There has been a series of warnings of an upcoming financial downturn; just too many strains on and impediments to the domestic and global economy, with inflation galloping and interest rates following, it seems – as the markets certainly believe – a downturn is coming or is already here. That is why the financial markets and central banks have responded with equal fear and, and in the case of the central banks, they are deploying or about to deploy their remaining might to avert recession or minimise its effects. And in a financial downturn loans go into default: What will lenders do?
Refinancing
Before the global financial crisis in 2007–2008, borrowers typically refinanced their syndicated facilities a couple of years before maturity. There was significant liquidity available and low interest rates (i.e., cheap credit). While the financial crisis caused a significant amount of company collapses (affecting smaller companies more than larger ones) a lot of companies survived the financial crisis. This was in the face of the level of leveraged loans made between 2005 and 2007, which led to a “refinancing wall”, a wave of maturities falling due between 2012 and 2014. Lenders were unwilling to enter into new facilities but they were also pessimistic about the likely returns from an immediate insolvency process or enforcement. This led to a ubiquitous approach or strategy.
Amend and extend
As an alternative to refinancing, many lenders were ready to “amend and extend” their facilities for a higher margin, additional fees, and, in some cases, the amendment of financial covenants. With an abundance of easy credit and a belief that asset values would rise year on year, which has at least been the case until recently, what was to be lost by postponing default? Hence the “amend and extend” deal, also waggishly called, not inaccurately, a “pray and delay”, became common.
The amendment of U.S. loan agreements typically required lower levels of consent (majority consent plus the consent of the extending lenders) than UK or European loan agreements. Many UK and European loan agreements required unanimous consent, or super-majority consent, to amend and extend, particularly in the case of investment grade loans. So getting lender consent could be difficult. In some loan agreements there were facility change mechanisms allowing an existing tranche of debt to be increased or an additional tranche to be added. A borrower wishing to amend and extend its facility using the facility change mechanism would usually require consent from each extending lender, in addition to the majority of lenders (being 66 ⅔ percent) or a greater percentage as set out in the loan agreement. Interestingly, the level of consent required in UK and European loan agreements now often falls within a range which is lower than it used to be 15 years ago.
Liquidity is now tightening, and while there is no refinancing wall that is equivalent to the one overcome a decade ago, it is becoming more costly to refinance. Particularly in leveraged credits, lenders are becoming less willing to form a view of where a leveraged borrower may be in the coming years, that its assets will be worth more and accordingly the option to amend and extend is less likely to be offered. Notably, amend and extend activity in Europe decreased in FY21, with 137 deals, in comparison to FY20, which saw 159 deals.
Current market sentiment – are we reaching tipping point?
With interest rates and inflation increasing, it is becoming more expensive to refinance and to service debt. Lenders will be carefully considering both the creditworthiness of a borrower and whether its business is sufficiently resilient to tackle troubling times. Lenders can no longer have confidence that the value of the borrower and its assets will continue to rise. Understandably, there is hesitation to lend. A debtor company should be considering whether it can afford to borrow based on the margin it must pay. As a response to distress and over-leverage problems, “amend and extend” had a data based rationalisation, yet it was still too much like the panglossian philosophy of Charles Dickens’ Mr Micawber when facing bankruptcy that “something will turn up”.