Credit Solutions for the
In the Midst of
Observable Credit Markets
The new-issue credit market was largely closed late in Q1 due to coronavirus-related shockwaves. With liquidity challenges across industries due to business shutdowns, lenders have been focused on existing portfolio companies. While new deal volume has shrunk significantly, some deals with direct lenders are still being completed. Looking ahead, as lenders attempt to gauge risk, not only will there be increased discipline across leverage, rate, and covenant, but credit providers will reconsider at-risk industries and focus on deploying capital with sponsors with whom they are familiar.
Prior to the pandemic, spreads continued to tighten. Going forward, lender expectations will shift to higher credit quality, higher pricing, and tighter terms.
Middle market purchase multiples exceeded 12x in 2019. With private equity firms sitting on substantial dry powder, there may be opportunities to acquire companies at purchase price multiples below historic highs of 2019.
Middle market loan issuance halted in Q1, although scattered private financings continue to close.
Certain LBOs were closed prior to COIVD-19 disruption. More recently, attention has been shifted to non-elective financings and portfolio management, with almost no M&A activity while would-be-sellers wait more attractive prices.
Tips for Negotiating a Forbearance
Configure Private Credit Metrics
In order to provide you with additional insight into current middle-market lending conditions, Configure reached out to our broad array of lender relationships. We asked our accounts several questions covering a range of pertinent topics. We are pleased to share this glimpse into lender perspectives.
To what extent is your institution considering new elective and/or non-elective financing opportunities?
The majority of lenders are not seriously considering elective transactions (acquisitions, dividend recapitalizations, etc.) and have instead chosen to focus their efforts on transactions related to liquidity, rescue financing, and more urgent capital needs.
Has your institution developed diligence protocols for new transaction opportunities?
66% of institutions have developed protocols to effectively prosecute diligence on new lending opportunities in spite of travel and logistics challenges.
Is your institution considering new equity partnerships in the resolution of challenged credits?
Over half of lenders have begun dialogue with third parties, new operators, or fresh equity to assist in resolving current challenges with their portfolio companies.
Tips for Negotiating a Forbearance
In order to create the greatest likelihood of success, borrowers should approach negotiations with their lenders with a specific, defined request and a plan of action, in order to reach a mutual agreement and ensure ongoing partnership.
1. Review and understand the credit agreement
Although seemingly obvious, nuances of a credit agreement are often forgotten or overlooked in negotiations. It is safe to say that COVID-19 was not contemplated when negotiating terms and provisions, and therefore certain terms in credit agreements may have application in these circumstances. When in default, “business as usual” is not always possible, and limitations can be imposed by your lenders. Identify those contractual obligations and prepare to discuss the implications with your lender.
2. Overcommunicate and Partner with Lenders
Proactively engage with and solicit feedback from your lender(s). Most lenders have insights and real-time information into a number of industries due to their large portfolio of borrowers. Generally speaking, your lenders want to avoid/minimize challenges and should be willing to share the valuable insights they have gleaned from other borrowers. Minimize surprises (especially negative ones) by providing periodic business updates, and weekly liquidity projections. Consider lenders as your partners over the next several months.
3. Prepare a 13-week cash flow
Prepare a granular, bottoms-up 13-week cash flow projection based on customer collections, vendor payments, payroll, etc. Near-term liquidity should be projected based on expected receipts and disbursements rather than P&L assumptions. Apply discounts to receipts in order to account for a slowdown in customer payments. This will highlight any near-term liquidity issues and allow stakeholders time to negotiate a solution before it becomes a crisis. Institute weekly cash management protocols, including a roll forward and review of the cash flow forecast against actual cash flows from the prior week.
4. Be conservative in financial projections
Downside projection scenarios should capture the economic uncertainties related to COVID-19 as best as possible. Solicit the experience of outside professionals and of your lenders in developing these assumptions. These are indeed unprecedented times, and past experience may not apply. Pressure test your assumptions and analyze your fixed vs. variable costs on a zero-based basis. Deliver bad news early, often, and once.
5. Be prepared with a request and a justification
Many banks are allowing temporary deferral of principal and interest. Be aware that lenders view deferral of interest and deferral of principal differently (reach out to us to discuss this in more detail). These interim measures ameliorate near-term liquidity concerns in order to establish a long-term resolution. Before beginning discussions with your lenders, develop a specific request with ample supporting documentation. Whether requesting a P&I holiday and/or the flexibility for fresh capital, frame your ask in a way that demonstrates the benefits to all stakeholders and bridges to a permanent solution.
6. Demonstrate a bridge to the desired outcome
Provide your lenders with an understanding of the steps that have already been taken and outline a course of future action that details operational, financial and managerial changes that culminate in a permanent resolution. In some level of detail, demonstrate the action items necessary to accomplish the plan and preserve enterprise value. The capital markets will not remain challenged forever, and the rehabilitation of the balance sheet may entail some combination of refinancing and equity infusion. Absent a credible plan, lenders may be less willing to forbear and provide management time to “right the ship.”
7. Prepare for the “playbook”
Most lenders have a typical playbook for challenged credits. Do not view these actions as antagonistic or a sign of unwillingness to engage in a solution. Lenders may hire financial advisors, exercise cash dominion, and/or update collateral appraisals. Manage each action with appropriate timing, communication, and expectation. Cooperating with your lender, understanding their needs and the needs of their institution, and addressing their requests as important will ultimately build toward a desired outcome.