As companies try every tool at their disposal to weather the financial storm caused by the Covid-19 pandemic, many are turning to bond documentation in search of covenant loopholes that may give them extra flexibility.
Everything from possible force majeure provisions to the use of add-ons for leverage calculations to the ability to issue secured debt are under scrutiny as earnings season kicks off and corporate America braces for a rough couple of quarters.
After a boom in the primary market that saw looser and looser covenant structures in past years, high-yield issuers will no doubt be tempted to leverage such loopholes.
Covenant Review warned recently that distressed firms such as those in the oil and gas sector have at their disposal various ways to potentially increase secured debt and coerce bondholders into an exchange to avoid being primed by new debt.
Indeed finding more secured debt capacity will prove useful for credits as they look to manage capital structures in an increasingly tough environment.
"Secured debt capacity might be an issue as companies look for extra liquidity or an upcoming bond needs to be refinanced," said Scott Webster, a senior covenant analyst at Covenant Review.
"In the current environment where you have bonds trading at distressed levels that opens up an opportunity to capture that discount by refinancing unsecured bonds with secured debt. It is something we have been looking at more closely."
FOCUSING ON ADD-BACKS
Beyond existing loopholes, analysts are focusing on how the extraordinary circumstances created by the pandemic itself may be used to the advantage of borrowers.
A case in point are so called add-backs - which have long been a controversial part of leverage calculations in the high-yield market, but are once again under the microscope.
There are concerns that companies might try to use add-backs due to the virus to increase Ebitda for purposes of Ebitda-based calculations under their bond indentures related to dividends, secured and unsecured debt incurrences and other items.
"Depending on the covenants and definitions under the bond indenture for a particular company, if they are able to add back in their Ebitda calculation the impact of the virus on their business it will give them additional flexibility in those activities," said Andrew Weisberg, a capital markets partner at law firm White & Case.
"Companies are actively examining whether their indentures will allow them to add back the losses and expenses associated with the virus."
High-yield covenants typically have add backs for "extraordinary, unusual or non-recurring losses, expenses or charges," a definition that is likely to qualify under current circumstances where the pandemic is arguably a non recurring event, explains Ian Walker, an analyst at Covenant Review.
But for most companies, the Covid-19 pandemic has had a greater impact on earnings, compared to losses, charges or expenses. And the question will be whether those lost earnings qualify as add backs.
For instance, an airline that sold 100 tickets but had to refund those sales because of Covid-19 can count those losses as add-backs.
However, an airline that was anticipating selling 100 tickets and failed to fill those seats because of the pandemic could not.
"You can't say I would have sold a 100 tickets if the corona virus didn't happen so I will add it back," said Walker.
"That doesn't work and that is a big distinction that needs to be highlighted."
Bank lenders have already insisted on some clarity on this front, with Time Warner Music adding wording in a recent credit agreement that "any lost revenues due to COVID-19 will not be added back to Ebitda," according to an 8K filing.
"We expect to see more amendments for Ebitda. It is important in debt documents so much is tied to it," said Valerie Potenza, head of high-yield research at Xtract, a covenant research firm.
What companies reveal about such calculations will in coming month be important for bondholders, which don't necessarily receive as much information as other lenders.
Unlike bank lenders who typically receive quarterly compliance certificates from companies that contain a detailed Ebitda calculation, bondholders will not have the same visibility on the amount of virus-related Ebitda add-backs taken into account.
"Companies with outstanding bonds who issue new debt in reliance upon Ebitda-based provisions or undertake other actions in reliance on such provisions are likely to face increased questions from their bondholders as to how the company has calculated Ebitda for bond indenture purposes," Weisberg said.