Quid pro-quo: Conditioning Waiver Requests

Faced with a rapidly evolving business landscape, lenders, borrowers, advisors and other stakeholders in the leveraged finance market are working hard to assess and monitor current and anticipated problems in existing loan portfolios and how the terms of their debt documentation have been implicated by the COVID-19 crisis. 

For some companies, certainly those whose health may already have been questionable before the crisis, whole-sale restructurings will be inevitable. For others, temporary liquidity and short to medium term stabilisation measures should suffice to see them through until some normality returns.

Lenders are unlikely to take drastic action in the short term not the least of which is due to reputational risk, but from a practical perspective, enforcement action is likely to be highly value destructive and finding a buyer in the current climate at a basis for a suitable valuation would be difficult.  A growing number of countries have already introduced moratoria on enforcement action by creditors specifically arising from the crisis, so lenders’ hands may be tied. Assuming therefore that lenders will be willing to agree to grant forbearance at least for an initial period, this note takes a look at some additional considerations that lenders, both syndicated bank lenders and private credit, should bear in mind when faced with borrower requests.

To complement potential new equity injections from the sponsor and/or the establishment of a sponsor debt buy-back programme, the primary purpose of the waiver requests in most instances will be to preserve liquidity and, subject to jurisdictional restrictions, will include toggling cash margin to PIK, deferral of interest payments, temporarily resetting covenant levels and waiving covenant breaches. Given the sponsor-friendly state of the market prior to the crisis, many of the larger syndicated loans affected will, of course, not have maintenance covenants, but the majority of private credit loans are likely to have at least a leverage covenant.  In many instances, existing headroom levels are unlikely to provide companies with sufficient breathing space.

Limiting leakage

• With management teams already focused on preserving liquidity in the business in particularly difficult circumstances, in the absence of the sponsor injecting new equity, lenders should at least consider switching-off some of the more sponsor-friendly manifestations of restricted payment flexibility. Any ratio-based restricted payment basket is not likely to be available in any event for obvious reasons, but freebie baskets and general baskets should arguably not be available for use. Similarly, the payment out of monitoring fees and management fees during periods of forbearance are unlikely to be supported by lenders, and not all of these payments are limited by Event of Default blockers in every case.
• Many businesses will be analysing ways to generate much-needed cash to boost balance sheets, including though the sale of non-core assets or, depending on the nature of the business and its asset base, through the exercise of sale and leaseback flexibility.  While it is entirely feasible to allow for a 12 or 18 month reinvestment period to apply the proceeds of sale, lenders should consider tightening these periods to prevent the use of cash proceeds for purposes other than to de-lever the business. Similar consideration should be given to insurance proceeds, although it remains to be seen how the insurance industry will respond to claims arising as a result of the crisis.
•  A general health-check of the credit documentation should be conducted to identify weaknesses, many of which will already be known, in particular other leakage loopholes. Credit funds in particular will be wary as investors are unlikely to look favourably on sponsors exploiting documentation weakness when breaches have been waived and cash-pay margins may well have been toggled to PIK. 

Call Protection

The menu of economic amendments is likely to include changes to how and when interest payments are made, resetting of covenant levels and, in some instances, extending maturity dates. 

For some businesses, the existing capital structure will survive with some temporary protective measures. For others, including those who were in trouble already, the damage is likely to be more permanent, ultimately requiring some form of capital restructuring.

With that in mind, when considering waivers in the context of the latter category, lenders may wish to consider either extending or completely re-setting their call protection. This will provide some comfort that the credit work done to preserve value and to allow the company to turn the corner will not have been done in vain should the facility be refinanced as soon as calmer waters return. Considerations such as this are likely to be more applicable to private credit investors than lenders in the syndicated market.

Information rights

Access to timely and accurate information will be key for lenders to understand the position of the company’s financial health.  Waiting for quarterly information to be delivered at a time when material changes can happen on a daily or weekly basis will focus lenders’ minds more on the quality and frequency of reporting.  Many private credit deals already have enhanced information rights such as board observer rights, detailed monthly reporting and more regular and detailed lender presentation rights when compared to deals done in the syndicated market.  However, further information, particularly as it relates to a business’ cash-flow position, status of suppliers, trade creditors, employee status and other COVID-19 specific matters, is likely to be welcome, and likely to form part of any response to waiver requests.

At this time, it’s very likely that all lenders, particularly private credit portfolio managers, are in very regular contact with management teams to conduct business impact assessments, liquidity needs, and to try and quantify the inevitable damage caused. 

Transferability 

Sponsors and borrowers have been focussed in recent times on restricting transferability of their loans. Many credit agreements will restrict transfers, assignments and sub-participations without borrower consent unless to entities on an approved list, affiliates or related funds or when any or certain Events of Default are continuing. Often, there will be a blanket restriction on transfers and assignments to loan to own funds or distressed investors. Lenders considering waiver requests may wish to relax some of the more restrictive aspects of the transfer and assignments regime, particularly if they have been asked to continue supporting the business at a time when it is impossible to know what the future might hold.  Liquidity issues may become just as important for lenders and being able to trade out of the loans without restriction may be an important quid pro quo. 

It is likely in some cases that a spotlight will be shone on the scope of the “Loan-to-Own” or “Distressed Investor” definitions, particularly in those credit agreements that attempt to define distressed investor activity by reference to the percentage of distressed loan purchases in an overall portfolio. In the context of a market where many credit funds are purchasing first lien debt in the secondary market at prices in the 80s and low 90s, portfolio profiles may change considerably. It is arguable that any investor in the current market is, by virtue of the state of the market itself, a distressed investor. 

Private credit and syndicated lenders: a difference of approach?

How syndicated bank lenders and private credit funds will approach the situation when faced with a stressed borrower in the current climate will be interesting. No doubt there will be calls for banks to remember the rescue efforts made in their favour at the time of the global financial crisis. It should be acknowledged that the likely menu of additional conditions sought to be imposed by lenders when faced with a waiver request from a borrower is likely to vary depending on the nature of the lender base.

In this regard, it should be noted that the joint statement of the Financial Conduct Authority, Financial Reporting Council and the Prudential Regulation Authority on 26 March 2020, has encouraged regulated lenders to carefully consider their responses to waiver requests in light of Coronavirus related stress and, where appropriate, to refrain from imposing additional restrictions and charges.  This does not apply to credit funds. 

To some extent, any difference in approach taken to borrowers in distress between banks and credit funds is likely to be driven in part by both documentary and practical considerations. It is less likely in a widely syndicated bank deal than in a private credit deal, that a long list of additional protections will be feasible, partly because the lender “asks” would appear to be too restrictive in the context of broadly syndicated deal documentation.  In the context of a private credit deal, the dialogue between the fund and the management team will be more direct, and, as a result, we can expect to see more co-operation on both sides.

One nuance for private credit funds is that many are also borrowers themselves and have their own leverage facilities, subscription facilities and other fund-level bridging lines in place.  Forbearance at the portfolio level is likely to be how most funds will react at least initially as long as they sense at least some level of buy-in and support from the sponsor. The cumulative effect of a number of portfolio credits being categorised as distressed by the fund’s own creditors (often banks), could result in margin calls and other restrictions while the borrowing base is non-compliant.  Will private credit lenders suffer as a result of agreeing to waive breaches and co-operate with borrowers at the portfolio level, if banks, while playing nice with their own underlying borrowers, tighten the screw on the credit funds through fund level action?  It is not unreasonable to assume that potential instability at the fund level, particularly funds who may not have access to sufficient uncalled capital, will drive credit funds’ behaviour vis-a-vis individual portfolio companies should problems persist longer than a few quarters. 

From a reputational perspective, it is likely that neither syndicated lenders or private credit lenders will want to appear to be the aggressor, at least for an initial period. Whether additional conditions are imposed on borrowers coming to the table with waiver requests will depend on the individual circumstances, and the approach being taken by the ultimate shareholders.

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