating to amendments, consents, and waivers. Also, allow time for the noteholders to respond. With noteholders often operating with quite small teams, a response may not be immediate.
Be aware that lender engagement may come with a cost attached. Banks and noteholders may seek amendment fees and/or, if they feel credit strength has deteriorated, an increase in the interest rate being charged.
5 Consider OfS guidance carefully
Under the OfS’ Regulatory Advice 16, a "likely" breach of a financial covenant is always reportable. Careful consideration will therefore need to be given as to whether the projected breach is “likely” or not. Is the university pessimistically considering a worst-case scenario that is never likely to come to fruition or is the future breach one that is likely to occur?
The university will also need to consider the OfS’ guidance about when to report events that have yet to happen. This is likely to require a careful assessment of when the likely breach was first contemplated by the institution. Such assessments are fact-specific and, if the university is facing a forecast breach, specialist advice should always be obtained.
6 Consider your obligations to your pension schemes
Engagement with pension scheme trustees must also be considered. This is particularly relevant if the lenders are requesting security as a condition of the covenant amendment or waiver. The Universities Superannuation Scheme Debt Monitoring Framework should be considered carefully by universities who are participating employers. Even if the lenders do not require fresh security, the circumstances giving rise to potential covenant breach might amount to a materially significant impact on the university’s employer covenant and so may need to be disclosed to the trustees. As ever, professional advice and early engagement with stakeholders is key.
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