Best Practices in Debt Covenant Management & Compliance

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Proformative presents Best Practices in Debt Covenant Management & Compliance. Special thanks Jim Simpson, co-founder, Debt Compliance Services, Al Gever, EVP & CFO, Smart Balance, Inc., Bruce Lynn, Managing Partner, The FECG

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Best Practices in Debt Covenant Management & Compliance

  1. 1. THE RESOURCE FOR CORPORATE FINANCE, ACCOUNTING AND TREASURY PROFESSIONALS Best Practices in Debt Compliance April 29, 2010 Jim Simpson, Co-Founder, Debt Compliance Services Al Gever, EVP & CFO, Smart Balance, Inc. Bruce Lynn, Managing Partner, The FECG
  2. 2. Agenda Topic Speaker Organization Market Overview Bruce Lynn FECG Importance of Covenant Jim Simpson Debt Compliance Services Compliance Best Practices Jim Simpson Debt Compliance Services Corporate Perspective Al Gever Smart Balance Conclusions Jim Simpson Debt Compliance Services Q&A All
  3. 3. Market Overview Banking at 12/31/09 Capital Markets after 2009 • 30% of all banks in the US unprofitable • Loan reserve ratio: highest since 1930’s • Non current loans = 391BN, > 5% of all loans (highest in 26 years) • Charge offs: most in 26 years • Avg net interest margin = 350BP (4qtr) • ROE = 90BP Source: FDIC NY Times 3/15/10
  4. 4. Market Overview Credit stnds remain tight; few banks loosening credit “Tightening Standards” implies : • More restrictive covenants • Higher loan spreads / LIBOR floors • Lower loan limits • More collateral • Shorter maturities Source: Federal Reserve Senior Loan Officer Opinion Survey on Bank Lending Practices – Jan10
  5. 5. Market Overview Source: CFO Magazine: Jan/Feb 2010
  6. 6. Agenda Topic Speaker Organization Market Overview Bruce Lynn FECG Importance of Jim Simpson Debt Compliance Services Covenant Compliance Best Practices Jim Simpson Debt Compliance Services Corporate Perspective Al Gever Smart Balance Conclusions Jim Simpson Debt Compliance Services Q&A All
  7. 7. Increased Focus on Debt Compliance • Under the new SEC proxy rule 33-9089, companies must disclose the Board’s role in risk oversight, including how such risks are identified, managed and mitigated o It is expected that this will include debt compliance because of the potential adverse effect on access to capital • Lenders are less forgiving regarding any covenant breach o Lenders are using even minor technical defaults to drop the credit or re-price the credit and charge higher fees and spreads • Auditors are more aware of the risk of non-compliance and paying more attention to their assurance letter of no default to the lenders • Senior management is more concerned about the loss of credibility with the Board, lenders, vendors and other creditors
  8. 8. “Soft” Costs of Non-Compliance • At least temporary loss of access to credit • Loss of credibility with banks, the CEO, and the Board • Press releases and 8-K public disclosure • Diversion of management time • Business disruption and vendor concerns • Substantial increase in spreads and fees • Substantial legal and audit fees • Financial restatements and being cited by the auditors for a “material weakness” or “significant deficiency” • Forced refinancing, fire sales of assets, workout, or Chapter 11
  9. 9. The High Cost of Default $50M 3-Year Facility, $40M O/S in $000 Years Cost BPs Year 1 2&3 Total Amendment/Waiver Fee 50** $250 $250 Default Interest Spread * 200 133 133 Increased Spread 200** 800 1,200 2,000 Increased Comm’t Fee 50 50 100 150 Legal & Audit Fees 250 250 Total Cost $1,483 $1,300 $2,783 Management time & Priceless credibility *Assumes 2 months to renegotiate **Per CFO Magazine, June 2009, quoting an S&P 1Q09 report
  10. 10. Agenda Topic Speaker Organization Market Overview Bruce Lynn FECG Importance of Covenant Jim Simpson Debt Compliance Services Compliance Best Practices Jim Simpson Debt Compliance Services Corporate Perspective Al Gever Smart Balance Conclusions Jim Simpson Debt Compliance Services Q&A All
  11. 11. Best Practices in Debt Compliance Debt Compliance Company Policy Training Financial Modeling Detailed CFO Letter Covenant Web-based & Lender Checklist Data Management Gathering Deliverables Exception Calendar Analysis © 2009
  12. 12. Debt Compliance Policy • Objectives • Assignment of responsibilities to operating and corporate management for being knowledgeable about what causes defaults • Description of the quarterly compliance process o Compliance checklist and questionnaires o Resolution of covenant issues • Ongoing covenant compliance o Responsibility of timely reporting of potential covenant issues • Documented SOX procedures • Loan administration
  13. 13. Covenant Compliance Checklist • A comprehensive list of all key debt provisions and compliance requirements – Checklist analyzes the requirement • Category (default event, notice, deliverable, etc.) • Brief description • Responsibility (often multiple) • Timing of notification, cure period – Checklist forms the basis for Compliance Questionnaires
  14. 14. Financial Modeling • The Financial Model incorporates the debt agreements’ definitions to calculate the required Financial Ratios o The Financial Model calculates the current periods ratios but also projects into the future o Integrated with the Corporate Budgeting and Forecasting processes o Stress tested by Treasury to ascertain leeway in future periods
  15. 15. Web-based Data Gathering • Compliance data is collected via a questionnaire forwarded to the responsible corporate parties identified in the Checklist o Yes/No questions with explanations for exceptions are drafted by Treasury and Legal o Questionnaires answered before and after quarter- end  Only after quarter close is often too late o Questionnaires serve as one basis for educating the responsible parties on the actions and events that have compliance implications
  16. 16. Exception Analysis • The questionnaires are analyzed by Treasury and Legal in an Exception Report which lists all issues respondents have identified this quarter and last quarter o Treasury and Legal work to resolve all exceptions • The Exception Report and the Financial Model provide the background required for the CFO’s review of Quarterly Certification Letter o In addition, provides information for the SOX 302 Quarterly Disclosure Process
  17. 17. Deliverables/Payments Calendar • A listing of the timing of required deliverables and payments: o Due date o Description, such as financial statements, auditor’s certificate, ERISA filing, CFO certification, etc. and well as when loan fees are due o Responsibility (generally treasury, sometimes Controller’s) o References the appropriate debt section
  18. 18. Lender Management • Pro-active and open communication with Lenders o Recognizes that Lenders do not like “surprises” and adversely evaluate companies that don’t seem to have a handle on their operating performance o Advance warning of potential issues provides the basis for the Lenders to be more willing to work fairly with you  Bank credit committees are running the show these days, and your account officers need to show them that you are really in control
  19. 19. Company Training • It is essential that all appropriate individuals that may impact compliance are trained on the requirements of the debt agreement o Many covenants have little or no notice/cure period, which means Treasury needs to be informed before the fact, rather than after the fact o Today, covenant compliance is an ongoing exercise, not something that can wait to next quarter-end’s compliance review
  20. 20. Agenda Topic Speaker Organization Market Overview Bruce Lynn FECG Importance of Covenant Jim Simpson Debt Compliance Services Compliance Best Practices Jim Simpson Debt Compliance Services Corporate Perspective Al Gever Smart Balance Conclusions Jim Simpson Debt Compliance Services Q&A All
  21. 21. CFO Perspective Al Gever EVP &CFO, Smart Balance
  22. 22. Corporate Profile • $250m Public Food Marketer • Operates in Health & Wellness Space • Went public May 2007 (thru acquisition by public SPAC) • Debt (part of acquisition): o$120mm Term Loan o$ 40mm Second Lien o$ 20mm Revolver
  23. 23. Organizational Overview • Nine Corporate Finance / Accounting Staff: oFive Professionals oFour Clerical • CFO performs Treasurer function • Lean organization, multitasking critical
  24. 24. Company Evolution • Prior private company: o Very entrepreneurial o No debt o Little controls o Little automation • New public entity: o Highly leveraged (requiring careful attention to performance against credit facilities) o Systems focused (ERP, planning, reporting) o SOX compliance need
  25. 25. Primary CFO & Treasurer Responsibility Optimize Capital Structure Ongoing Negotiate Refinancing Maintaining Negotiate 3 – 6 Months Access to Financing Capital 3 – 6 Months Covenant Compliance 3 – 5 Years
  26. 26. Transitions • Manual > automated • Internally focused > externally focused • High risk acceptable > risk averse • No financial planning > plan focus
  27. 27. Credit Agreements Credit Agreement Inefficient, risky process of ensuring compliance
  28. 28. Credit Agreements (at acquisition) – Two individual agreements – Each agreement 100+ pages – Paper copy / Word document / PDF – Quarterly review of compliance - manual
  29. 29. Compliance is More than Calculating Ratios Affirmative Covenants • Financial Reporting Insurance coverage • ERISA filings Corporate events • Legal undertakings Environmental compliance • Litigation reporting Negative Covenants • Restricted payments Permitted baskets • Liens Stock buybacks • Loans, leases and Change of control guarantees Acquisitions • Operating restrictions Hedging restrictions
  30. 30. Compliance is More than Calculating Ratios • Reps & Warranties • Continuing • Post-closing • Events of Defaults • Payment failures • Mandatory prepayments • Cross-defaults
  31. 31. Solution • Utilize automated tool to provide: o Efficient search of credit documents o Linking of defined terms / clauses o Storage of compliance certificates, amendments, bank communications • Results: o Dramatic reduction in time and effort o Dramatic improvement in control o Dramatic reduction in risk
  32. 32. Update • November 2009 – o Smart Balance secures a new $100m credit facility o New bank group o One agreement • Automated tool provides significant support – o Negotiation preparation o Negotiation effectiveness o In analysis and comparison of offerings to old facility o Compliance with new facility
  33. 33. Agenda Topic Speaker Organization Market Overview Bruce Lynn FECG Importance of Covenant Jim Simpson Debt Compliance Services Compliance Best Practices Jim Simpson Debt Compliance Services Corporate Perspective Al Gever Smart Balance Conclusions Jim Simpson Debt Compliance Services Q&A All
  34. 34. Web Technology • Web technology can convert an informal, manual process to a robust, automated process: o Dramatically reduce the time to understand and research a debt agreement by converting it into hyperlinked web pages o Automate the development of a truly compre-hensive compliance checklist o Convert the checklist to web questionnaires with a database producing the exception reporting o Convert the checklist to webcasts for training operating and financial management
  35. 35. Using Technology in Debt Compliance © 2009
  36. 36. Conclusion • The risks of breaching covenants are greater than ever before because banks are eager to use even slight technical defaults to re-price the credit risk • The risks are now too great to leave to an informal, manual process • Develop a compliance policy grounded by a comprehensive compliance checklist • Technology can: o Improve collaboration between Finance and the business units o Significantly reduce compliance time o Minimize errors that turn into expensive defaults
  37. 37. THE RESOURCE FOR CORPORATE FINANCE, ACCOUNTING AND TREASURY PROFESSIONALS Q&A
  38. 38. Thank You!!
  39. 39. Speaker Contact Information • Bruce Lynn • Jim Simpson • Managing Partner • Co-Founder • The FECG • Debt Compliance Services LLC • (203) 655-4806 • (203) 329-7491 • blynn@thefecg.com • Jim.simpson@debtcompliance.com • • Al Gever • John Kogan • Executive Vice President & CFO • CEO • Smart Balance, Inc. • Proformative • (201) 421-3913 • (408) 400-3993 x101 • agever@smartbalance.com • JKogan@proformative.com

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