High yield and leveraged loan values for retailers in North America and Western and Southern Europe fell by around a quarter in Q1 2020 compared to Q4 2019, from US$12.6 billion to US$9.3 billion, and were flat on Q1 2019 figures. Volumes dropped 44% year-on-year.
The COVID-19 lockdowns have weighed heavily on retailers’ finances, with non-food retailing particularly troubled. Since the pandemic took hold, the pricing of non-food retailing loans has fallen by around a fifth and retail loans were among the biggest loan decliners overall in Q1 2020.
This has added further pressure to a sector that was already in a state of flux. Online entrants and discounters had upended brick-and-mortar retail business models and increasing labor, property and business costs had knocked profitability.
Ratings agencies now expect retailers will account for around a fifth of defaults over the rest of the year. In the US, retail bankruptcies have started to climb, according to Debtwire, accounting for five of the 22 Chapter 11 filings in March. Only the troubled oil and gas sector has been hit harder. Recent retail bankruptcy filings include online retailer and owner of Fingerhut catalogs Bluestem Brands, as well as Modell's Sporting Goods.
In the UK, meanwhile, many high-profile retail brands have also tipped over the edge: Cath Kidston, Debenhams, Oasis and Warehouse Group have all called in administrators.
Lenders zero in on credit quality
Across all sectors, lenders have intensified their focus on credit quality and tighter terms, and the retail sector has been viewed as a particular risk. High yield bond and leveraged loan markets have been effectively shut to retailers since the onset of COVID-19, with a few exceptions––for example, discount retailer Burlington (formerly Burlington Coat Factory), came to market with a US$300 million high yield bond in April.
Meanwhile, direct lenders that had issued large loans to retailers prior to lockdowns have all but ceased activity in the sector. In some cases, direct lenders have also sought to exit positions in retailers where possible. Bain Capital Credit, the credit arm of private markets manager Bain Capital, for example, recently sold its stake in UK menswear retailer TM Lewin to buyout firm SCP Private Equity.
But there have been some bright spots in the sector. Food and online retailers have reported strong, resilient earnings. For food retailers in particular, the COVID-19 crisis has accelerated the shift to online distribution and there have already been acquisitions along these lines, such as Target’s purchase of online delivery group Deliv. When markets settle and lockdowns are lifted, similar strategic deals could come to market. Such transactions will require funding and retailers able to weather the storm may find that lenders are receptive.
Liquidity is key
For now, though, the priority for all retailers will be to shore up liquidity and renegotiate terms on existing loans where possible. Lenders have shown an initial willingness to allow covenant holidays, waivers and amendments, but the scope for such accommodations will vary from case to case. Retailers that were stretched prior to the lockdown will have less room to buy time.
In the US, the Federal Reserve’s program to buy up corporate bonds and bond exchange traded funds has given some relief to retailers that require cash. The program will include commitments to buy the bonds of “fallen angels” (borrowers that have been downgraded from investment grade to junk status). The Gap is included in this group, having recently suffered a downgrade.
The bond buying program has strengthened lender appetite for debt issued by retailers and, as a result, some retailers have moved to take advantage of this window. Nordstrom, for example, priced US$600 million of senior secured notes in April, after drawing down US$800 million on its revolving credit facility.
Open to options
Retailers, however, are not relying exclusively on loan and bond markets for borrowings, with many exploring alternative options for raising finance.
Sale-and-leaseback is one option that has come to the fore. US discount retailer Big Lots, for example, agreed to a US$725 million sale-and-leaseback financing with Oakstreet Realty Capital.
Distressed debt and restructuring investors could also feature if lockdowns are prolonged and earnings continue to deteriorate. For now, though, loan-to-own and distressed investors are waiting on the sidelines to see where valuations and earnings bottom out, and to what degree things are going to reset.
Looking ahead
Regardless of how the COVID-19 crisis plays out for retailers, the lending options available to the sector are likely to shift for at least the next few years.
Credit quality will be the primary concern for lenders, so not all credits will get funded, and pricing will be higher than what borrowers enjoyed prior to the downturn (Nordstrom, for example, had to pay 8.75% for its recent borrowing). Terms and covenants can also be expected to tighten.
COVID-19 has accelerated the trend toward a consolidated and digitally-driven industry. Companies that can see out this downturn will look to finance acquisitions that support these strategic aims in the future.