2020-04-04 IFR Magazine

92 International Financing Review April 4 2020

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Leveraged credits face reality check on

debt load sustainability

„ EUROPE Fitch says credits with low leverage headroom likely to face negative ratings action

Some 40% of European corporate high-yield

bond and leveraged loan issuers have low

leverage headroom and could struggle to cope

with the downturn caused by the coronavirus,

Fitch Ratings said in a recent report.

Prior to the virus outbreak, leverage ratios,

or debt-to-Ebitda, on these credits was already

high for their ratings, Fitch said after screening a

total of 454 issuers.

Many issuers with plans to deleverage, either

through operating cashflow growth or other

management initiatives, are now expected to

struggle to do so due to the crisis and debt load

sustainability will be a key issue.

“I think the sudden and severe nature of the crisis

exposed some degree of over-optimisation and

fragility inherent in leveraged strategies,” said Edward

Eyerman, head of leveraged finance at Fitch Ratings.

“The debt is fixed while the cashflows can come to a

sudden stop. The immediate concern is available cash

to meet near-term interest and payables.”

Leveraged credits in recent years have

increasingly overestimated benefits from

acquisitions by making assumptions of cost

savings via synergies and staff cuts, and

generous Ebitda adjustments in a bid to

maximise the leverage, investors said.

Leverage levels have been increasing and

after taking out the unrealistic assumptions,

could haunt the market in a crisis.

Fitch said credits with low leverage headroom

were more likely to face a negative rating action

and around 42 credits, or 9%, that are also in

a sector with high virus exposure will be under

even more acute pressure.

EARLIER THAN EXPECTED

Any downgrades could come earlier than

expected, with lockdown measures bringing

most economic activities to a halt.

S&P downgraded Cineworld’s credit and

issue ratings last month to B from BB– after

Britain’s biggest cinema operator announced

a temporary closure of its theatres, while Fitch

also placed the credit on Rating Watch Negative.

“Normally credit agencies tend to make a

ratings change after a financial result, but they

are now more proactive on downgrade rather

than reactive to it,” said an investor.

S&P has so far has made 65 ratings actions

in Europe’s speculative-grade market related

to the fallout from the coronavirus. The actions

included downgrades, outlook revisions and

putting issuers on Credit Negative Watch.

While downgrades are expected to continue

to hit the market, particularly after the release

of first-quarter results in the coming weeks, the

secondary market has already largely priced in

such expectation, investors said.

“Everyone knows which names will get

hit,” the investor said. “You won’t be in a

situation that you could trade out before

everybody else.”

The average prices of European leveraged

loans in the secondary market fell to under

80% of face value – lows not seen since 2009

• before bouncing back to 85.69 on March 31,
  according to Refinitiv LPC data.
  The widely held credit for Finland-based
  AMER SPORTS fell slightly from 70.33 to 68.6
  on Wednesday after Moody’s downgraded the
  sporting goods company’s ratings on Tuesday
  by two notches to B3 with a negative outlook on
  a potential profit decline triggered by the virus.
  The credit saw its lowest level at 67 two weeks
  ago.
  “Some cyclical businesses and virus-exposed
  sectors have already been beaten up quite badly,
  an expected downgrade is unlikely to make
  another massive fall,” said another investor.
  Prudence Ho

9 IFR Loans 2327 p 75 - XX.indd 92 03 / 04 / 2020 19 : 26 : 37