Amid Pandemic, Firms Look To Negotiate Debt Covenants

The pandemic has decimated top and bottom lines for firms across virtually all verticals.

And for firms carrying debt amid declining balance sheets and continued cash burn, there’s danger in triggering repayment as they violate covenants on that debt.

As estimated by Moody’s Investors Service, a number of larger, publicly traded companies are seeking to negotiate debt terms with their lenders and avoid violations as they navigate the economic downturn.

Generally, debt covenants are thresholds tied to financial ratios or other calculations that can reflect the financial health of a borrower. In one illustrative example, there may be covenants stating that the debt to EBITDA (or earnings before interest, taxes, depreciation and amortization, a rough measure of cash flow) may not exceed 3:1. Other debt covenants can stipulate that borrowers not take on additional debt or that they sell key operating assets.

If debt covenants are violated, lenders can “call” the debt or force it to be repaid.

As reported by The Wall Street Journal, and as estimated by Moody’s, roughly 100 public companies have looked to score waivers or amendments to loan agreements as measured through the middle of May.

Pursuing that strategy may not always work out. Consider the case of Hertz Global Holdings, the car rental giant that filed for bankruptcy. The company had “limited” waivers in place with lenders after missing $400 million in lease payments in April, and then found itself filing for Chapter 11 once the waivers and forbearance ended on May 22. Separately, but within the same vertical, as noted by the Journal, Avis Budget Group got an April waiver on a $1.2 billion term loan and a $1.8 billion revolving credit facility (until June of 2021), and was able to amend its lending terms to take on new debt.

Calculating Expenses

Separately, some firms have been looking for adjustments on how they calculate expenses that may be non-recurring or non-cash (covenants typically include caps on those expenses) and related to the pandemic as they calculate EBITDA, in an effort to strengthen that metric and comply with covenants.

“Our expectation is that companies will push to make more adjustments to their EBITDA,” David Zion, head of accounting and tax research firm Zion Research Group, told the Journal.

Relaxing or forgiving at least some loan terms may be a near-term strategy to avoid long-term pain in a world where defaults can have significant ripple effects.

In an interview with PYMNTS conducted just as the coronavirus began to impact U.S. firms, Jerry Flum, CEO of CreditRiskMonitor, said that several sectors of the economy are intertwined throughout the world, especially as supply chains have gotten leaner. At the same time, Flum said then, balance sheets have become ever more leveraged in an era of cheap debt.

With a nod toward just the United States alone, according to Flum, bond debt (not counting loans) held by public companies represents 48 percent of the GDP, and total debt outstanding (public and private) represents multiples of GDP.

“That’s a record,” he told PYMNTS, “and a lot of it is junky corporate debt. The quality of debt has come down over the last several years because the governments of the U.S. and around the world suppressed interest rates.”