Germany: Assisting Private Equity firms during uncertain market situations
The Coronavirus, its impact on our social and economic life as well as the specific financing programs recently initiated by the German Government are relevant for Private Equity firms and their portfolio assets in many ways.
KfW will support companies through RCFs, capex facilities or guarantees. The assistance can be in the form of direct lending as part of a consortium or indemnity bonds. While the applications will be submitted through the housebank, the treasury departments of the firms together with the PEH deal teams will be central for drafting the application, specifically as certain requirements of the KfW will have to be met:
- Low default probability (< 6.67% for 1y) and going concern prognosis (auditor qualifications may require accelerated discussions with the financing parties)
- Contribution of the incumbent bank(s) in providing additional uncovered exposure
These additional financings may cause some considerations for a successful application:
- How to overcome blocking lenders (a wider structural adjustment clause may avoid 100% approval requirements)
- Shared collateral / pari passu clauses (specifically in parallel Schuldschein facilities)
- Ranking of the new facility (e.g. in 1st out / 2nd out structures)
- Maturity profile (other facilities may have shorter maturity or higher amortization)
- Specific requirements for guarantee facilities etc.
Covenants of existing financings may have to be adjusted. Subject to the individual EBITDA adjustment clauses in the SFA, pro forma normalizations may be proposed to reflect Corona impacts for missing sale or idle costs. However, this may be seen as an aggressive move so securing the debt service may be the primary focus. Conditional commitments (additional equity or security) based on forward-looking covenant tests may be an appropriate tool to consolidate different stakeholder interests (maybe also relevant for new financings). Given the magnitude of EBITDA reduction plus further financing requirements, the testing of leverage ratios may need to be replaced by other criteria (min. liquidity , absolute EBITDA).
PEH may still be actively seeking investment opportunities. So the question is whether to equity-fund the closing or test an acquisition financing despite the adverse market developments. In acquiring new businesses, concepts are being discussed on how to appropriately reflect Corona-based uncertainties in the financing cases. Overfunding of debt service and temporary surplus covenant headrooms may be considered.
The debt capital markets already reflect these adverse developments through an increase in the iTraxx crossover (+ c. 500bps within one month) as well as a reduction of the HY bond index (c. -20% within one month). Financing parties are busy collecting specific Corona related information from their borrowers who are in turn drawing RCFs and safeguarding MACs clauses. While some institutions are currently blocked, others still seem to be open for new business, however the financing terms will be more onerous:
- higher return requirements (to price the increased risk)
- lower leverage (to provide for additional buffer)
- scrutiny re corona (requiring additional downside cases)
- obligatory current trading for March at least (preventing fast tracks)
Speaking to the right financing parties is therefore even more important.
In all of this, independent expert advise may be reasonable prior to approaching financing parties.
Clearwater International as independent partner-owned corporate finance house with 300 employees across 16 offices advised on various private equity and corporate financings many of which included support schemes of the KfW.
Our senior team members advised clients during earlier crises (e.g. 2000, 2008) so are familiar with less obvious challenges, specific stakeholder interests and process dynamics under demanding circumstances.
We would be delighted to discuss with you our views regarding the general debt capital markets environment and potentially specific situations where we could assist you!