Mon 07/20/2020 12:23 PM
The Covid-19 crisis is forcing middle market lenders to lower leverage in debt transactions to match investors’ appetite for lower risk. As the private debt market shifts, margin on borrowing has increased and covenants are tightening, sources told Reorg.

“Generally, we are seeing leverage coming down up to half a turn for the more defensive businesses in sectors such as software and healthcare,” Stephan Caron, head of European middle market private debt at BlackRock, said.

In the wake of the Covid-19 pandemic borrowers are set to face tighter conditions in documentation and restrictions in terms of debt levels, sources said. Leverage for mid-market debt structures, such as unitranches, is going to decrease in comparison with pre-crisis conditions. This would shift the balance of power in favor of lenders rather than borrowers.

Some recent transactions reflect tighter conditions. The €115 million unitranche for Paragon’s acquisition of German media group WEKA Holding had a leverage level of 4x, sources said. A debt advisor told Reorg that comparable credits would have allowed up to 6x of leverage before the crisis.

In the acquisition of German hygiene and infection prevention solutions provider Schülke by private equity firm EQT, private credit funds MV Credit and HPS Investment Partners lowered the leverage to 4.5x due to Covid-19, sources familiar with the matters told Reorg.

In the last five to six years Europe’s private debt market had seen a steady growth and increase in lenders competition. As of June 2019, assets under management (AUM) in the private credit segment reached a record $812 billion, according to Preqin’s Alternatives 2020 report. Although so-called dry powder levels in that period rose by only $4 billion to $296 billion, investors and direct lenders are still keen to deploy, the report added.

Because of the coronavirus crisis, borrowers are increasing their demand for liquidity amid a lack of cash flow revenue. This is happening while banks are retrenching further from corporate financing due to stricter ruling in terms of their risk profile, as reported.

Pricing for strong credit borrowers is rising compared with the pre-crisis levels. Before Covid-19 margins for senior debt transactions decreased to between 500 basis points to 550 bps. Now levels are up to 650 bps to 800 bps, sources said.

Tighter Terms

Investors and market participants expect that maintenance covenants will feature more prominently in future transactions as the pre-crisis borrower-friendly environment is gradually replaced by a lender-friendly one. In recent years, the majority of deals were covenant-loose, which means only one maintenance covenant was included in the documentation.

“Post-Covid-19 we expect two to three covenants to be included in the documentation,” Axel Rink, director financial advisory Deloitte Germany said.

In recent years, EBITDA figures, used to calculate the leverage multiples and transaction multiples for a company, was adjusted. Some private debt funds say that the difference between real EBITDA and the adjustments can be up to 50%.

“We don’t know what the mid-market recovery post-Covid-19 will look like,” BlackRock’s Caron said.

As a result, borrowers may have to accept stricter conditions in terms of EBITDA and leverage levels, debt advisors told Reorg. There may still be adjustment to account for the exceptional circumstances the coronavirus imposed on markets.

“We will see new leverage multiples and the so-called EBITAC, which includes the Covid-19 pandemic impact on the business,” Robert von Finckenstein, managing partner at Alantra Germany said.

--Kerstin Kubanek
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