As a consequence of the ongoing COVID-19 pandemic, many lenders are proactively offering principal and interest payment deferrals to distressed customers, typically for 90-180 days. In addition to the necessary financial details of any deferral, this presents an opportunity for lenders to modify additional loan terms, including interest rate floors and LIBOR fallback terms, and to review loan collateral to make sure the lender is properly secured and protected in a changing environment. Lenders that offer interest rate swaps should also understand their options with respect to the swaps, whether the swap will be amended to match the modified loan or continue unmodified despite the loan deferral.
In this client alert, we discuss general drafting considerations for loan deferral modifications, as well as the additional steps a lender should take for associated interest rate swaps.
General Drafting Considerations for Loan Modifications
Lenders should consider the following when drafting loan modifications for deferrals of principal and/or interest:
- The loan modification should clearly state these terms:
- Original loan agreement and/or note details (title of loan agreement, promissory note, date, original principal amount);
- Current outstanding balance;
- Whether the deferral is for principal only or both principal and interest;
- Modified payment terms;
- If loan pricing is changing, the new interest rate and margin;
- The lender is not waiving any defaults, except as to the deferred payments and any other specifically enumerated defaults;
- The modification is not a novation of the original note;
- A reaffirmation of the terms of the existing loan agreement and note, except as specifically modified;
- A general release of claims against, and a covenant not to sue, the lender; and
- A reaffirmation of any guaranty signed by the guarantors.
- Whether financial covenants or deliveries should be suspended during or for a period of time after the deferral period.
- Whether to waive, amend, or restrict availability on revolving credit facilities.
- Whether LIBOR fallback language should be added or updated.
- Whether to add a 0% floor (including consideration of any related swaps that do not have a floor), given the historically low rate environment.
- Whether additional collateral or guarantors are required, and whether to add “belt-and-suspenders” cross-collateralization language.
- If there are any known deficiencies in the loan file or collateral package, whether to address such deficiencies as a condition to the modification.
Drafting Considerations for Loan Modifications with Associated Interest Rate Swap
For deferred loans with an associated interest rate swap, lenders should also consider what, if any, action should be taken with respect to the interest rate swap and how the swap should be addressed in the loan modification. In the early stages of the COVID-19 crisis, our lender clients have generally fallen into one of four categories with respect to an interest rate swap associated with a deferred loan:
- Amend the interest rate swap to reflect the new economics of the deal after deferring principal and interest payments. For amended swaps, at a minimum, lenders who are not “Swap Dealers” under the Dodd-Frank Act (1) must reconfirm that the customer and any guarantors are “eligible contract participants” under the Dodd-Frank Act, (2) must prepare an amended trade confirmation, and (3) should also consider whether to deliver to the customer a financial analysis on the marked-to-market value of the swap before and after giving effect to the amendment.
- Do not amend the interest rate swap and do not defer monthly swap payments.
- Do not amend the interest rate swap but defer monthly swap payments.
- Do not amend the interest rate swap and capitalize deferred monthly swap payments under a separate promissory note.
In each case where the interest rate swap will not be amended, lenders should still address the interest rate swap in the loan modifications to make clear that:
- The interest rate swap remains a separate contract from the loan;
- Monthly payments on the swap will continue to accrue and be paid, deferred, or capitalized, as the case may be;
- Aside from the loan deferral, if any other default or termination event occurs with respect to the swap or loan, then the lender may exercise all of its rights with respect thereto, including the acceleration of any deferred payments and termination of the swap; and
- The deferral of payments on the loan will result in a mismatch between the principal amount of the loan and the notional amount of the swap, and the customer should consult its own legal, financial, tax, and accounting advisors regarding the election to defer loan or swap payments.
Michael Best can provide sample language to address the interest rate swap on loans where swap payments will be paid, deferred, or capitalized.
Do you have any questions? Michael Best’s Banking and Financial Services lawyers can assist with interest rate swap and loan documentation solutions that are efficient and cost-effective, and we are here to help lenders meet increased demands for loan modifications, including loans with associated interest rate swaps