The world-wide disruption caused by the COVID-19 pandemic has created an unprecedented situation for the hotel industry. With much of Europe having entered into a full lock-down as a result of the Coronavirus, most hotels are now closed. Even if hotels are allowed to reopen later this year, it is clear that it will be some time before the hotel industry returns to business as usual.
As hotel owners and funders begin to comprehend the impact on the industry, their businesses and their funding arrangements, we look at the key issues that hotel owners and funders should be considering in the next few weeks and months.
Funding working capital
For hotel owners one of the key questions will be how to fund the key working capital requirements of the business at a time when income has completely dried up. Even where hotels are closed, there will still be a cost to ensure that security and health and safety standards are maintained.
European Governments have put in place substantial emergency funding packages to help businesses with their cashflow requirements during the COVID-19 pandemic. These include deferral or waiver of taxes, furloughing of employees, cash grants, loans to businesses and other aid.
In the UK this includes the Coronavirus Job Retention Scheme which allows owners to furlough staff (currently until 30 June 2020), a 12 month business rate holiday for retail, hospitality and leisure businesses and the Coronavirus Business Interruption Loan Scheme ("CBILS") which will be delivered by way of loans of up to £5m[i] from high street banks which will be interest free for the first year. The UK Government will provide the lenders with a guarantee of 80% of the amount of each CBIL loan.
In practice many hotel owners are finding the CBILS scheme difficult to access, which was perhaps inevitable given the scale and urgency of the scheme. Those lenders who offer the scheme have been inundated with applications and have had to process those applications with their entire team working remotely, whilst also having to deal with requests for covenant waivers and hotel closures on their existing loan portfolio. Lenders are required to carry out a proper underwriting process on loan applications and ensure that hotel owners satisfy the requirements of the scheme. The government are now considering offering a 100% guarantee on loans up to £25,000 which will hopefully speed up the process.
For hotel owners considering the CBILS loan scheme, questions arise as to how the CBILS loans will interrelate with their existing funding and security arrangements, especially where the CBILS lender is not their main commercial funder. It is likely that owners will need consent from their existing debt funder to enter into the CBILS loans in these circumstances and as existing funders are likely to have security over the hotel and operating assets, hotel owners are unlikely to be able to offer much in the way of security to the CBILS lender.
Default under financing arrangements
There is widespread acceptance in the hotel lending community that hotel owners will breach the financial covenants in loan agreements. As most hotels in the UK only begun to feel the impact of Coronavirus on trading performance in March, many hotel owners will have met their financial covenant tests for the 12 month period ending in March, but it is widely expected that the vast majority of hotel facilities will fail to meet their covenants at the end of June 2020. With widespread hotel closures across Europe, curing those breaches through normal covenant cure mechanics simply isn't a viable option.
Most lenders have already recognised that financial covenants will have little meaning given the likely impact on trade and are considering waiving or have already waived financial covenants for an initial period, in some cases until the end of 2020. Consideration also needs to be given to how covenants are tested once trading returns to normal. The usual position is for leverage and debt service covenants to be tested over a 12 month period, but in reality owners and lenders will need to reset covenants by reference to when hotels are likely to reopen for trade, test for short periods initially and assume a ramp-up period as hotels re-establish trade.
The circumstances created by Coronavirus may also constitute a number of other defaults under financing arrangements, including a default under the material adverse change provisions. Hotel owners should seek a waiver of these provisions at the same time as waiving financial covenant breaches.
In addition to financial covenants, hotel closures are likely to be a breach of the terms of most financing arrangements. Even though the hotel closures were mandatory, hotel owners should approach their lenders for consent if they have not do so already.
The cash flow shortages and significant breaches of banking covenants that will occur in the next few weeks and months mean than many hotel companies will be unable to pay creditors as they fall due or become balance sheet insolvent. In addition, as hotel owners borrow money to fund their cashflow over the next few months, many will emerge from the crisis with significantly higher gearing.
Whilst the government has suspended the wrongful trading provisions retrospectively from 1 March 2020 in response to the current pandemic, directors should still consider their position once normal trading resumes and decisions will still need to be made in considered way, taking into account the long term viability of the business. Any additional debt taken on now will ultimately need to be repaid in the longer term and directors should consider whether the business can sustain that amount of debt once trading returns to normal.
Whilst many lenders are taking a supportive and pragmatic approach to the challenges that lay ahead, some of the more opportunistic lenders may view the current crisis as an opportunity to acquire assets at a low value. A number of European jurisdictions are introducing legislation to protect companies from insolvency proceedings during the pandemic and it is likely that other jurisdictions will consider similar protections.
The UK Government has announced changes to insolvency rules which include a moratorium for companies of up to 28 days (which can be extended to 56 days) to allow time for a rescue or restructuring to be put in place and new rules preventing suppliers from terminating supply contracts.
Looking to the future
It is becoming increasingly clear that securing new debt financing for a refinancing or an acquisition as we emerge from the crisis is likely to be significantly more difficult for a period of time. Margins for new debt are likely to increase, at least in the short term, and there will be fewer lenders actively looking for new financing opportunities. Many lenders will need to review all of the loans in their existing portfolio to ensure that the financing arrangements are still viable. For hotel owners who took out working capital facilities during the crisis, lenders are likely to seek to consolidate these into the owner's main financing arrangement and to extend the term to allow for a more gradual amortisation profile.
Hedging markets are unsurprisingly volatile and are likely to remain so for some time, so for hotel owners who are looking either to refinance or to sell a hotel during 2020 the marked-to-market position of existing swaps may have a significant impact on that decision.
[i] For businesses with a turnover of up to £45m. For businesses with a higher turnover the Coronavirus Large Business Interruption Loan Scheme allows businesses to borrow up to £25m.