DC Advisory's European Debt Market Monitor: The effect of Covid-19, May

The provision of liquidity by local government programmes has started to take off in the last two weeks with many governments expanding the programmes, addressing initial issues and providing further clarity on the eligibility of businesses.

Mirroring the political, health-focused and fiscal responses to the pandemic, and reflecting similar patterns to the Great Recession, financial markets are becoming increasingly domestic-focused, with bank lenders seeking to retreat to their core home markets and address the high volume of applications for the various government-backed lending schemes.

In response, lenders are reviewing their portfolios as a matter of urgency to identify borrowers that are most impacted and have immediate liquidity concerns. On the whole, lenders have been supportive of existing borrowers that were performing before Covid-19, particularly where other key stakeholders also do their part. However, lenders are less willing to support those borrowers that were struggling prior to this crisis, with the expectation that shareholders should be supporting these borrowers. It is clear that there will need to be on going dialogue between lenders, borrowers and shareholders for some time to come.

Those lenders that remain open for new business are increasingly selective and the bar is high; resilience is a must have for any potential new borrower. At this stage there are insufficient reference points to determine the new market normal, however we expect:   

• Increased pricing reflecting a higher cost of capital and higher risk
• Lower leverage
• Tighter covenants and other terms
• Increased diligence

Given the fundraising challenges and restrictive lending environment, we have seen a number of sponsors exploring alternative financing solutions, looking to increase fund fire power through structures such as NAV debt facilities at the fund level.

UK Highlights

• As lenders and sponsors continue to focus on portfolio reviews, new business activity is largely on hold. There has been an increased focus on the available UK Business Interruption Schemes as borrowers continue to shore up liquidity. The eligibility criteria for the CBILS scheme have been refined since the initial launch, however accessing CLBILS remains a challenge
• Whilst the government has confirmed that PE-backed companies can apply, the ‘undertaking in difficulty’ test has proven problematic, resulting in many high growth businesses that employ vast numbers across the UK locked out of the scheme for now and as a result, urgent clarification is being sought from the government
• Businesses should therefore look to: 
  • Engage with all stakeholders to maximise liquidity for the near term - if seeking to access one of the government schemes, have a clear "ask" as lending decisions will remain economically rational so lenders need to know that your business is viable in the longer term
  • Consider the impact on upcoming financial covenants and other potential technical breaches of banking agreements - although lenders are unlikely to engage in discussions until their capacity constraints ease and borrowers have a clearer view on trading, understanding the situation early is important
  • Understand if liquidity is needed to return to normal when the lockdown eases - do you need to fund working capital to re-open or ramp up activities? Have you deferred any payments that will need to be unwound

France Highlights

• The French Prime Minister has announced a plan to ease the coronavirus lockdown from May 11, excluding restaurants, cafés and large meeting places
• For most of the PE funds there was a focus on managing the liquidity risk of their portfolio companies during this period, whereas now they are working with lenders to avoid any anticipated covenant breach due to the lockdown
• Since the spread of the Covid-19 in March, very few Covid-19 free M&A processes are still live – with most M&A deals being postponed until there is more visibility on the potential financial impacts
• In this context, lenders’ appetite is limited and even for Covid-19 free deals, terms and conditions are, and will probably remain, less borrower friendly than they were previously
• Businesses should therefore look to: 
  • Review existing capital structures based on an anticipated back to “normal” EBITDA
  • When securing deals, ensure legal documentation is flexible enough to avoid any potential covenant breach in the coming months and if not, to initiate discussions with lenders

DACH Highlights

• The primary focus of lenders is still on their own portfolios rather than on acquiring new business. Since the start of the Covid-19 liquidity programmes, banks have faced problems in dealing with the high number of loan applications within a short time period
• Markets which have not been negatively impacted by the pandemic (i.e. Healthcare) are still showing signs of LBO activity
• The government has reacted in response to the restrictive lending environment with the launch of the KfW instant loan program, releasing banks from 100% credit risk and establishing a faster credit approval process to increase lending activity
• Companies are already drawing their RCFs, increasing the risk of triggering springing net leverage covenants. As lending remains overall restrictive, PE investors are more likely to execute all-equity LBO transactions
• Businesses should therefore look to: 
  • Approach their existing lender(s) as soon as possible if applying for the coronavirus liquidity programmes, as lenders are already receiving a large number of requests
  • As time is key for the loan application process, companies should clarify the required documents in advance and have them all on hand when filing a loan application

Spain Highlights

• Sponsors remain focused on their portfolios and those with dry powder still remain active in looking for opportunities 
• The Government support program, which provides State-backed financing (ICOs), is being distributed through the banks, with €40bn of the approved €100bn used so far
• Banks are moving at different paces on channelling the liquidity, with some banks having fully deployed their budgets from the Government support program while others are less proactive on providing this product
• Currently we mostly see companies securing liquidity with the ICO program, although there is uncertainty if it will be sufficient to fill the gap. In the coming months, once the lockdown is lifted, we will start seeing the real funding needs
• There are a number of restructurings and covenant work deals in the market, mostly in companies that were already struggling pre-Covid-19
• The lack of visibility to assess the economic impact makes it difficult to define business plans, so companies are opting to secure liquidity to buy themselves time
• Most of the refinancing and restructuring cases will appear in the next 6-12 months with a continuous number of rating downgrades, causing an intense secondary market activity
• M&A activity has slowed down except for in a few industries, such as telecoms, infrastructure, online retailers, etc.
• Businesses should therefore look to:
  • Preserve liquidity, fully draw available ancillary lines and postpone non-critical cash outflows
  • Preparation is key – identify your objectives and build a liquidity plan for 24 months using conservative assumptions
  • Once prepared, approach lenders as soon as possible given the large number of new credit requests
  • If new money is required, it is vital for businesses to identify the best lender/s for the specific situation/requirements

Italy Highlights

• The total amount of private equity deals announced in March 2020 showed signs of a slowdown compared to March 2019 (10 vs 16). The Covid-19 impact will have possibly caused an even deeper worsening in April 2020
• Lending / sponsor activity is likely to follow the trend observed also during the global financial crisis, with a disproportionate impact on the following sectors: fashion, furniture, food service and hospitality
• Starting from May 4th, Italy is looking ahead to a second phase of the crisis where it will attempt to restart the economic machine. The relaxation of the containment measures and the potential improvements in business confidence could re-encourage the deal flow activity going forward
• Italian businesses are likely to need more support than those in other European regions, in that the Covid-19 crisis has hit its northern economic heartland particularly hard, and its lockdowns came vigorously and early. This means that there will be a high demand of liquidity and (re-)financings to meet the needs of numerous businesses
• From an M&A standpoint, the current environment has inevitably caused some live deals to be put on-hold. However, as business activity reopens and government support is granted, these are expected to be resumed
• Business should therefore look to:
  • Closely monitor the liquidity of the business – through weekly cash-flow models – aimed at understanding promptly any deviation from expectations or at properly managing any liquidity shortfall
  • Take advantage, if needs be, of the credit lines made available by the banks following the recent agreement with Sace, the arm of state development bank CDP specialised in credit insurance. Firms of all sizes can access Sace-guaranteed loans for up to 25% of their 2019 turnover and for up to 6 year tenor
  • Ask for the support of debt advisory and restructuring specialists in case there is need to enter into discussion with lenders, or simply to get an independent view on the best course of action in these times

As ever, we are here to advise our clients in all types of market scenarios. Our Debt Advisory & Restructuring practice provides a full suite of balance sheet solutions, including advice on short-term liquidity, amendments, refinancings, covenant waivers and resets and restructurings. With access to the full range of capital providers we are abreast of the developments in the loan market and in particular, the impact from Covid-19.

Please do feel free to reach out to the team via the details below - we would be delighted to discuss any market or specific questions you may have.