The impact of the COVID-19 pandemic is affecting individuals and businesses across the globe. For middle market borrowers and their lenders, this is a critical time for risk assessment and proactive action. There has been increased focus on a number of issues, summarized below.
- Revolving Draws. In response to actual or anticipated liquidity shortages, borrowers are evaluating whether and how much to draw under revolving credit facilities. Should a borrower draw down its entire line or a portion of the line sufficient to cover conservatively forecasted liquidity needs? This action requires a borrower-specific analysis, based on such variables as the ability of that borrower to predict the impact of the crisis on liquidity levels, leverage constraints in financial instruments, the composition of its lender group and the relationship between the borrower and its lenders. Lenders are evaluating their lending relationships on an individual basis, engaging in dialogue with borrowers regarding the foregoing and evaluating their rights under credit agreements. Many credit agreements have “net leverage” provisions that reduce indebtedness by the amount of unrestricted cash such that a revolver drawing is often a neutral event for purposes of calculating a borrower’s leverage ratio.
- Representations and Conditions. Most credit agreements with revolvers and delay draw term loans require borrowers to “bring down” representations and warranties at the time of any borrowing. Borrowers and lenders are considering the impact of COVID-19 on those representations. Virtually all credit agreements contain a representation, in some form, that no material adverse effect has occurred. Delayed draw facilities may also require that borrowers demonstrate financial covenant compliance on a pro forma basis as a condition to drawing.
- EBITDA Add-Backs. EBITDA add-backs are being examined by borrowers and lenders to determine their applicability to lost income and increased charges or expenses related to COVID-19. Most credit agreements include add-backs for extraordinary, non-recurring or unusual charges and expenses. Others often include add-backs for restructuring charges, reorganizations and/or consolidations of facilities and fixed assets, staff reductions and other similar expenses. We expect these provisions to come under enhanced scrutiny during this crisis. This will likely result in changes to “market” EBITDA definitions going forward.
- Post-closing Deliverables, etc. We have seen an increased focus by lenders on shoring up any post-closing deliverables that remain outstanding. While lenders might have customarily extended delivery dates in the past, less tolerance for such delays may be exhibited in the current environment.
Increased Collateral. Credit documents generally do not require that borrowers grant liens on assets owned by a foreign subsidiary or other assets where the cost of perfecting a security interest outweighs the benefit provided to the lender in having a perfected lien. Lenders are increasingly focused on obtaining a perfected security interest in such additional collateral as reasonably possible, and borrowers are seeking ways to provide such collateral in exchange for greater loan availability. In light of last year’s change in tax laws that eliminated the “deemed dividend” issue for many borrowers, lenders and borrowers are considering whether to include foreign collateral or foreign subsidiary guaranties.
- LIBOR Floors. Many credit agreements provide for a LIBOR floor (typically 1%) that provides for protection to the lenders in the event that LIBOR falls below this threshold. For credit agreements without this protection, some lenders are proposing floors, particularly in light of the Federal Reserve’s recent interest rate cuts.
- Audit Delays. For private companies, credit agreements typically require that audited financial statements be delivered to the lenders by a certain date, often within 120 days following the end of the fiscal year. In light of government restrictions on in-person meetings, it is likely there will be delays in completing audits, which will need to be addressed by borrowers and lenders in the very near future.
- Lender Group Dynamics. From both lenders’ and borrowers’ perspectives, a careful assessment of the lender group is warranted. Lenders will have differing risk tolerances, internal policies, or views on the long-term prospects of a borrower. At the time of this publication, many syndicated term loans are trading at discounts. Discounted trading environments attract non-traditional participants to the debt markets whose interests may not be aligned with borrowers and other lenders. Lender dynamics are likely to have a significant influence on the ability of borrowers to obtain funding and waivers and amendments to credit facilities.
Our debt finance team is actively working with clients to formulate strategies to weather these difficult times. We will continue to monitor these issues and will provide future client updates concerning these topics.
Visit our COVID-19 Resource Center often for up-to-date information to help you stay informed on the legal issues related to COVID-19.