The Proximity Premium

If a borrower breached a covenant tomorrow, would you be surprised? If the answer is yes, the warning signs may have been there for months. That's the question at the heart of the proximity premium. Hello, I'm Brendan Richards from Rebound Advisory. Let's look at how a seemingly comfortable loan can become a very uncomfortable conversation.

Imagine a borrower that's meeting its repayments. The last covenant test passed. Management says trading is broadly on plan. Then a major customer starts paying later. Margins soften.

The borrower stretches payments to its own suppliers. The monthly accounts arrive late with an explanation that sounds reasonable enough. Each issue on its own might be manageable, but together they suggest the business could be using up its room to move. The business can still report a profit while cash gets tighter. Sales have been booked, but the money hasn't arrived.

Meanwhile, wages, rent, and suppliers still need to be paid. By the next covenant test, the lender may face an urgent funding request, nervous suppliers, and very little time. The breach is new information in the credit file. The deterioration is already months old. That's what I mean by proximity, understanding what's happening early enough to do something useful about it.

For a private credit manager, time matters. A refinancing that needed three months may now have three weeks. An orderly sale can become an urgent one. Management spends more time explaining yesterday's shortfall and less time fixing tomorrow's problem. The proximity premium is the value of seeing the problem while you still have choices.

This works best when the relationship is established before there's a problem. Regular, specific conversations make it easier to recognize when an explanation has changed or an assumption no longer holds. So how do you know whether you're close enough? Start with three questions. First, what actually drives this borrower's cash and margin?

Think back to that late paying customer. How much of the business depends on them? Is the delay a one-off or is it becoming a pattern? Can the borrower absorb another month without that cash? Then get underneath the explanation.

Has the invoice been accepted? Is there a dispute about the work? Has the customer actually committed to a payment date? Those are different problems, and they need different responses. The reported profit doesn't answer those questions.

You need to understand the movements behind the result. A conversation with management should help you connect the numbers to what is happening operationally. Second, what does the next thirteen weeks of cash look like? Put that customer's expected payment into the forecast. Then ask what happens if it arrives four weeks later.

Which payments come under pressure? Where is the low point? How much room remains? Don't stop at the closing balance. Look at the weeks in between.

A forecast can finish in a comfortable position and still contain a payment the business cannot meet along the way. Compare the forecast with actual cash week by week and investigate the gaps. Was a receipt delayed? Was a cost missed? Or was the original assumption too optimistic?

Repeated misses deserve more attention than a reassuring explanation. The point is to see the pressure early enough to respond while there's still time to test the available options. Third, what would make us act before a breach? For this borrower, it might be another missed customer payment, further stretched suppliers, or another late set of accounts. Agree the signals, who reviews them, and who starts the conversation.

Put a date on the next review. Be clear about what evidence would reassure you and what would require a different response. A warning sign only helps if somebody responds to it. Those three questions belong together. Understand the cash drivers, test the next thirteen weeks, and agree when to act.

Better information needs a decision attached to it. Early action doesn't automatically mean taking control or starting a formal process. It might begin with a candid conversation, a closer look at cash, or an independent review of what the business can realistically support. That can create room to improve operations, reset funding arrangements, or explore a sale while there is still time to prepare. And sometimes the business simply isn't viable.

A formal process may be the right outcome. The aim is to make that decision with a clear understanding of the options while meaningful choices remain. Early intervention can't guarantee recovery. It can give you a better chance of preserving value. So think about a borrower in your portfolio that nobody is especially worried about.

If its cash position started deteriorating next month, how would you know? And how quickly could you respond? At Rebound, we help lenders examine those questions through confidential early warning reviews of selected exposures. If there's a borrower you'd like to look at more closely, Claire Gaffney or I would be happy to talk it through. Early is always better than late.