Europe’s Mid-Market Lenders Take a Flexible Approach

Lenders and borrowers have collaborated to amend many loan agreements, avoiding defaults for now. Juliana Ritchie, Director at Alter Domus in the UK, examines the critical role of facility agents.

Something strange is happening in Europe’s debt markets. Despite the coronavirus pandemic plunging Europe and the UK into a historic recession with the kind of drop in business activity normally only seen in war, there have been few defaults on loans so far in 2020.

The default rate for European leveraged loans reached 1.7 percent in June 2020, according to Fitch Ratings. While an increase from 0.8 percent in December 2019, it is still a low level. Additionally, Fitch’s loan default forecast for all of 2020 is 3.8 percent, up from pre-pandemic forecasts of 2.5 percent, but still small given the severity of the recession.

It is no secret that many of Europe’s mid-sized corporate borrowers have struggled to service their loans. Conversations with facility agents across the market suggest that most of Europe’s mid-market borrowers have needed to raise additional liquidity or adjust lending facilities – often as a matter of survival. But, so far, lenders and borrowers have collaborated, and defaults have remained rare.

In April and May, there was a flood of activity as loans were amended. These unprecedented volumes stress tested the infrastructure behind the loans market, exposing any weaknesses in facility agents’ technology. For instance, communicating through online portals rather than by email facilitated the processing of large volumes of requests, minimising logjams.

For some lenders, administrative issues proved an unwelcome distraction. “If the lender can focus on the credit and they're not having to worry about the administration of the loan, then borrowers can get their funds in a timely fashion, because often all these requests are coming in a really narrow window,” explains Ritchie.  

Mastering the practicalities of loan amendments

At the start of the pandemic outbreak in Europe, the UK regulator, the Financial Conduct Authority, issued guidance recommending that lenders defer payments on personal loans and residential mortgages, setting the conciliatory tone for the corporate market. With many debt funds managed from London, that influenced their approach.

With their income evaporating, many of Europe’s mid-market businesses were able to raise additional liquidity or adjust their credit facilities. As is well known, the tourism, hospitality, retail and leisure industries have been severely affected. In the tourism industry, borrowers have been allowed to make payments in kind, or to compound or capitalise interest. Some have negotiated a postponement of reporting requirements until 2021, and others have put their annual financial statements on hold until further notice.

The rush in April and May to amend loan agreements and provide additional liquidity highlighted the importance of practical issues such as agile systems. If deals are amended to include part payment, deferred payments or compound interest, for instance, computations must be quickly updated. Operating through a portal also improves efficiency and security.

“Other agents have had cyber security issues where people can intercept either notices or banking details by email,” says Ritchie. “Using a portal minimises IT issues and security issues.”

A wave of restructuring to come

Looking forward, it seems unlikely that the low level of defaults can continue forever. A point will come when it is clear that loans can no longer be amended and companies will have to restructure their loans, although the exact timing of this is unclear.

“While banks still have cash to lend and the direct lenders still have liquidity, they’re likely to fund any tricky deals that they might have to put liquidity into,” notes Ritchie. “Probably people will stumble through 2020 and we won’t see the results of all this until the first quarter of 2021.”

In the meantime, she expects to see some banks sell distressed loans in the secondary market. Debt funds with excess liquidity are likely to buy some of these loans.

“Some debt funds expect to be very busy in the next few months,” says Ritchie. “They’ve raised funds from their investors that they need to invest. Loans are cheap to buy right now, and they see it as an opportunity.”

As banks sell down their loans, there will be a need for independent facility agents that can coordinate the actions of all a borrower’s remaining creditors over the course of a restructuring that could take several years.

It’s likely that in 2021 the rate of defaults in Europe’s mid-market will no longer defy the reality of recession. Then lenders, borrowers and facility agents will move to a new phase – the frantic initial phase of amending a flood of loans to offer short-term relief will move on to the longer-term negotiation of restructurings.

This article was originally published in Sensus Magazine. Download the latest issue below.