I was recently called to evaluate the financing strategy for a profitable business with an annual turnover of circa. $150 million. The business had a $30m corporate facility and was going great with plenty more new product lines coming to the market which underpinned a further 20% growth next year. Whilst it had a stable relationship bank, the company was cognisant of the importance of developing another banking relationship to diversify its banking risk. One interested bank proposed the following four attractive options.
- To assist with the warehouse fitout, it proposed to take on an equipment financing facility on a standalone basis. This bank said it understood the importance of not disturbing the existing banking relationship. The only requirement was to have the existing bank entered into a Deed of Priority arrangement. Or;
- With the existing bank, this bank jointly established a club bank arrangement. It further explained that a club bank arrangement would allow the best pricings for the company whilst both banks share common security. Or;
- Of course, the bank would be pleased to refinance the whole facility from the existing bank. The proposal stipulated broad parameters of the terms and conditions and pricings which were all more competitive than the current facility. Or:
- Even better, this bank proposed to refinance the company on an “unsecured” basis because the business was doing so well. This would save about $100,000 in stamp duty in NSW.
All these four proposed options make a lot of sense. BUT, the situation was far from straightforward.
Let’s examine each option presented by the challenger bank.
Option 1. Equipment finance on a stand-alone basis and not disturb your relationship with the incumbent bank. It was my client’s preferred option. But, this option contained a hidden “land mine”, which was the request for a Deed of Priority Arrangement with the incumbent bank. This arrangement effectively would provide the challenger bank with a carve-out or secondary claim in the general security of the business. So it would have complicated an otherwise simple and clean, single bank arrangement.
Banks nowadays are not inclined to entertain this kind of request, after seeing a few precedents where other banks, with secondary charge of the security, accelerated their rights to become the first- ranking creditor. This option would definitely unnecessarily ruffle the feathers of your relationship with the incumbent bank.
Option 2 – Establish a club bank arrangement. A $30m facility was too small to be a club bank arrangement. No bank would genuinely be interested in being a part of a small club. Also, the legal fee involved in establishing a common deed of security would likely outweigh any efficiency gained in pricing. This option seemed attractive, but was likely to be unrealistic.
Option 3 – Complete refinancing. Whilst this was always a viable alternative, we must evaluate the costs and benefits. One of the largest costs of refinancing was the NSW stamp duty of 0.4% of the facility value. So, for a $30m facility, stamp duty could go up to $120k, to which we need to add other legal fees, management time, etc. The incoming bank’s proposal had to be very attractive for this option to be viable. Refinancing should always be the last resort.
Option 4 – Refinance on an unsecured basis. This would negate the requirement to pay stamp duty on refinancing, but the borrowing cost would be higher than a secured facility. Not only we should consider the quantum of increase in cost, but also that was highly questionable whether a bank would really offer an unsecured facility to a middle-tier company.
After examining the four options, one would wonder about the challenger’s intention. I hope the diagram below helps explain it:
Taking the most cynical perspective, the challenger smelled a great opportunity to disrupt the status quo. To the challenger bank, the status quo provided it with absolutely no payoffs. For the challenger, it was a risk-free move to disrupt my client’s relationship with the incumbent bank and potentially gained a high return. That was if the client took the bait and progressed with one of its proposals and then later found itself trapped with fewer strategic options at hand.
For the company, it meant:
- taking on all the risks of potential damage to its current banking relationship
- facing the huge uncertainty of refinancing
- compromising the otherwise stronger negotiating position it was in.
Things often are not as simple as they first seem. Beware of land mines. It is always wise to get an independent evaluation.