As COVID-19 continues to wreak havoc on the economy, many companies are experiencing lower revenues, resulting in lower future cash flows and longer collections cycles. This ripple effect across companies puts significant burdens on certain companies' liquidity.

Debt covenants are agreements between the company and its lenders, usually specifying limits or thresholds anchored on financial ratios or business operating KPIs. When a company violates a debt covenant, the lender may impose on the company, for example, higher interest rates on the debt agreement, require a penalty payment, demand full immediate payment, and increase the underlying collateral amongst other things. These factors potentially can put an additional financial strain on an already-strained company. Renegotiations and receiving waivers on the covenant violations may provide a much-needed critical lifeline.

Debt Covenant Challenges as COVID-19 Reduces Cash Flow and Liquidity

Looking at the filings for 2020, a search using idaciti’s Disclosure Research application revealed close to 250 companies that have mentioned “debt covenant violation” OR “debt covenant not in compliance” OR “debt covenant out of compliance”. Not surprisingly, the industry with the highest number of companies with debt covenant violations by far is Real Estate Investment Trusts, comprising 11% of the sample. Covid-19 has severely impacted office, and retail real estate demand as employees continue to work remotely. Also, the consumer foot-traffic through shopping malls has slowed down. It is followed by Crude Petroleum and Natural Gas (3%) and Retail - Eating Places (3%).

Disclosure Research Provides Insights into How Companies Discuss Debt Covenant Violations

Much can be told from reading through the disclosure tea leaves of companies in covenant violation. Below are two examples of companies that have violated their debt covenants and the subsequent potential outcomes.

Example one. Although this company received PPP funds to assist with short term liquidity, the EBITDA debt covenant violation was nevertheless triggered. The company may face accelerated payments in the future in addition to penalty fees. The company is currently renegotiating with the lender.

Example two. This company violated its debt covenant before Covid-19 in 2019 Q3 and was granted a waiver by the lender at that time, giving it short-term relief. However, comparing its disclosures in 2020 Q1 and 2020 Q2, we can see that its language in its Q2 filing signals increased the risk of debt covenant violation again. The lesson to investors and analysts is that monitoring subtle differences in language across filings can provide further insights into changes like increased liquidity risks.

The impact of Covid-19 on companies’ financial liquidity depends on several factors; for example, a rebound in the economy and consumer confidence.  It also depends on how companies manage their financial and operational metrics upon which debt covenants are determined for companies with outstanding debt.  For companies in violation, renegotiation and obtaining waivers may provide a temporary lifeline. It pays to closely monitor not only how companies discuss their covenant violations but also any ongoing renegotiations. Utilizing machine learning and digital financial disclosures can help you do that.  

At idaciti, our Disclosure Research application can provide you with up-to-the-minute alerts on debt covenant violations and renegotiations.

See how modern disclosure research application can provides insights to how companies discuss debt covenant violations and other critical maters