Private credit lenders seek protection in minimum liquidity protocol

By Andrew Hedlund

NEW YORK, Jul 9 (LPC) - Private credit firms are requiring their borrowers maintain a strong liquidity cushion as the coronavirus pandemic forces middle market companies to wrestle with spiking leverage levels and falling profits.

These investors, also known as alternative lenders, are amending existing deals to put minimum liquidity covenants in credit agreements, provisions that require businesses to have a certain amount of cash on hand, as a way to safeguard their investments, according to several private credit sources.

The covenant measures the amount of money a company needs to run its business and meet its financial obligations. The provision has increased in usage since the onset of the health crisis. Companies, reckoning with dwindling profit margins – often measured as earnings before interest, taxes, depreciation and amortization (Ebtida) – are seeking relief from tests in their credit agreements, noted law firm Ropes & Gray.

As Ebitda falls, leverage can rise, making a borrower more likely to trip covenants, which are provisions to help keep the borrower on the financial straight and narrow.

“A liquidity covenant is a good yardstick for measuring the financial health of a distressed or stressed borrower,” said Gary Creem, a partner at law firm Proskauer. “It provides downside protection for a lender by serving as an early warning sign of further financial trouble while providing a borrower with flexibility to recover from a temporary period of financial difficulty.”

Private credit behemoth Ares Management in April and Teligent agreed to include a minimum liquidity provision in the pharmaceutical company’s borrowing documents. Ares is a lender on a first-lien revolving credit facility and a second-lien loan, according to credit agreement amendments submitted to the Securities and Exchange Commission (SEC).

The Buena, New Jersey-based borrower, which markets US Food and Drug Administration-approved injectable medicines and topical products, must now operate within a liquidity range of US$4m-US$10m. A total net leverage covenant was also eliminated, the SEC filings show. Doing so allows Teligent to focus on cash management.

Getting rid of a leverage covenant gives the borrower a reprieve from concerns about the level of its Ebitda, so the company can focus on other aspects of its financial health. Spokespeople for Ares and Teligent declined to comment.

Exela Technologies is another company that was forced to add minimum liquidity covenants to its borrowings, SEC filings show. In May, the company amended its first-lien credit agreement, initially hammered out in July 2017, to require a minimum liquidity of US$35m, according to an SEC disclosure.

Business development companies (BDC) Garrison Capital and Investcorp Credit Management BDC are lenders to the business process automation company, according to Refinitiv LPC BDC Collateral. Representatives for the firms did not respond to emails requesting comment.

Exela lined up a five-year US$160m accounts receivable (A/R) securitization facility with BDC Sixth Street Specialty Lending in January, Shrikant Sortur, the company’s chief financial officer, said in an email, noting the company also completed a US$40m asset sale in the first half of the year.

The A/R facility requires that Exela have minimum liquidity of US$40m. He said the company has been “almost exclusively focused on liquidity” since November and has plans this year to complete additional asset sales of between US$110m and US$160m.

A spokesperson from Sixth Street declined to comment. ALL ROADS TO ROME

Borrowers can arrive at the minimum liquidity amount in several ways.

The US dollar amount needed is often derived from updated financial models provided to lenders by company management or the borrower’s private equity owner. It can be measured by cash on hand or borrowing availability under the company’s revolver.

Healthcare borrowers have used liquidity covenants where they have been impacted by stay-at-home orders and the cancellation of elective procedures, Creem said. The travel and retail sectors, among other spaces, use liquidity covenants in connection with restructuring procedures.

When lenders have tried to calculate a borrower’s Ebitda, they have used different methodologies, according to Rob Wedinger, a vice president at investment bank Houlihan Lokey.

Some private debt managers are drawing up a “deemed Ebitda,” a proxy for the profit level of the borrower had the coronavirus pandemic not occurred, he said. But others are avoiding that exercise altogether.

“Some people don’t want to spend time and energy to quantify the Ebitda covenant because it will require a revenue adjustment,” Wedinger said. “If you just look at minimum liquidity, you take Ebitda out of the equation. Every conversation has ended up around liquidity.”

(Reported by Andrew Hedlund. Edited by Michelle Sierra and Kristen Haunss.)