Companies looking to refinance or increase borrowings in 2023-2024 will find themselves in a changed environment. Even a year ago, the markets were full of cash looking for returns. But now, lenders are retreating, trying to reduce their commitment and pushing for higher pricing and stricter terms. In this article, we describe how borrowers can prepare for financing transactions in this new lending landscape. We also discuss some of the innovative solutions that have helped close recent financing deals. Finally, we advise borrowers not to wait in hope of more favourable market conditions in the future, but to kick-start their upcoming financing transactions now.
How the landscape has changed for borrowers
During COVID, many borrowers attracted or refinanced debt at historically low interest rates and very borrower-friendly terms. This was due to a liquid debt market fuelled by government and central bank stimulus. The largest portion of this debt will mature in 2024 and 2025 – which means we expect a surge in borrower demand for refinancing in the next 12-24 months.
Borrowers looking to refinance - and those needing to attract additional funding in the coming years - will do so in a different landscape. This is owed to macro factors that characterised 2022 and will, to a lesser extent, continue to dominate 2023 (inflation, the war in Ukraine, trade disruptions and weak economic forecasts). As a result, many borrowers are feeling a strain on their business and financial outlook. Rating agencies take a more pessimistic view on borrowers, especially those with mixed performance, and downgrades are on the rise. This further complicates borrowers' refinancing efforts.
Adding complexity, this crowded demand side is being met by a dwindling supply side, as lender operations are also being affected by the same adverse macro-economic factors. Market liquidity has been reduced by central bank benchmark rate hikes and lender asset sales to normalize balances sheets. And the recent turmoil caused by Silicon Valley Bank and Credit Suisse further exacerbated these trends and led to increased volatility. In addition, significant sub-par trading in secondary markets due to inflation and rising interest rates makes it difficult for primary lenders to syndicate debt without large discounts to make up for the lower yield in these loans. This, in turn, makes primary lenders wary of accommodating financing and refinancing requests, unless the borrower/issuer is willing to accept significant original issue discounts (OID). We also see some borrowers opting to pause transactions until the market improves.
As more traditional lenders such as banks retreat or reduce commitments, borrowers can still access liquidity from other debt sources. Increasingly prevalent are direct lenders – such as private equity and credit funds - who sit on a lot of dry powder but charge higher margins than traditional lenders. This was just recently exemplified by a consortium including Apollo and Blackstone which provided a largest-ever USD 5.5 billion loan to Carlyle to fund the 50% acquisition of healthcare analytics company Cotiviti.
All in all, the current state of the tradeable debt markets is unpredictable and prone to sudden swings. As a result, there may be short windows of opportunity to execute a refinancing or new financing if market conditions are right, but those moments may end abruptly. Identifying the right time and best deal is crucial but challenging. Borrowers who choose to wait for more favourable market conditions do so at the risk of losing optionality further down the road. Especially if a borrower's trading has lagged or its sector is under pressure with financiers, the increased cost of debt may be a price worth paying for a few years of funding runway.
Borrowers to face tougher, more protracted negotiations than before
In this changed landscape, despite lenders still having dry powder available, borrowers should expect to have more lengthy and difficult conversations than they had with their lenders five or even two years ago when they sought to refinance or increase their credit lines. The same will apply to technical waivers, such as for seasonal dips in financial performance. This results from lenders looking to decrease their commitments or even to withdraw from underperforming sectors against the backdrop of multiyear uncertainty ahead of us. The result is that even stronger credits that are used to relationship banking only, now may need to expand the consortium of banks or even add mezzanine or junior debt. Having such a larger or more varied group of lenders increases deal complexity and transaction timelines.
Borrowers should expect substantially longer lead times to negotiate amendments, refinancing and new money deals. Aside from increased scrutiny and, potentially, changes to the group, we also expect the sheer volume of deals on lender desks to affect borrowers' ability to do a quick deal. This is especially true if borrowers have to find additional or replacement lenders. This is why we advise kick-starting refinancing or new financing processes well before the typical 12-18 months' maturity horizon.
Some Borrowers facing maturity, an upcoming auditor's going concern review, or requiring additional funding may not be able to timely complete refinancing or new financing. They may need to switch gears to an "amend-and-extend" transaction, providing extra funding runway but often at a cost, or even a more comprehensive overhaul of their debt structure. In these circumstances, sound and proactive liability management is paramount.
Proactive deal management: getting in shape
When a suitable refinancing or new financing opportunity arises, the borrower's board and treasury should have done their homework and be ready to seize it. Questions to have answered include: what are the liquidity forecasts and when does the business reach its liquidity low point? Which assets are unencumbered and could serve as collateral for additional financing? Is the sponsor on board to support the process, possibly with a capital injection? Considering the market backdrop, early and open-minded exploration and preparation of options will be rewarded. Below we set out some guiding principles for getting in shape for refinancing or new financing, relevant for stronger and weaker borrowers alike:
- Building your refinancing information base. This is an obvious but sometimes overlooked first step. Management will have all the business information they require at their fingertips, but new incoming lenders might need different information. We regularly see transaction time being lost and borrower credibility affected by the borrower having to adapt its reporting system to provide requested information - such as risks and opportunities, liquidity low points and other data points. In light of the economic outlook, borrowers should anticipate closer scrutiny on their creditworthiness and resilience, more conservative asset valuation approaches, and a tendency for lenders to view the worst case scenario as the base case. Borrowers should also re-evaluate if their covenants are still sustainable, taking as a starting point the latest forecasts instead of current covenant levels. Covenant-light debt has given borrowers much freedom, but also concealed underperformance and other problems.
- Expanding your collateral base. Borrowers should review whether they have any unencumbered assets or assets in or outside of the restricted group that may be used to support additional debt or provide additional comfort to hesitant lenders. A borrower may for example have an unrestricted subsidiary with regular revenue (rent, lease or licence payments, etc.), representing a sufficient borrowing base for additional financing.
- Improving your liquidity position. Liquidity gives borrowers an edge with lenders by buying them time to find an attractive deal or being able to offer deleveraging options as a sweetener. Borrowers could try finding cash pockets and cost-saving opportunities in their business, conduct non-core asset sales, or utilise any available commitments under existing instruments.
- Rallying sponsor support. Borrowers may consider calling on their sponsors to support their financing and/or deleveraging efforts, via capital injections or participating in new equity or equity-like instruments. Bolstering portfolio companies makes sense, with many sponsors postponing their exit to muted M&A markets and to signal confidence in the company's performance and future. In fact, as we explore further below, sponsor contributions have been key in closing many recent transactions. We do see sponsors negotiating the right to extract such contributions after a year if performance indeed proves resilient, in order to protect their rate of return.
Proactive deal management: refinancing options
The current lending market is not business as usual, which means that borrowers must get creative. As transactions in the past few months have shown, in an unpredictable and hesitant market, innovative and unorthodox transaction structures have proven necessary to bring a successful refinancing or new financing together. Below we set out some structures we have come across that enable borrowers to create extra runway by: pushing out maturities; combining refinancing with deleveraging to get lenders on board; or re-tranching existing and new debt to rebalance the risk profile of their capital structure.
Opportunity-minded and discretionary refinancing and new financing
Borrowers with strong performance and sufficient runway may seek to refinance or obtain new financing when they spot a window of opportunity. They should still prepare for longer transaction timelines, pressure on pricing and terms, and individual lender downsizing. Cov-loose and cov-lite are no longer as common as they were. Getting in shape ahead of the lender-facing process remains key to moving quickly when the moment is right.
Simple amend & extend
For borrowers unable to complete a holistic refinancing deal, recent transactions have demonstrated lenders' willingness to accommodate "amend & extend" transactions. These types of transactions extend maturity, typically by one to two years, in order to give the borrower more time to prepare for a refinancing when it is in better shape and when market conditions have improved. An amend & extend could be preferred by PE sponsors who want to delay an exit until the M&A market improves. An extension will always be accompanied by an amendment of terms, such as an extension fee and/or higher margins, tightened terms, and possibly (but only if the credit standing has come down) an improved security package and/or consent fees as sweeteners to get the requisite lender consent and sufficient lender participation.
While a simple amend & extend is an effective tool to push out maturities and provide breathing space, it does heavily rely on the borrower's business case and may not be within reach for all borrowers in the current market.
Complex amend & extend
Where the borrower's business case is more affected by market circumstances, we see lenders requiring pay-downs and even changes to the borrower's debt structure. Lenders are focused on avoiding an "amend & pretend": an extension based on wishful thinking that does not address a borrower's structural problems. Aside from business-specific improvements, lenders may require deleveraging by the borrower, which can be achieved by, for example:
- reducing total commitments;
- making a substantial repayment (funded by new debt, equity, excess liquidity or asset disposal proceeds);
- offering to exchange existing debt for new debt at a discount; and/or
- restructuring liabilities such as mass tort liabilities or unprofitable portfolios.
Re-tranching, or the redistribution of debt over several levels of seniority, is another way to compensate for existing lenders that decrease their commitments or retreat altogether. This often takes the form of reducing existing senior (secured) debt by adding it to the junior (subordinated or unsecured) tranches, to allow the borrower to attract new senior funding. Recent complex amend & extend transactions have used re-tranching to add new debt without alienating existing senior lenders, thus securing their support. Examples include: adding junior commitment from a new lender; entering into a payment-in-kind (PIK) facility with existing lenders; or issuing a PIK facility at the holding level, outside of the restricted group. This junior debt is expensive, but borrowers may prefer to accept higher pricing in return for a signed deal now, as opposed to waiting for the market to improve.
Ultimately, each refinancing or new financing exercise requires careful structuring tailored to the particular needs of a borrower. The landscape a borrower finds itself in can be challenging but also offer opportunities to seize. We look forward to discuss successful case studies with borrowers and explore innovative solutions for their capital structure.