The borrowing hunt

In the middle of the storm, some borrowers are creative and innovate to find solutions to face breaches of financial covenants and provisions. This creativity can help temporarily. Nevertheless, the risks are big to change the future terms and conditions of loans and bonds, as lenders will try to better protect their positions and mitigate their risks.

Credit Storm Notice

In these times it is difficult to get credit as it could have been obtained before the COVID 19 crisis. You must be creative and willing to make concessions to get a life-saving credit. We have seen some trends, some new methods, intelligent approaches to circumvent obstacles but also more delicate situations. The post-COVID period, in terms of borrowing, will certainly be more complicated and heavier than before. You must be prepared for that. Without wanting to be exhaustive (it would not be possible), we will try to list some phenomena noticed and possible new trends on the bank loan and capital markets. I am afraid about the over-reactions from lenders if we try to adjust too far existing loan/bond provisions to resist to current crisis and its financial consequences for the borrowers. It is a tricky game in the long run for all. I would like to list few of these phenomenon’s we have noticed so far and start with “smart accounting presentation”.

Smart accounting presentation

We already mentioned in previous article the new concept of EBITDAC, to consider the crisis impact. We also mentioned the “JCrewed techniques” to re-interpret loan documentation to exclude some assets. These types of attitude will drive to stringent provisions in documentation in future. Eventually, we addressed the guarantee issue. These days, every single guarantee or pledge are welcome, and some companies have sold their soul to the devil. We saw a lot of equity injections as credits were more complicate to obtain. These equity increases were aimed at rebalancing balance-sheet and debt to equity ratios. There are also number of hybrid bonds, like recent BP 12bln issue, as an alternative to equity and loan. The market is adapting to the current circumstances.

Now, borrowers would like lenders to consider and accept rolling profits from 2019 to avoid breaches of financial covenants. Lenders seem to be reluctant to accept this crazy idea. Businesses suffering plunging revenues because of the health crisis were seeking to avoid potential financing breaches by substituting last year’s profits (i.e. 2019) in place of this year (i.e. 2020) in the documents they will present to the banks. Smart idea indeed… however tough to swallow for a banker. It seems that Live Nation, Punch Taverns, Samsonite, and others have tried to bring forward this idea. This tactic amounts to asking lenders to imagine that the pandemic had not happened, but debt holders have so far accepted it because acknowledging depressed 2020 earnings could cause problem on both sides. Conceptually, it does not make sense. Because in some cases, the negative trends could continue (e.g. airline industry could only recover in 2023 and what about boat cruises). It is a messy and dangerous path to take.

Breaching covenants

When a borrower breach terms know as financial covenants, such as a requirement to respect certain ratios of debt to earnings, lenders are normally at liberty to demand immediate repayment or in extreme cases trigger restructurings and take control of the business assets. However, lenders’ acceptance of old earning figures would be a sign that they are holding back on such drastic measures and instead giving borrowers time to recover events over which they have no control. But there are already cure periods to recover from breaches. The bondholders are willing to accept changes provided they are temporary. They cannot see other alternative routes to sort this out. In case of default, the lender may be left holding assets that are hard to offload. Imagine a lender having 100 of pubs in UK for sale or having airplanes or equipment extremely tough to sell now. In the current environment, lenders do not consider the default as a good solution. Then, we come back to the crazy idea of EBITDAC (before Corona virus) concept. The lenders are concerned because it would allow companies to evade restrictions on how much they can borrow. ESMA has expressed its concerns. We should faithfully present our financial performances. We are developing a new era of adjustments in which borrowers would ignore non-recurring or exceptional impacts on their results. We understand the demands. However, there is a risk of dangerous precedent. If COVID has long term effects on customer behaviors and on businesses and if it takes more time than initially thought to recover, then it does not make sense. It would be fine if it were really exceptional and temporary. But who knows? If so, lenders will be less flexible in future. If a borrower can interpret covenants, its lender might rethink the way covenant work going forward and it may completely change the framework.

No one can claim he has the answer. It will be a case-by-case approach. Nevertheless, what is done once can be replicated and can create trends. If we change the rules, players could decide to stop playing going forward, to re-adapt the rules or to simply increase spreads and fees to compensate extra-risks. At the end of the day, I am not convinced we will gain from flexing the provisions and covenants too much, despite the exceptional character of this health crisis. We will follow the market trends with attention in the coming months. As would have said Cecil B. DeMille about creativity without limits of finance executives: “creativity is a drug I couldn't do without”.

 Fran?ois Masquelier, SimplyTREASURY