The State of COVID-19 Disclosure, Part I: Debt Covenants

It’s coming from celebrities. It’s coming from aunt Sally’s Facebook feed. It’s even coming from heads of state. Misinformation is one of the biggest obstacles in the fight against COVID-19, and it seems to be coming from everywhere. But if the SEC has its way, it won’t be coming from public companies. Last week, as the agency’s chief accountant emphasized the need for “high-quality financial reporting,” the SEC released guidance imploring issuers to speak honestly to investors about their financial health, including their chances of surviving the pandemic.

Updating the COVID-19 guidance it first issued on March 25, the SEC’s Division of Corporation  Finance told companies to get real with their disclosure (or at least to “proactively revise and update disclosure as facts and circumstances change”). The guidance gives issuers plenty to consider. It includes a long list of issues that public companies should keep investors apprised of going forward. Like Jeopardy! answers, they come in question form. They are also grouped in three broad categories, two of which are government relief received under the CARES Act and issuers’ ability to continue as a going concern. Watch this space for updates on what companies are saying about those two hot-button topics.

For now, we’re going to narrow in on the third category (“Operations, Liquidity, and Capital Resources”), and one question in particular that the SEC asks companies to address: “Are you at material risk of not meeting your covenants in your credit and other agreements?”

Debt covenants, of course, are restrictions that lenders place on borrowers to increase their chances of getting repaid. According to Moody’s, debt covenants have weakened significantly over the last decade, but still pose a serious concern to businesses, especially private equity portfolio companies loaded up on debt. And many covenants—like the insistence that borrowers maintain a certain debt-to-EBITDA ratio, or even just stay open for business—have proven impracticable in the pandemic.

Lots of companies, in other words, would have to answer “yes” to the SEC’s question.

A search of Intelligize reveals, assuringly, that issuers had already begun disclosing seemingly forthright answers to that question even before the recent guidance. Here are four examples, all filed before the June 23 guidance:

HOST HOTELS & RESORTS, INC. (10-Q, MAY 8): “We currently are in compliance with all our financial covenants under the credit facility and expect to remain so through the second quarter of 2020. However, due to the current level of operations, we believe that it is probable we will breach certain of these financial covenants based on third quarter of 2020 results. Therefore, we are currently in discussions with the lenders under our credit facility to seek a waiver from these covenants.”

XENIA HOTELS & RESORTS, INC (8-K, May 11): “The Company is engaged in active discussions with its unsecured lenders to amend each of its unsecured borrowing agreements, as it breached a financial covenant on each of its unsecured debt borrowings at the end of the first quarter and expects to breach additional financial covenants at the end of the second quarter.”

DIAMONDROCK HOSPITALITY CO. (8-K, JUNE 8): “We have finalized the documentation for an amendment to our credit agreements, subject to final lender approval, that provides for covenant waivers through March 31, 2021 . . . .”

SPIRIT AEROSYSTEMS HOLDINGS, INC. (8-K, JUNE 22): “Spirit could breach the financial covenants under its credit agreement in the fourth quarter of 2020 without an amendment or waiver.”

Of course, the mere act of seeking waivers, or disclosing the need for them, doesn’t guarantee a happy ending. Hertz sought extended waivers from loan terms this spring; when it didn’t get them, it had to file for bankruptcy. But at least none of these issuers are telling us that a hair dryer can treat COVID-19.