Inner Circle: The impact of Coronavirus on banking arrangements in the hotel sector

(Open bank vault door and gold light)

James Salford, partner, Bird & Bird, is part of the Inner Circle, a group of industry leaders and innovators we have brought together to help us contribute to debate in the sector.

As countries shut borders, advise against travel and lock down entire countries, many hotels are considering closing their doors. The worldwide disruption caused by the COVID-19 pandemic has created an unprecedented situation for the hotel industry. As hotel owners and funders begin to comprehend the impact on the industry, their businesses and their funding arrangements, we look at the key issues that hotel owners and funders should be considering in the next few weeks and months.

For hotel owners one of the key questions will be how to fund the key working capital requirements of the business, such as employee salaries and supplier invoices, at a time when income completely dries up.

A number of lenders to the hotel industry are already anticipating requests for working capital facilities to meet these funding requirements. The challenge however will be how those funders process and document the sheer volume of these requests in a time frame that enables hotel owners to meet their financial obligations, whilst at the same time dealing with substantial financial covenant defaults and missed interest and capital payments across their loan book.

A number of governments have put in place substantial emergency funding packages to help businesses with their cashflow requirements during the COVID-19 pandemic. These include deferral or waiver of taxes, cash grants, loans to businesses and other aid. In the UK this includes a 12 month business rate holiday for retail, hospitality and leisure businesses and the Business Interruption Loan Scheme which will be delivered through high street banks. This may be a welcome lifeline for hotel owners, but as with working capital facilities from lenders, it is unclear how quickly and easily these funds will be made available in practice given the likely level of demand.

For hotel owners considering the government loan scheme, questions arise as to how the Government backed loans will interrelate with their existing funding arrangements. Will the Government backed loans be secured or unsecured? Once business returns to some degree of normality how will interest payments and repayments of capital under the Government backed loans interact with payments due under their commercial funding arrangements? Hotel owners will need consent from their commercial funders in order to borrow from the Government schemes and so a pragmatic approach from all parties will be needed.
Financial covenants

There is widespread acceptance in the hotel lending community that hotel owners will breach the financial covenants in loan agreements. Chinese hotels in key cities saw a decrease in RevPAR of over 90%, and with widespread hotel closures expected across Europe (and in some cases mandated by Governments) curing those breaches through normal covenant cure mechanics simply isn't a viable option.

Most lenders have already recognised that financial covenants will have little meaning given the likely impact on trade and are considering waiving financial covenants for an initial period. Consideration also needs to be given to how covenants are tested once trading returns to normal. The usual position is for leverage and debt service covenants to be tested over a 12 month period, but in reality owners and lenders will need to reset covenants by reference to when hotels are likely to reopen for trade, test for short periods initially and assume a ramp-up period as hotels re-establish trade.

The cash flow shortages and significant breaches of banking covenants that will occur in the next few weeks and months mean than many hotel companies will be unable to pay creditors as they fall due or become balance sheet insolvent. For directors of these hotel companies ensuring that they act quickly and prudently will be critical in ensuring that they comply with their duties as directors. Whilst there is likely to be a significant degree of empathy for the position directors of hotel companies now find themselves in, decisions will still need to be made in a considered way, taking into account the long term viability of the business.
Insolvency proceedings

Some European jurisdictions are introducing legislation to protect companies from insolvency proceedings during the pandemic and it is likely that other jurisdictions will consider similar protections. Whilst many lenders are taking a supportive and pragmatic approach to the challenges that lie ahead, some of the more opportunistic lenders may view the current crisis as an opportunity to acquire assets at a low value. Given the lead being taken by some governments we would hope that similar protections will be introduced in all jurisdictions to protect hotel owners.

The key advice for hotel owners has to be:

    act quickly to secure additional funding lines, whether that is from their existing lenders or through Government funding schemes;

    approach lenders as early as possible to discuss financial covenant waivers, capital repayment holidays and interest roll-up options;

    consider the longer term impact of the additional borrowing and ensure that once activity returns to normal, the business will be able to sustain its funding obligations;

    directors should consider the long term viability of the business taking into account the additional debt they will take on during the current process.