ELFA’s Fox: Investors are focused on how covenants will impact recoveries

With bond and loan issuance having been brought to a crashing halt by the coronavirus crisis, Sabrina Fox says weak covenants will be equated with weak governance.

“I think at this point the market is broken,” says Sabrina Fox, executive adviser at the European Leveraged Finance Association, the London-based trade body that campaigns for a fairer and more transparent leveraged finance market.

“Issuance has almost completely stopped for bonds and loans,” she adds. “Volatility is so significant that it’s hard for people to know what to do and what levers to pull. The velocity of the deterioration left the street completely unprepared to deal with the shock. Firms were so long they just couldn’t lift accounts. Everyone needs to clear paper, but there are few buyers because everyone is bracing for outflows.”

Fox, who has just returned to work after suffering symptoms similar to those associated with the coronavirus, says the focus of investors has shifted from close scrutiny of covenants for portfolio management to how those covenants will impact their recovery rate analysis.

She says ELFA, which promotes its goals through dedicated initiative committees and runs seminars and workshops, has been thinking hard about how best to serve its members at the current time. Issues that had been climbing up the agenda – notably environmental, social and governance matters – have been put into sharp perspective.

“These events have focused investors even more on factors feeding into ESG analyses, so we are continuing our work on it in anticipation of the market coming back,” she says. “ESG will be even more relevant when the dust settles. Weak covenants are now being viewed through the lens of weak governance, as shareholders will be forced to balance competing interests of all of their stakeholders.”

She says there will undoubtedly be a shift in power in the leveraged finance market, where the negotiating power of borrowers has grown stronger and stronger at the expense of investors and lenders: “Companies will use flexibility to the detriment of investors, and investors won’t forget. They will currently be focusing on how covenants are being used and reminding themselves of how much flexibility they have given away.”

She thinks there will be a reset of terms and conditions, and that the most egregious elements will fall away. But it could take months before the market begins to return to normal, because of the “tsunami overtaking Europe”.

The most important thing in the near term, thinks Fox, is for governments to keep order and prevent economic collapse. She anticipates some businesses staying alive only through government support and even nationalisation, and plenty of workouts. By August or September, “if we’re lucky”, the leveraged finance market will be in a position to assess the damage and decide how it can function effectively going forward.

Fox adds, however, that she received a call from a banker wanting to discuss a new primary market tool that was being developed – suggesting that he, for one, was still planning for a functioning primary market on the other side of the crisis.