Structuring Covenants in Leveraged Loans and High Yield Bonds for - - PowerPoint PPT Presentation

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Structuring Covenants in Leveraged Loans and High Yield Bonds for - - PowerPoint PPT Presentation

Feb 11, 2023 445 likes •679 views

Presenting a live 90-minute webinar with interactive Q&A Structuring Covenants in Leveraged Loans and High Yield Bonds for Borrowers and Lenders Analyzing Financial and Performance Covenants, Equity Cures, Builder Baskets, Events of Default

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Structuring Covenants in Leveraged Loans and High Yield Bonds for Borrowers and Lenders

Analyzing Financial and Performance Covenants, Equity Cures, Builder Baskets, Events of Default and More

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THURSDAY, APRIL 3, 2014

Presenting a live 90-minute webinar with interactive Q&A Maura E. O'Sullivan, Partner, Shearman & Sterling, New York Benjamin M. Cheng, Counsel, Shearman & Sterling, New York

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April 3, 2014 Maura O’Sullivan– Partner – New York mosullivan@shearman.com Benjamin Cheng – Counsel – New York bcheng@shearman.com

Structuring Covenants in Leveraged Loans and High Yield Bonds for Borrowers and Lenders

Strafford Webinar Program

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Table of Contents

Loans vs. Bonds 7 Financial Maintenance Covenants 8 Financial Maintenance Covenants (continued) 9 Benefits for Lenders of Financial Maintenance Covenants 10 Borrower’s Response to Financial Maintenance Covenants 11 Borrower’s Response to Financial Maintenance Covenants (cont’d) 12 Covenant-lite Loans: Why now 13 Debt Incurrence 14 Acquisitions 15 Repayment of Junior Debt 16 Builder Baskets 17 Restricted Subsidiaries 18 Restricted Subsidiaries (cont’d) 19 Events of Default 20 Opportunities and Risks 21

NYDOCS02/1023813

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Loans Vs. Bonds

  • Historically, syndicated bank loans had tighter covenants than high yield

bonds

  • One of the main differences was the inclusion of financial maintenance covenants

in syndicated loan agreements

  • Maximum leverage ratio
  • Minimum interest coverage ratio
  • Minimum fixed charge coverage ratio
  • Other significant differences:
  • Bonds have incurrence style negative covenants while loans historically have had fixed

dollar baskets as exceptions to the negative covenants

  • Floating vs. Fixed interest rates
  • 5/6 year maturity for term loans vs. 8/10 year maturity for bonds
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Financial Maintenance Covenants

  • Require borrower to meet certain financial performance levels on a periodic

basis

  • Performance levels generally tied to model provided to lenders prior to

commitment

  • Covenants can be applied on a quarterly basis or at any time basis
  • Failure to comply results in an event of default (typically no grace period)
  • Maintenance Covenants are applicable whether or not a borrower intends to

engage in a transaction that may be limited by the negative covenants

  • Maximum leverage ratio → the borrower cannot exceed a specific ratio of

debt to a cash flow measure (typically EBITDA)

  • Total debt
  • Secured debt
  • First lien debt
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Financial Maintenance Covenants (continued)

  • Minimum Interest Coverage Ratio → the borrower must have at least a

specified ratio of cash flow (EBITDA) to interest expense

  • Total interest
  • Cash interest
  • Minimum Fixed Charge Coverage Ratio → the borrower must have at least

a specified ratio of cash flow (EBITDA) to fixed charges

  • Interest expense
  • Capital expenditures
  • Scheduled amortization payments
  • Rent expenses
  • Dividends
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Benefits for Lenders of Financial Maintenance Covenants:

  • Maintenance covenants provide early warnings of financial difficulty
  • Payment default
  • Bankruptcy default
  • Early warnings allow lenders to be pro-active in devising solutions
  • Early seat at negotiating table with borrower
  • Maintenance Covenants can deter borrower from pursuing transactions that

have negative impact on cash flow

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Borrower’s Response to Financial Maintenance Covenants

  • Equity cures
  • Cash injection within 10 business days after delivery of financials
  • Standstill
  • 5 for life of loan and 2 for every 4 quarters
  • Not any larger amount than is necessary for the cure
  • Disregarded for other purposes
  • Cash injection increases the cash flow companent of the ratio and may also be negotiated

to decrease the debt companent

  • Net leverage tests
  • Maximum cash
  • Unrestricted cash
  • Cash of foreign entities
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Borrower’s Response to Financial Maintenance Covenants (cont’d)

  • Springing Covenants
  • Triggered if outstandings under revolver exceed a certain percentage of

commitments

  • Letters of credit often exclude in calculation
  • Cushion to base case model
  • Covenants-lite term loans
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Covenant-lite Loans: Why now

  • Key factors that today are affecting market dynamics:
  • Interest rates are low so more debt investors are looking to the leveraged market

for higher yields

  • Belief that interest rates will increase so floating rate debt (loans) is preferable to

fixed rate debt (bonds)

  • Leveraged acquisition activity has not increased enough to keep up with demand
  • As a result, certain borrowers have more negotiating leverage to obtain

more favorable terms

  • Private equity sponsors
  • Higher rated leveraged borrowers
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Debt Incurrence

  • Fixed dollar baskets
  • Ratio basket
  • Cash interest coverage ratio, fixed charge coverage ratio, leverage ratio
  • “if, on the date of such incurrence and after giving effect thereto on a pro forma

basis (including giving pro forma effect to the use of the proceeds thereof) no Default or Event of Default has occurred or is continuing, the Issuer and the Restricted Subsidiaries may incur Indebtedness if the Issuer’s Consolidated Fixed Charge Coverage Ratio for the most recent four full fiscal quarters for which financial statements are available immediately preceding the incurrence of such Indebtedness taken as one period is at least equal to or greater than 2.00 to 1.00”

  • Grower components so that baskets can grow as business expands
  • The greater of $__ and __% of total assets
  • Ability to secure new issuance of debt with collateral on either pari passu basis or

junior basis

  • Test if typically a maximum total secured leverage ratio, or a first lien leverage ratio
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Acquisitions

  • Traditional loans would limit acquisitions to a fixed amount per year or over

the life of the loan (sometimes with a per acquisition limit)

  • Covenant lite loans allow unlimited acquisitions subject to pro forma

compliance with an incurrence test (leverage ratio or interest coverage)

  • If the covenant lite term loan is paired with a revolver then the test might be

pro forma compliance with the financial covenant for the revolver regardless

  • f whether it is then applicable
  • Generally will include a limit on acquisitions of non-credit parties
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Repayment of Junior Debt

  • Junior Debt can be junior lien debt, unsecured or subordinated debt
  • Traditional loans would have a small fixed dollar basket with which the

borrower could prepay the junior debt

  • Junior debt is typically more expensive than first lien senior secured debt and

therefor it is beneficial for borrower to pay down the junior debt

  • However, this would mean that the senior lenders would have lost the cushion of

junior debt in a work-out scenario (through the depletion of the borrower’s cash)

  • Covenant-lite loans may allow the borrower to prepay junior debt subject to

compliance with an incurrence test (typically a leverage ratio)

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Builder Baskets

  • In covenant-lite loans, for acquisitions, investments and repayments of

junior debt, one would normally see builder baskets

  • Starter basket (fixed dollar) + retained excess cash flow or 50%

consolidated net income

  • Plus:
  • Equity injections or issuances
  • Returns on investments
  • Asset sales proceeds
  • Leverage test for use of builder basket for dividends
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Restricted Subsidiaries

  • Traditional loans would typically cover all subsidiaries of the Borrower in

the representations, covenants and events of defaults

  • Covenant-lite loans typically permit the concept of unrestricted

subsidiaries and therefore only restricted subsidiaries of the Borrower are subject to the representations, covenants and events of defaults

  • Restricted Subsidiaries vs. guarantor subsidiaries
  • Traditional loans would have restrictions on money/assets flowing from

creditor group to non-creditor group

  • Bonds typically have restrictions on money/assets flowing from

restricted group to unrestricted group

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Restricted Subsidiaries (cont’d)

  • Bonds do not typically have restrictions on money/assets from credit

group to non-creditor group

  • Covenant lite loans typically continue to have restrictions on

money/assets flowing to non-credit group

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Events of Default

Bonds Senior Bank Loans Default in interest payment 30 days grace period 3-5 business days grace period Covenant default 60 days grace period

  • ther than mergers,

asset sales and failure to repurchase upon a change of control None for negative covenants and certain affirmative covenants; 30 days for others Default in other material debt Cross acceleration Cross default

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Opportunities and Risks

  • Opportunities for sponsors/issuers: better financial terms
  • Opportunities for investors: risk arbitrage
  • Risks:
  • Investors beware
  • Systemic risk and regulatory tightening