VideoDespite a downturn in its business, AMN Healthcare Services, a $1.2 billion staffing company, is in no danger of flat-lining. Its revenue rose 3% in the December quarter, its net income was positive, and its leverage ratio was a thin 1.5. And yet CFO David Dreyer has recently spent some long days trying to renegotiate a leverage-ratio covenant and extend the tenor of the company's revolving line of credit.
Cash expenses for a restructuring (such as severance packages) were weakening the company's EBITDA (earnings before interest, taxes, depreciation, and amortization), but not to a degree that would appear to violate its loan covenants. The difficulty for Dreyer was that AMN Healthcare's banks and loan investors were examining every fee and rate with the intention of repricing the debt package. It was taking a lot to convince them not to extract more than the situation called for. "Even with the relationship banks, the process is night and day compared with what it used to be," Dreyer says.
Welcome to the harsh new world of loan covenants. Like AMN Healthcare, more and more companies are having to renegotiate covenants as the recession weakens earnings. "We're doing a lot of amendments — many more amendments than new deals," says Larry Mack, executive vice president, KeyBank Debt Capital Markets.
A number of highly leveraged firms are now breaching the leverage ratios, fixed-charge coverage ratios, and net-worth minimums that were set in stronger, more-liquid markets. According to Standard & Poor's Leveraged Commentary & Data, there were 98 covenant amendments (publicly disclosed ones, that is) to high-yield corporate loan agreements in the first quarter of 2009, up from 62 in the previous quarter. Experts expect just as many, if not more, in the second quarter.
Other, less-leveraged companies will also be talking to their lenders about amending covenants. (According to one academic study, between a quarter and a third of all public companies will trip a loan covenant over a 10-year period.) And the conversations may not be pleasant. When credit was abundant, many banks felt they were taken advantage of, says Steven Bavaria, managing director of leveraged finance at credit-rating agency DBRS. "The gun was at their heads to reduce fees and spreads," he says. "Now some of the same borrowers have to go hat in hand and ask for covenant relief. They shouldn't expect a warm, helping hand from the bankers."
Still, if the CFO warns lenders of a potential covenant breach early on, the experience need not be painful. Banks may even waive the violation, in hopes the company can recover by the next reporting period.
Penalties, Fees, and More
A company that breaches or is close to breaching a covenant will usually pay for the indiscretion. The penalty may be in the form of a pricing increase, upfront fees, a LIBOR floor, or the reduction in size of revolving credit commitments. Tighter covenants or new ones may replace the old, depending on the situation.
In the first quarter of 2009, lenders charged an average 204 basis points in interest and 56 basis points in one-time fees in exchange for easing loan terms, according to S&P. Arrangers are asking for fees of up to $1 million just to consider a loan amendment, says AMN Healthcare's Dreyer, and consent fees — payments to the members of a loan syndicate — are up three- and fourfold. "The pricing is the most shocking thing right out of the gate," Dreyer says.
Banks need to reprice risk, but there are other reasons why customers are paying more. When borrowers come to KeyBank wanting a covenant amendment, there is now both a credit decision and a capital decision to be made, says Mack. "As the credit quality deteriorates, we're required to keep additional capital, so we have to be compensated for that," he explains. "Our capital costs have increased — the bank market is charging more for everything." Even if the lead bank in a syndicate has a solid relationship with the borrower, it has to give other participants "market terms," says Mack.
Penalties are increasing partly because the market will bear it, says John Walenta, a director at Oliver Wyman, but partly for legitimate reasons as well. Deteriorating corporate credits force banks to spend more time managing loan portfolios. "There's an opportunity cost for the banks — they're not out cross-selling," Walenta says.
Still, Walenta can see why escalating fees and price increases drive CFOs mad. "The bank is concerned about the company's liquidity, but at the same time it's extracting fees and rate hikes," he says. Generally, CFOs who haven't been to the loan markets recently are in for a surprise, says James Moran, head of corporate lending for Credit Suisse's investment-banking arm. "There is an element of sticker shock in terms of what the market requires to amend a financial covenant," he says.
Can We Talk?
It's best not to run from the shock. On the positive side, a loan-covenant violation can be resolved with some-thing less punitive than an asset seizure or liquidation. "It's an opportunity to have a dialogue with the company," says Greg Becker, president of Silicon Valley Bank. "There is a serious violation only 1 out of 10 times."
Reader Comments» Post a comment