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Europe’s Leveraged Loan Issuers Draw on Revolving Credits to Preserve Liquidity

Restaurant and retail chains are among the first European leveraged finance borrowers to draw down on their revolving credit facilities to preserve cash, and many other businesses are expected to follow suit given the sudden economic stop caused by COVID-19 containment measures.

Burger King France, which is owned by private equity firm Bridgepoint, has fully drawn down its €60 million RCF to cover urgent cash requirements, as all its restaurants across France have temporarily shut due to the outbreak of the coronavirus. The company told bondholders this week that it currently has sufficient cash reserves to manage the liquidity situation but has also begun implementing cost-curtailment measures and is considering availing itself of the aid programmes announced by the French government to help businesses handle the present crisis.

CBR Fashion, the German women’s clothing firm that owns brands such as Street One and Cicil, has this month drawn €10 million of its €30 million revolver, a company spokesperson confirmed, as non-essential shops across Germany closed down.

A flurry of other borrowers are expected to follow suit and draw on available credit lines, namely RCFs, working capital, and acquisition facilities, European-based debt fund managers and banks told LCD.

“The challenge for us as lenders is to assess the ability of our portfolio to withstand what is an unprecedented liquidity shock,” said one lender.

In North America, large corporates from the airline, travel, leisure and entertainment, and retail industries have also begun to draw on credit lines or have indicated they will do so in the future. Boeing said it would draw down the balance of its recently netted delayed-draw term loan, according to various media reports. The loan was placed amid a deepening cash burn related to the grounding of its 737 MAX program, but ahead of the worst of the coronavirus-driven hits to the outlook for global aviation. To preserve cash, Air Canada said this week it drew its $600 million revolver line, and Southwest Air said it drew down its $1 billion revolver on March 16, while also warning its first quarter earnings will be hit.

Private equity giants such as Blackstone, The Carlyle Group, and EQT are also urging portfolio companies to do whatever it takes to stave off a credit crunch, according to press reports.

Cash is King

Having access to liquidity or credit will be the key determining factor to a company’s “life or death” leveraged finance market participants agree, as the sudden shut-down of businesses will force many to burn cash more quickly than expected.

“Most companies have interest only to pay on their term loans, so if your maturities are far out, then all you need to pay for is your loan interest and your working capital to keep business fully running,” one banker said.

As a result, bank lenders and credit fund managers say they expect a huge flood of drawdowns in March and April.

Mid-Market Update

Mid-market companies are acting in the same way as larger companies, and drawing on their lines. It will likely take months to quantify the impact of COVID-19 on companies and the market, sources comment. Meanwhile, in order to keep some sort of stability, cash management will be paramount, sources add. For this, lenders recommend all their portfolio companies to draw all the lines, and sponsors are telling them to do so, too. “I am asking all my portfolios companies to draw," one private equity fund partner comments. “We [PE funds] are all doing that.”

In addition, direct lenders, who are already quite flexible by nature, will probably show even more flexibility to face the crisis ahead. “Although you cannot use an acquisition line to compensate for a lack of cash flow, as a lender I will do what I can to make it easier for my portfolios companies in these exceptional times,” one direct lender said.

This is the case for even more resilient companies. “Revolvers: this is what they’re for, for liquidity. It’s clearly precautionary,” another financier said.

Many argue it is not only prudent but not hugely expensive for the safety net they provide, with some commenting that in the U.K., a borrower may pay around 3% interest on the RCF, which are super senior, and such interest is negligible compared to a lack of cash.

Default Concerns

Certainly, default rates are suddenly expected to rise much quicker this year, even though governments across the globe are taking measures to support businesses. Both S&P Global Ratings and Moody’s have increased their default expectations for speculative-grade rated companies. S&P Global anticipates double-digit default rates for non-financial corporates in the U.S. and a material increase to high single-digits in Europe over the next six to 12 months. Moody’s said in its global monthly Default Report that in its pessimistic scenario, it sees the global speculative-grade default rate rising to 9.7%.

While drawing on revolving lines will shore up cash balances and provide immediate help, it may also heighten the risk of a default. This is because once a revolver is drawn, borrowers need to comply to a springing leverage covenant that becomes effective once drawings go beyond typically 30–35%. It is then tested four times a year. In a research note published last week, Deutsche Bank said: “We could expect to see defaults in H2 2020 if the slowdown persists and is material, with some of them driven by RCF covenant breaches, however the quantum of defaults in 2020 may still be limited especially if the coronavirus disruption is transitory.”

In response, fund managers say they expect reasonable forbearance from lenders in these cases given the nature of the crisis, while also noting that headroom is often set at very generous levels. “The most important thing for us is that the companies are liquid," states another lender. “We are going to be very flexible on the covenant breach. We are all in the same boat, so it’s not important at the moment.“

Local European governments have also announced a number of aid measures to support businesses and allow them to access credit, but some firms will also have to rely on potential equity injections from private equity owners, while distressed debt funds are readying themselves to provide financing.

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LCD comps is an offering of S&P Global Market Intelligence. LCD’s subscription site offers complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here.