We are sadly amid one of the most extraordinary times any of us can remember. The prevailing hope and expectation is that the current extraordinary times and related disruption is temporary. The rise in “cov-lite” and “cov-loose” financings in the European market also, hopefully, means that, in many cases, borrowers will have more breathing space than in previous downturns. That said, financing-related concerns will inevitably need consideration.
- Maintaining Liquidity: In such an uncertain environment, the priority from a financing perspective is likely to be ensuring that the borrower group has sufficient liquidity to enable it to cope with the economic and market disruption.
- Borrowers may wish to consider (and in fact many are) drawing down their revolving credit facilities in full to maximise flexibility, notwithstanding the additional interest cost, and to ensure that the facility is not draw-stopped in the future. Removing any future issues around the standard “no default” and repeating representation draw-down conditions not being met if the current situation deteriorates further. In deals with a springing financial covenant (i.e. tied to a percentage of drawn RCF utilisations), thought needs to be given to the fact that drawing the RCF in full will trigger the need to test the financial covenant, particularly when the original financial model may not have anticipated it being tested at this point.
- Provided capital can be called or is otherwise readily available, shareholders or sponsors could consider injecting further equity, either by way of an equity cure, in line with the terms of the relevant facilities agreements, to remedy a financial covenant breach or to generally provide liquidity and/or to avoid any forecast covenant breach. Depending on the circumstances and the treatment of equity injections in the underlying facilities agreement, it is likely that injecting equity to support liquidity and the net debt position in advance of any expected financial covenant breach (where permitted) would be of more benefit to the group than waiting for a breach and using the prescribed equity cure mechanic. This approach would avoid or minimise constraints on how the additional equity could be applied or otherwise included in the calculations under the documentation. From the shareholders/sponsors perceptive, it is likely that they will want protection for the continuing economic uncertainty by wanting to structure any injection of further equity with appropriate preference terms. It should be possible to structure such equity investment to achieve debt-like ranking and repayment incentives, whilst still be treated as equity from a legal perspective and for the purposes of constraints and calculations under the financing documentation. Such further equity could (assuming permitted) also be injected by way of subordinated debt. Noting, in all cases, rating agencies equity treatment may also need to be considered.
- EBITDA or similar financial metrics will be (or should be) closely reviewed to see how they are being impacted. EBITDA is a key metric across the facilities agreement not just for financial covenants but also for ratio-based permissions such as permitted debt incurrence and various baskets in other covenants. Proactively quantifying the impact on EBITDA of the Coronavirus situation in real time will be important in managing the overall liquidity impact (e.g. in respect of the need for and/or sourcing of additional liquidity). There is a current debate about the ability to add back the impact of Coronavirus to EBITDA. While it very much depends on the specific terms of the facilities agreement, being able to do specific Coronavirus EBITDA add backs is very unlikely. That said, there have been one or two deals that came to the market just before the syndicated debt and high-yield markets shut that effectively included an EBITDA addback for lost revenue related to the Coronavirus. This approach would transfer the underlying risk to the lenders, as issues are masked rather than being dealt with.
- Optimising the Capital Structure: Prior to the Coronavirus situation, many borrowers/issuers already had plans to refinance or re-leverage given the prevailing low interest rates. With the syndicated debt and high-yield markets now effectively shut, there will be an increased focus on keeping balance sheets under close review as there is now no clear access to the markets to easily refinance and/or re-leverage. When the markets do reopen, we anticipate pricing will increase and/or terms will tighten, at least initially. However, current market volatility will present some borrowers/issuers with an attractive liability management opportunity (i.e. given where debt is currently trading, borrowers/issuers may look to buy back a portion of debt at a discount). Borrowers and issuers may also want to consider utilising liquidity lines available from their relationship banks and/or receivables financing or, perhaps, private securitisation structures which may be available to the group to further enhance liquidity.
- Distressed situations: restructuring dynamics will naturally be different in the “cov-lite”/”cov-loose” era. As lenders have fewer early-warning triggers (such as meaningful financial covenants) they will find themselves being brought to the table much later than previously. There will, therefore, be a greater onus on sponsors and the borrower’s management teams to proactively address distress, and potential distress, situations themselves. In any event, we would not expect to see many (if any) lender enforcements. Given the level of distress is across the whole economy and impacting the whole market, we expect lenders to be extremely reluctant to take any enforcement action. However, if distressed investors were already in the capital structure prior to the Coronavirus situation they may act opportunistically and look to ‘take the keys’ to the borrower.
- UK Government COVID-19 schemes:
- On 17 March, HM Treasury and the Bank of England announced a Covid Corporate Financing Facility (“CCFF”), which will operate for at least 12 months. The CCFF will provide funding to businesses who were in sound financial health prior to the Coronavirus shock. This will be done by purchasing commercial paper (i.e. an unsecured short-term debt instrument) issued by corporates (or their finance subsidiaries) that make “a material contribution to the UK economy”. Such commercial paper needs to (i) have a maturity of one week to twelve months; (ii) where available, have a credit rating of A-3 / P-3 / F-3 from at least one of S&P, Moody’s and Fitch as at 1 March 2020; and (iii) be issued directly into Euroclear and/or Clearstream. Commercial paper with non-standard features, for example extendibility or subordination, will not be accepted. Commercial paper issued by the following companies/entities will not be eligible for the CCFF: banks; building societies; insurance companies; other financial sector entities regulated by the Bank of England or the FCA; leveraged investment vehicles; or companies within groups that are predominantly active in businesses subject to financial sector regulation. While having previously issued commercial paper is not a requirement, the CCFF effectively looks like a backstop facility for investment grade corporates that, due to market conditions, are finding it extremely difficult to issue new, or to roll any existing, commercial paper. As such, it appears very difficult for leveraged companies or their subsidiaries to benefit from the CCFF.
- HM Treasury announced, and brought forward implementation of, the Coronavirus Business Interruption Loan Scheme (“Scheme”). The Scheme, as of 23 March 2020, is now available through participating lenders. The Scheme is designed to support the continued provision of finance to UK businesses and to offer more attractive terms for both businesses applying for new debt facilities and the respective lenders. The Scheme provides the relevant lender with a government-backed partial guarantee (80%) in respect of the outstanding balance of the relevant facility (subject to an overall cap per lender). Which potentially enables a ‘no’ credit decision from a lender being a ‘yes’. Although the borrower always remains fully liable for the debt, the Government will, as well as providing the above noted guarantee, make a payment to cover the first 12 months of interest and any lender-levied fees. Any facility provided under the Scheme is to be up to a maximum amount of £5 million and for a period of six years for term loans and asset finance facilities and three years for overdrafts and invoice finance facilities. The Scheme may be used for unsecured facilities of £250,000 and under. For unsecured facilities above £250,000, the lender must establish a prior lack or absence of security before being able to use Scheme. To be eligible for the Scheme: (i) the business must be UK based; (ii) have a turnover of no more than £45 million per annum; (iii) have a borrowing proposal that would have been, were it not for the current Coronavirus situation, considered viable by the lender; and (iv) the provision of finance, in the lender’s opinion, will enable the business to trade out of any short-to-medium term difficulty.
Direct lending: anecdotally, it appears that direct lenders currently still see ample opportunity for capital deployment. Particularly, as volatility has taken hold of the term loan B and high-yield markets. The current volatility will likely dampen direct lenders’ fundraising activities though. Also, of note is that distressed investors may start coming into play. Although it currently appears that distressed debt investors may be keeping their powder dry until the market finds a bottom before they look at investing.