The COVID-19 lockdowns have had an impact on the dynamics of market supply and demand.

Global leveraged finance issues (high yield bonds and loans) in North America and Western and Southern Europe fell by a quarter in the second quarter of 2020 to reach 368.3 billion US dollars compared to US $ 493.5 billion in the first quarter. The decline was even more pronounced in Asia-Pacific (excluding Japan), with leveraged finance issues falling from US $ 40.8 billion in the first quarter of 2020 to 17 billion US dollars in the second quarter of 2020.

This drop in demand for new loans and high yield bonds has altered lenders’ appetite for risk and prompted lenders to take a closer look at borrower-friendly debt structures that were common before the pandemic. However, lenders in different markets have responded differently to the challenges posed by COVID-19, with US lenders generally taking a more conservative approach than their colleagues in Europe and Asia.

Price protection measures vary by region

The most notable change in the literature is in pricing, with LIBOR floors – which guarantee a minimum interest rate for lenders in the event of falling interest rates – in the US market and increases in issue discounts. original (OID or discounts offered on the face value of loans to attract lenders) is gaining in importance.

The U.S. Federal Reserve, Bank of England, Bank of Canada, Bank of Japan and Central Bank of China all cut rates in 2020 to support economies affected by COVID-19. Australia’s central bank also cut rates to record levels.

Amid falling base rates, interest rate lows in the United States were rebased with a notable move towards higher LIBOR lows, according to By debt. The percentage of trades with 1% LIBOR floors has increased from 12% in Q1 2020 to 47% in Q3 2020 to date. The percentage of US institutional loans with 0% lows fell from 86% to 26% over the same period.

Professional services firm Duff & Phelps and Kissner Group, a manufacturer of pool salts and water softeners, are among the issuers of loans to include LIBOR floors in documents for loans issued during the pandemic.

In Europe, by contrast, there have been fewer examples of lenders requiring 1% floors, and 0% floors remain a feature of the market.

Bigger discounts on original numbers

OIDs may also expand due to the impact of the pandemic. OIDs have always been a feature of the market and are typically done by borrowers to underwriters, who then typically pass discounts on to the market.

OIDs were offered by underwriters to the market before COVID-19 but, according to By debt, more than half (52%) of institutional leveraged loans issued in the United States in Q2 2020 were issued at 98 or less. In Q1 2020, by contrast, 52% of US loans were priced at or above par. The merger of the Eldorado Resorts and Caesar’s casino groups, for example, saw the issuance of a $ 1.8 billion loan to fund the proposed transaction at 97% of par.

The European market has also seen high profile examples, such as Bain Capital’s refinancing of consumer research agency Kantar under a proposed deal at 93.5; and a general purpose loan issued by cruise line Carnival at 96.

Additions in the spotlight

Lenders also focused on certain borrower-friendly terms that had become regular features of the documentation.

For example, lenders have looked at unrestricted subsidiary structures. These allow borrowers to transfer assets from legal entities against which loans are guaranteed and / or which are subject to restrictive covenants, to other unrestricted entities. This facilitates additional borrowing by these unrestricted entities.

The decline of lenders to unrestricted affiliates was not necessarily a direct result of COVID-19 – lenders were already joining forces and pressuring borrowers to unwind transactions from unrestricted affiliates before the pandemic. However, during the lockdown, this remained a matter of concern.

Additions to EBITDA, which are certain categories of expenses and other deductions, as well as certain pro forma adjustments, which may be added to EBITDA, are also subject to further consideration. Lenders pay close attention to justifications for profit adjustments, which can make profits appear artificially high and delay defaults and restructurings.

There are still examples of borrowers reviewing loan documents to see if costs and financial impacts related to COVID-19 can be included in adjusted EBITDA numbers to avoid breaking a commitment. Lenders, however, are ensuring that the drop in income is not covered (in a second wave of a pandemic, for example).

Attitudes towards issuing covenant-lite loans did not change much during the pandemic. According to By debt, 91% of European institutional loans issued in H1 2020 were cov-lite, with 81% of US loans granted on a cov-lite basis over the same period.

The slowdown in mergers and acquisitions and leveraged finance activity means that there have not been enough deals to confirm a definite trend, but the fact that deals like Eldorado / César are closed on a cov-lite basis indicates that lenders focus more on other terms in the Documentation.

Regional nuances are also at play. In the bank-led Asian market, for example, there has never been much cov-lite issuance. Since the start of the pandemic, lenders in the region have focused on credit quality rather than trying to tighten conditions. As in other regions, EBITDA additions remain a priority, but bank lenders remain pro-market, while keeping a cautious eye on credits that could be too affected by Sino-U.S. Trade tensions or market disruptions. the supply chain.

Indeed, credit quality is a topic in all jurisdictions. Attractive loans will continue to secure financing on good terms, but lenders are holding up in some areas.

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