In brief...
In the investment management world, the volatility
created by an unexpected occasion such as the
coronavirus pandemic might be a challenge, it might
be an opportunity, it might be a trigger for strategy
adaptation like any other market fluctuation.
Unlike operating businesses which are broadly negatively
impacted (unless you happen to be in some very particular
industry segments), investment managers can trade,
many very successfully, through these types of market
events. However, amidst all the focus on portfolio and
investor matters, on delivering returns in dynamic market
conditions, it is important to review the fund’s leverage
arrangements as well.
Covenants: This is probably the most obvious area,
and the place where most minds will immediately turn.
Depending on the type of facility, financial covenants may
be commitments orientated, in which case reviewing
the triggers on commitment eligibility will be important.
Generally any indication from an investor that it will be
unable to fund its commitment when due would create
both an information reporting obligation under the facility
and potentially lead to the commitment falling out of
eligibility. That should be reviewed and monitored, with
the credit condition of investors clearly being key in this
regard. In a hybrid or asset-backed facility there will also
be some covenants which are asset-facing and these are
likely to need urgent reconsideration in light of fluctuations
in portfolio values. In particular with quarter end reporting
dates in mind, consequences of breach, potential cure
periods and waivers might need to be on the table.
Other “material adversity” terms: There has been some
discussion around the potential for trigger of Material
Adverse Change (MAC) clauses in current circumstances,
however, this is likely to be less relevant in the majority
of fund financings which should not generally contain
unamended MAC clauses. Concentration is also relevant
– broadly based portfolios are often more resilient in
any case. Of course there will be some fund financings
over very concentrated portfolios in particularly badly affected sectors which may therefore be more “at risk”
of this kind of general trigger, but the view now (similarly
to previous “crisis” markets) is that if there is a MAC then
there are likely to be other facility clauses which give a
much stronger basis for event of default which would be
triggered instead.
Reputationally, MAC is not something on which banks
would be keen to rely and for funds whose lenders fall
under the authority of the Prudential Regulation Authority,
some express guidance has been issued urging leaders
to differentiate between normal covenant breaches and
those which may be arising as a result of the pandemic,
to waive circumstance-specific breaches and to act in good
faith, not implementing new charges or restrictions on
borrowers in connections with such waivers. Obviously
this may be helpful for funds when discussing and such
matters with their lenders.
Drawstops: In the event that new monies are required,
or under a Revolving Credit Facility (RCF) which is subject
to periodic rollover, it is necessary to consider drawstops
that might apply. Generally, RCFs will be subject to event
of default drawstop on rollover but documentation may
need to be reviewed to confirm. If default does apply,
which will generally be the case for new monies at least,
consideration will also need to be given to the prospects
of an event of default as well as whether one has
actually occurred.
Hedging limitation: Some facilities may contain
limitations on hedging. Whilst implementing derivatives
strategies to assist portfolio strategies is often key,
the facility may require this to be effected in a particular
level in the structure (e.g. asset holding vehicles may
be freer than the funds themselves), the facility may
have restrictions around how this can be structured
(e.g. prohibiting some types of associated security
and credit support (which might also be “financial
indebtedness” impacting facility covenants depending
on where it comes from in the structure)), and there may
be an outright financial cap. All of these elements should
be taken into account before new hedging strategies are
undertaken in leveraged structures.
Tenure: Given future uncertainty, particularly around
finance liquidity in the coming months, it is a good
time to take a look at loan maturity schedules, consider
extension provisions, accordions which might be useful
in the circumstances and to understand what refinancing
options might be available should that become necessary.
In our view, the market is likely to deliver less favourable
refinancing terms in the short to mid-term. Factoring that
in to decision making over, for example, the commerciality
of potentially more expensive extension fees but which
then maintain a more favourable covenant environment, will make up some of the important decision making funds
need to take around tenure and leverage availability in the
coming months.