Fresh off a credit crisis that sent the world’s banks scurrying for capital, lenders are in no mood to renegotiate loans on friendly terms for the most distressed borrowers.
Moody’s Investors Service is projecting that 292 of 2,700 rated non-financial corporate issuers, or 11% of all rated non-financial corporate issuers surveyed, will probably breach at least one financial covenant in their loan agreements this year. Of that total, 130 have a better than 50% probability of violating one or more covenants.
The majority of the companies, 230, are based in the US, compared with 34 in Europe, the Middle East and Africa and 28 in the Asia-Pacific region. In the Americas, however, more than 90% of issuers are held to one or more financial covenants, compared with just under 60% of issuers in Asia and EMEA.
“The lending climate is risk averse and that probably won’t change this year,” said Moody’s senior VP Glenn Eckert. The root causes driving potential breaches include weak consumer spending, soft housing demand, as well as scheduled covenant tightening.
“The process for weaker companies to reset covenants or get waivers is no longer simple or straightforward,” Eckert said.
The restaurant, packaging, construction, leisure, media and auto industries have the highest concentration of issuers facing potential loan-covenant violations, says the ratings agency. Among companies that face a moderate or high probability of a covenant violation, 41% point to deteriorating operating performance, 17% to weak housing demand, 5% to rising input costs and 3% to aggressive mergers and acquisitions.
In the recent past, the vast majority of companies could easily negotiate amendments and waivers, with little resistance from lenders. In the current environment requests can create a minefield for borrowers, including large increases in borrowing spreads, tightened security documentation and borrowing base requirements.
Most distressed borrowers can expect that covenant relief will come with cuts to credit facilities and shorter maturity dates, as has been the case with several homebuilders.
For the weakest borrowers, however, Moody’s believes that banks, suffering from lender fatigue, will begin to cut credit altogether, refusing additional covenant relief that is seen as forestalling inevitable business failure.
Moody’s expects covenant violations among the lowest-rated credits will certainly lead to costly restructurings and contribute to a spike in bankruptcy rates this year and next.
This year through to March 31, there have been 13 payment defaults or bankruptcies among rated companies. Of these, eight had executed at least one amendment or experienced at least one outright covenant violation before the default event and one company filed for bankruptcy protection before breaching covenants.
The forthcoming default cycle could be led by many of the recent leveraged buyouts. Companies that underwent leveraged buyouts, particularly those funded in 2006 and 2007, have lower liquidity scores than the general universe of companies Moody’s looked at and more than half carry the agency’s weakest liquidity ratings.
Private-equity investors have a controlling stake in more than 500 issuers, or about 18% of the rated issuers included in the survey.
The cash crunch at some troubled companies may be partially mitigated by the willingness of private equity owners to provide additional equity infusions or “equity cures” to protect their stakes. But many of the private deals of the past few years were financed with private equity shops putting little true value at risk, said Eckert.
While a sponsor may be willing to provide additional equity infusions, they are just as likely to walk away.
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