Despite a downturn in its business, AMN Healthcare Services, a $1.2 billion staffing company, is in no danger of flat-lining. Its revenue rose 3% in the December quarter, its net income was positive, and its leverage ratio was a thin 1.5. And yet CFO David Dreyer has recently spent some long days trying to renegotiate a leverage-ratio covenant and extend the tenor of the company’s revolving line of credit.
Cash expenses for a restructuring (such as severance packages) were weakening the company’s EBITDA (earnings before interest, taxes, depreciation, and amortization), but not to a degree that would appear to violate its loan covenants. The difficulty for Dreyer was that AMN Healthcare’s banks and loan investors were examining every fee and rate with the intention of repricing the debt package. It was taking a lot to convince them not to extract more than the situation called for. “Even with the relationship banks, the process is night and day compared with what it used to be,” Dreyer says.
Welcome to the harsh new world of loan covenants. Like AMN Healthcare, more and more companies are having to renegotiate covenants as the recession weakens earnings. “We’re doing a lot of amendments — many more amendments than new deals,” says Larry Mack, executive vice president, KeyBank Debt Capital Markets.
A number of highly leveraged firms are now breaching the leverage ratios, fixed-charge coverage ratios, and net-worth minimums that were set in stronger, more-liquid markets. According to Standard & Poor’s Leveraged Commentary & Data, there were 98 covenant amendments (publicly disclosed ones, that is) to high-yield corporate loan agreements in the first quarter of 2009, up from 62 in the previous quarter. Experts expect just as many, if not more, in the second quarter.
Other, less-leveraged companies will also be talking to their lenders about amending covenants. (According to one academic study, between a quarter and a third of all public companies will trip a loan covenant over a 10-year period.) And the conversations may not be pleasant. When credit was abundant, many banks felt they were taken advantage of, says Steven Bavaria, managing director of leveraged finance at credit-rating agency DBRS. “The gun was at their heads to reduce fees and spreads,” he says. “Now some of the same borrowers have to go hat in hand and ask for covenant relief. They shouldn’t expect a warm, helping hand from the bankers.”
Still, if the CFO warns lenders of a potential covenant breach early on, the experience need not be painful. Banks may even waive the violation, in hopes the company can recover by the next reporting period.
Penalties, Fees, and More
A company that breaches or is close to breaching a covenant will usually pay for the indiscretion. The penalty may be in the form of a pricing increase, upfront fees, a LIBOR floor, or the reduction in size of revolving credit commitments. Tighter covenants or new ones may replace the old, depending on the situation.