There was widespread relief throughout the building industry and in banking circles last week when the housebuilder McInerney Holdings issued results for the first six months. Even though they disclosed crippling losses of €22m and a €27.6m write-down on the company's land bank, curiously the update was viewed positively by bankers, the company's executives and the odd stockbroker.
Since the start of the year rumours surrounding the financial health of McInerney, the only house builder quoted on the main Irish stock exchange, have been plentiful, colourful and occasionally poisonous. Enquiries submitted to the company a few weeks ago by this newspaper drew a strongly worded rebuke, by way of a solicitor's letter.
However the company now has one thing in its favour – the rumours about its finances should halt, at least for now. There is also a chance that major cost-cutting (it has reported savings of €47m) will help preserve margins allowing the company to exist to generate cash. But most fascinating were disclosures about its relationship with its banks.
The company has €267m of debt on its books. It sold only 142 houses in Ireland in the first half, a painful 45% contraction. It sold the houses at €239,000 a unit, a 13% plunge in selling price. Against that background the company has been in danger of breaching its banking covenants and that rumour has been haunting the company for weeks now.
Banking covenants are simple pieces of housekeeping for lenders. They tie borrowers to financial parameters, like a certain debt-equity ratio or level of comfort in relation to interest payments. If breached, the company either has to pay back all its debts, restructure its loans or negotiate a new set of covenants.
Breaching the covenants, at least in public view, is a pretty serious matter. McInerney said the following in its accounts published last Thursday: "The group's banking covenants were measured at 3 June 2008. Of these, some covenants were breached." That was interesting enough – the largest house builder on the exchange admitting things had deteriorated to those levels.
But far more interesting and potentially explosive for the Irish banking sector was the next sentence: "To the extent any measured covenants were breached, the breaches were waived by the banks concerned."
This decision by major lenders to effectively loosen their contractual terms with a major listed Irish plc may not surprise many. The banks were unlikely to play hardball with a company of McInerney's scale. The company, remember, has a large land bank in Ireland and Britain, and if it went to the wall confidence in the building industry in Ireland would evaporate entirely.
The banks who were prepared to ease up on the covenants were not detailed directly by McInerney. However chief executive Barry O'Connor pointed to his annual report where the following banks are listed: Bank of Ireland, Royal Bank of Scotland, Anglo Irish Bank, Bank of Scotland and IIB Bank.
The McInerney statement does not detail the precise banking covenants involved in its deal with the banks, but it referred to a loosening of tangible net-worth covenants. These are rules relating to the stripped-down value of the company; again if the figure drops below a certain point covenants can be breached.
The decision of banks here to waive the covenants is similar to the steps taken by lenders in the UK. There is now a range of strategies to help construction and property development firms trade out of their difficulties – workouts, covenant waiving, interest roll-ups, debt restructurings, asset sales and of course equity investment by the banks themselves.
Of course things could yet go wrong for McInerney – last week it was still talking to one of its lenders about agreeing the new covenant package and chief executive Barry O'Connor declined to provide a time scale on this.
But one thing is clear Irish (and UK) banks are prepared to waive certain bank covenants to help companies restructure and boost their cash positions. All of this is good in the short term for the economy and the construction sector. Nobody has any appetite for foreclosing on a major construction firm, although smaller entities might not find the reception so warm when they open discussions with their lenders.
Most banks at this stage in the credit crunch are more worried about outright default than the niceties of banking covenants. But equally these sometimes obscure contractual terms are there for good reasons and any widespread move to abandon them will further erode the credit quality of Irish bank balance sheets.
But as one banker told the Sunday Tribune last week: "Survival is the name of the game for many firms right now and the banks are working with them on that. Other issues have to be put aside in the short term."
That of course is true, but covenants are often there to stop firms from harming themselves by taking steps that make defaults more likely.
There is also the added consideration of fairness. Will bigger building firms be allowed to have their credit terms loosened, while the smaller players go out of business?