The availability and value of debt in the leisure and hospitality sector underwent a sudden and material change of fortunes in early March when COVID-19 lockdowns began to be implemented around the world.
High yield bond and leveraged loan values for the sector in North America and Western and Southern Europe stood at US$20.5 billion in Q1 2020, down 22% compared to Q4 2019. Issuance was more than double Q1 2019 levels, but this was only because of a bright start to the year before lockdown measures came into play.
The closures of large segments of the sector following worldwide lockdowns––including restaurants, hotels, casinos, gyms, cinemas and theaters––sent debt issuance and pricing indicators spiraling downward. Entertainment and leisure loans saw average bids fall to 79.4% of face value from 96.2% during March, according to Debtwire Par, while hotel and gaming fell from 98.1% to 83.4%. Only a handful of credits have successfully raised funds at significantly higher costs than what the market was offering just a few months earlier.
The leisure and hospitality sector is no stranger to volatility but the depth and speed of this downturn has significantly stretched the finances of most, if not all, of the businesses in the sector.
Holding on until the dust settles
The COVID-19 crisis only began to take hold in Europe and North America toward the end of Q1 2020, but significant damage has already been done.
According to the American Hotel and Lodging Association, 70% of hotel employees have been furloughed or laid off and eight-in-ten hotel rooms are unoccupied. Restaurant chains on both sides of the Atlantic, including TooJay’s and FoodFirst Global Restaurants in the US and Carluccio’s in the UK have already gone into bankruptcy. The coronavirus has also forced Gold’s Gym into Chapter 11.
Under the circumstances, unable to shift business online because of their reliance on foot traffic, companies struggling in the sector have focused on implementing liability management strategies and negotiating amendments or grace periods on existing loans.
Borrowers that were on a stronger footing prior to the pandemic will be the best-placed to negotiate quarterly waivers, extended maturities and payment delays. Lenders seem willing to give borrowers the benefit of the doubt for now, but as the full impact of the lockdown on the sector becomes clear, restructurings will very likely enter the picture.
Boosting balance sheets
To stave off potential further damage, many leisure and hospitality businesses have drawn down as much liquidity as possible and as quickly as possible from their revolving credit facilities. There is often a leverage test at the end of each quarter that companies must meet to be able to draw. If the leverage test is breached at the end of a quarter, then drawdowns from the revolver can be declined. Companies worried that they may be unable to pass that test, either at the end of the current quarter or the next, are drawing now so they do not have to worry about it later.
For a select group of leisure and hospitality players, the debt capital markets have offered a source of much-needed liquidity. For example, fast food chain Yum Brands raised a US$600 million bond at the end of March and, around a month later, Restaurant Brands International priced a US$500 million bond at 5.75%. Cruise line operator Carnival, meanwhile, saw its US$4 billion high yield bond, also priced in April, several times oversubscribed.
But while there may be appetite among investors and lenders for the right hospitality and leisure credits, tapping the market has come at a cost. Carnival’s latest bonds priced at 11.5% versus borrowing of €600 million (US$652.3 million) in 2019 at a 1% yield.
In a sector where earnings have been suddenly put on ice, however, companies have been willing to pay more to secure cash that will be required to see out the downturn.
Hotel groups have been among those turning to bond markets in Q2 for finance. US chain Hyatt Hotels, which has retained investment grade status despite COVID-19’s impact on its earnings, raised US$900 million. Hyatt will use the funds to pay down its revolving credit facility, which will free up liquidity to access in the future to see itself through this downturn.
This followed earlier successful forays into the bond markets by rival hoteliers Marriott International and Hilton. Marriott raised US$1.6 billion through issuance of a five-year bond and Hilton secured US$1 billion, split evenly across a five-year bond and eight-year bond.
These companies all had to pay higher prices for their recent funding rounds when compared to earlier borrowings, even though the recent bonds were oversubscribed.
Lending markets may be open to credits from the hospitality and leisure space, but risks and uncertainty remain. Investors will continue to demand pricing premiums until it becomes clear when hotels, restaurants and others can reopen, and whether the pandemic has shifted long-term consumer spending patterns in a material way.
Many operators in the sector have shored up their liquidity positions for now, but there is still a long and unpredictable path ahead.