How many borrowers in the high yield and leveraged loan markets would want to answer a question from investors right now about EBITDA addbacks? It’s a pertinent consideration thanks to a new covid-19 reporting best practice guide produced by the European Leveraged Finance Association.
ELFA was the investor’s friend during the pre-covid years. It pushed for greater transparency from borrowers in a period when to say they held the balance of power in negotiating deal terms and conditions was an understatement. But now that many borrowers are in trouble and in need of a few favours, ELFA has seen the opportunity – on behalf of its members – to ask some demanding questions.
The guide is intended to be used for investor calls as a handy reference: a reminder of what investors should be asking to get the information they need. Many of the questions – in areas such as operations, liquidity, debt incurrence and cashflow – are straightforward enough. Few borrowers would decline to be as helpful as possible. But then there are the tougher ones, such as that referred to in the opening paragraph, where borrowers are invited to state “current EBITDA as calculated under your covenants, clarifying addbacks in relation to covid-19 as well as other addbacks”.
It’s a tricky one because addbacks are so controversial – having been effectively used to disguise the extent of leverage in companies by incorporating “potential” as well as actual revenues into debt/EBITDA calculations. Some may resist answering these and related questions, having perhaps been told to do so by their advisers. But ELFA executive advisor Sabrina Fox believes “the best in class will answer everything and be really up front”.
Fox admits to being an optimist in hoping that a new era of transparency has arrived in the leveraged loan market. Certainly, prevailing conditions are helpful. Companies that need more capital or help with restructuring also need positive relationships, and transparency is a good way of fostering them. Being open will create the impression of trustworthiness. “It’s an opportunity to divide those willing to be constructive from those who won’t bend,” says Fox. “The difference between the two will be very telling.”
What will also be telling is how the proliferation of covenant-lite deals ends up affecting investor outcomes. Speculation about this has been rife for a long time. Only from now will the truth be revealed.
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