With respect to debt, recently, market interest rates have increased significantly and high volatility could be observed. It is very likely that this volatility will continue for some time in view of the COVID-19 pandemic. Hence, matching market conditions with the timing of intercompany debt is important and companies should consider the interest rate gap that was created throughout March. Specific caution should be given to (extremely high) increases for non-investment grade debt as well to the consideration of selecting the term (in view of differences in short term and long term market conditions).
As debt funding might not be an option or optimal solution for all companies, certain equity options could be considered. In the past, a debt waiver was popular. Considering evolutions in tax law, it should be reviewed whether this would still be a viable option. Moreover, options realistically available (“ORA”) for both lender and borrower should be considered as well as current market conditions (considering that in most cases the fair value of the debt instrument would have a latent loss). Companies could also make a contribution in kind of intercompany debt instruments. In case when such debt-equity swaps are considered, it is important to focus on the exchange ratio, i.e. the amount of shares issued with respect to the contribution. Furthermore, the fair value of the shares is another important factor to consider. When the transaction would be under scrutiny from the tax authorities, it cannot be excluded that they will attempt to use hindsight to determine fair value. Therefore, it is recommendable to have sufficient support in the determination of the fair value of the debt instrument as well as the fair value of the shares.
For more details, we refer to our article: http://www.taeconomics.com/tackling-financial-distress-in-times-of-corona