There may not be a debt crisis this time round
Whist gearing levels have crept up close to the levels reached prior to the 2008 recession, the health care services sector is much less likely to face a crisis this time round because there are fewer covenants and the sector is favoured.
In general, private equity houses using leveraged finance to raise debt over £200m have enjoyed a buyers market for the past 2-3 years, says Helier Drage-Smith, managing director at Rothschild & Co’s debt advisory arm. For deals of this size, ‘maintenance’ financial covenants, which test EBITDA to debt ratios every quarter, got dropped as lenders fought to win business. They have been replaced by ‘incurrence’ covenants which are only tested when a significant discretionary event is planned, such as a major acquisition.
Excluding equity-like borrowings, such as preference shares, he says that the health care services sector in Europe has recently been able to borrow net debt that is 5-6 times EBITDA, with the most favoured extending up to over 7 times.
“The focus in this crisis has been more on liquidity than covenants – because there often aren’t any” says Drage-Smith. “Many borrowers have some flexibility to raise liquidity from a variety of sources alongside their existing debt package and some are deciding to do so as a precaution”. The absence of covenants and the fact that private equity is sloshing with uninvested money means that PE houses are quietly able to pump more equity into businesses who have reached or are close to their borrowing limits.
Below £200m, ‘maintenance’ covenants remain the norm. And they also remain the norm for non-PE backed businesses. Drage-Smith says: “It can seem counter-intuitive that a listed group or a family owned business with debts of, say, only 3 times EBITDA, is likely to be quite tightly covenanted whilst a large PE-backed group on 5-6 times probably won’t be.”
Debt below £200m is typically issued by credit funds these days, rather than banks. So how are these new players likely to view operators who are in breach of covenants? Drage-Smith says their response has generally been constructive. “For years they have been claiming that they want to build responsible long-term relationships with borrowers and this is their first chance to prove they mean it. They are generally taking the view that they will benefit long-term by being flexible.”
He says that the sector is also one of those favoured by lenders. “For lenders, health care is generally in the top half and often in the top quarter of industries.” That means that health care businesses which can demonstrate a likely return to 2019 EBITDA within 18-24 months will likely be supported.
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