UNIDENTIFIED PERSON, BYLINE: NPR.
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DARIUS RAFIEYAN, HOST:
2020 is on track to be the biggest year ever for corporate debt. Big companies have already borrowed more than a trillion dollars so far this year, almost as much as was borrowed in all of 2019.
CARDIFF GARCIA, HOST:
And the reason for that is fairly obvious. COVID-19 has devastated the world economy, and it's left many companies with a huge budget shortfall and lots of bills to pay. So a lot of companies are making up that shortfall by borrowing money. But as the effects of the pandemic drag on, a question remains. Will companies be able to ultimately pay back these big piles of debt they've been accumulating?
RAFIEYAN: Well, some have devised an innovative new strategy to avoid breaking the terms of their loans - lying.
GARCIA: Well, not lying exactly.
RAFIEYAN: Yes, yes. Sure. Being economical with the truth, let's say. This is THE INDICATOR FROM PLANET MONEY. I'm Darius Rafieyan.
GARCIA: And I'm Cardiff Garcia. Today on the show, why some of the world's biggest companies and financial institutions have agreed to kind of temporarily suspend reality. And how a meme on the side of a coffee mug is turning the world of corporate finance upside down.
RAFIEYAN: When a big company borrows money, there are protections built into the terms of that loan. The company has to sign something called a covenant. A covenant is a promise. Maybe it's a promise to have a certain amount of cash on hand or a promise not to rack up too much debt. Whatever it is, it's negotiated at the time of borrowing. And then each quarter, when the company reports its earnings, the covenant is tested to make sure the business is still meeting those requirements.
SABRINA FOX: It gives lenders sort of a seat at the table as it were. So they get to check in with companies from time to time.
GARCIA: Sabrina Fox is executive adviser at the European Leveraged Finance Association, which represents big institutional investors that loan money to big companies. Sabrina says covenants are an important protection for lenders to make sure companies are not misleading or taking advantage of those lenders. And in a lot of cases, the lenders could even be pension funds, which invest on behalf of working families for their retirement.
RAFIEYAN: Right. Or if you yourself have a retirement account like a 401(k), it's possible that you might be indirectly lending money to these companies. So covenants protect big financial institutions but also lots of normal people throughout the economy.
GARCIA: And Sabrina says covenants allow lenders to provide an important oversight role. If companies know that they have to meet certain requirements every single quarter and that lenders are going to be checking in and keeping them honest, then the companies are going to be less likely to act recklessly, and they'll be more likely to live within their means and avoid unnecessary risk. Again, that is good for the entire economy.
RAFIEYAN: Now, in the event that a company does break its covenant, it can find itself in default, which can have some pretty nasty consequences. It may mean the company's credit rating gets downgraded, making it harder to borrow in the future. Or it might give the lender the right to call in the whole debt all at once. In some cases, it may even mean that the lender can take control of the business in question.
FOX: They basically take the house away. They get the keys to the company. They can take it over. But most lenders don't really want to do that.
RAFIEYAN: Right. Sabrina says that most of these investors are big financial institutions who just want a nice return on their investment. They don't necessarily want to be worried about the day-to-day operations of some brick-and-mortar business. Take, for example, Punch Taverns, which is a chain of pubs in the U.K. that, earlier this year, was in danger of breaking its covenants.
GARCIA: So suddenly, this group of international financiers, lenders, were faced with the possibility that they might become the proud new owners of a bunch of struggling pubs in the U.K., which might sound appealing to, like, Darius and me, but, you know, not so much to other people who have better things to do.
RAFIEYAN: I'm thinking investors don't necessarily want to be stuck with a bunch of pubs that they need to somehow unload.
FOX: Exactly. Exactly. Like, I don't see many of them making a career change from, you know, loaning money to huge businesses to, you know, stepping behind a bar to serve drinks.
RAFIEYAN: And here's where the lying comes in.
GARCIA: Eh, not quite the lying. More like the massaging the truth, maybe bending or tilting reality ever so slightly.
RAFIEYAN: Massaging the truth just a bit. So to avoid breaking its covenant, which required that Punch Taverns make a certain amount of money, they agreed with their lenders to report last year's earnings in place of this years, which means technically they didn't break their covenants, at least on paper.
GARCIA: Yeah, other companies have struck similar deals. And these companies include concert organizer Live Nation and the luggage-maker Samsonite. But some companies have taken it a step further, going so far as to invent an entirely new accounting term. Enter EBITDAC.
RAFIEYAN: So if you're an accounting nerd like me, you'll be familiar with EBITDA. If you've never heard of it, don't worry too much about it. It's just a very popular way to measure a company's profitability. Now some are reporting EBITDAC, with a C at the end. The C stands for coronavirus. And again, if this is too wonky for you, all you need to know is that EBITDAC is a way for companies to report their hypothetical earnings, what their earnings would have looked like if coronavirus had never happened.
GARCIA: Yeah. And in fact, the term EBITDAC, so in other words, how profitable a company is in this magical world where coronavirus didn't exist, was originally coined as a joke on social media. Somebody started making novelty coffee mugs with EBITDAC emblazoned on the side.
FOX: Everybody thought it was funny until it actually started to happen. And companies were reporting their profitability, adding back lost revenues as if they had not had the disruption caused by coronavirus.
RAFIEYAN: That's right. Last month, German manufacturing company Schenck Process became, as far as we can tell, the first company to officially report its EBITDAC. They literally used this joke term in their earnings report. And this method of reporting hypothetical earnings may be starting to catch on a bit. Uber recently reported, quote, unquote, "adjusted earnings," which added back in some of its coronavirus-related expenses. And by one estimate, as many as 1 in 10 large companies may be using some kind of coronavirus-adjusted earnings metric.
GARCIA: Yeah. And as you might have guessed, there is an element of wishful thinking in all this. Basically what's happening is that companies are reporting what would have happened if we lived in the world we all wish we had, without coronavirus, instead of the world we actually have, which sadly does include coronavirus. Sabrina Fox concedes that agreeing to report these sorts of kind of fictitious numbers can be a useful way to avoid unnecessary upheavals and just keep the economy running as smoothly as possible. But she does worry that if companies are allowed to skirt these loan requirements, it could lead some businesses to borrow more money than they can eventually afford to pay back.
FOX: Then they're basically just throwing good money after bad. They're pretending that they're the same - at the same level of profitability that they would have been if coronavirus hadn't happened. But we don't know if that's ever going to be the case. So you're borrowing money based on a fiction, and then you're uncertain about whether you're actually going to be able to service that debt. That's when fiction of pretending like coronavirus never happened becomes really, really dangerous.
GARCIA: And this comes at a time when loan covenants are already historically weak. Over the last decade, investors all around the world have been eager to find a place to put their money where they can get a decent return. So they've been lending that money to companies where they can get that return. And that's giving companies a lot of leverage to allow them to negotiate looser and looser and weaker and weaker covenant terms.
RAFIEYAN: Yeah. And Sabrina worries that the pandemic may further erode the few protections that lenders have left. But, she says, given the scale of the crisis we're currently facing, we may all need to be OK with bending reality just a bit.
This episode of THE INDICATOR was produced by Kiarra Powell and fact-checked by Brittany Cronin. Our editor is Paddy Hirsch, and THE INDICATOR is a production of NPR.
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