covenant-lite loans: emerging trend in the syndicated loan...

Covenant-Lite Loans: Emerging Trend in the Syndicated Loan Market Analyzing Elements of Cov-Lite Loans Post-Credit Crunch; Weighing Pros and Cons for Borrowers and Lenders

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WEDNESDAY, MAY 16, 2012

Presenting a live 90-minute webinar with interactive Q&A

Susan C. Alker, Partner, Reed Smith, Los Angeles

Jamie Knox, Partner, DLA Piper, New York

Adam Cohen, Founder and Managing Member, Covenant Review, New York

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Covenant-Lite Loans Emerging Trends in the

Syndicated Loan Market

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Susan Alker

Overview What is covenant-lite?

Typical covenant-lite terms

Analysis of current market conditions favoring covenant-lite

Current market -- covenant-lite terms post-credit crunch

Advantages and disadvantages for borrowers and lenders

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What is covenant-lite? The “Diet Coke”

version of a credit agreement – somewhere between regular Coca Cola and Coke Zero

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What is covenant-lite? A-rated investment grade = covenant zero,

no financial covenants, two negative covenants (liens and fundamental changes)

Middle market = covenant heavy, several financial covenants, long list of negative covenants

Cov-lite = no financial covenants, maybe springing covenants, only a few negative covenants

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Financial Covenants Here’s what the

financial covenants look like in a typical covenant-lite deal:

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Financial Covenants If there is both a revolving line of credit and a term

loan, there might be a financial covenant applicable to the revolver alone: Leverage test – Debt to EBITDA Revolving lenders alone can amend, waive,

declare event of default, stop advancing $ If no waiver within [45-90] days, cross-default

kicks in and term lenders have a default as well

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Financial Covenants Events of Default: The Borrower shall default in the

observance or performance of any agreement contained in [Section 7(a)(ii)][the leverage test]; provided that such Event of Default shall constitute an Event of Default only as to the Revolving Loan Facility and the Obligations relating thereto (a “Limited Revolving Loan Event of Default”), provided, further, that if such Limited Revolving Loan Event of Default shall not have been waived in writing by the Majority Revolving Lenders within 45 days after the occurrence of such Limited Revolving Loan Event of Default, then on such 45th day such Limited Revolving Loan Event of Default shall immediately become an Event of Default for all purposes and with respect to all Obligations (it being understood that, for the avoidance of doubt, upon the occurrence of a Limited Revolving Loan Event of Default the Revolving Lenders and the Agent, on behalf of the Revolving Lenders, shall be entitled to immediately exercise the rights and remedies hereunder as a result of such default);

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Financial Covenants Amendments: Except as otherwise expressly provided in

this Agreement, with (a) the prior written consent of the Majority Revolving Lenders if (x) such amendment relates to [Section 7(a)(ii)] or (y) if only Revolving Loans, Revolving Commitments or Revolving Lenders are affected thereby, (b) the prior written consent of the Majority Term B Lenders if only Term B Loans, Term Loan B Commitments or Term B Lenders are affected thereby, or (c) the prior written consent of the Majority Lenders in all other cases . . .

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Springing Covenants It’s not unusual for the

financial covenant(s), lite though they are, to spring into existence (or disappear) based on the amount of revolving loans outstanding or based on ratings

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Springing Covenants If the [30-Day Average] aggregate principal amount of

outstanding Revolving Loans [at any time] exceeds $_________, . . .

If [at any time during the relevant period] any Revolving Loans are outstanding . . .

Reverse Spring: Notwithstanding anything to the contrary herein, the Borrower will not be subject to the covenants set forth in [Sections 7.4(a) or (b)] at any time the Facility has [Investment Grade Ratings] from both S&P and Fitch.

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Other Covenants First, no financial covenants

Then, only a few loose negative covenants: incurrence test or large basket for debt incurrence test for liens? dividends OK up to a percentage of net income or

EBITDA acquisitions unlimited (or unlimited if pro forma

compliance with a leverage test) repayment of sub-debt

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Other Covenants - Example Facebook Credit Agreement ($5B, 2/28/12) Debt covenant Lien covenant Fundamental changes

asset transfers Hedge agreements Restricted junior payments Transactions with affiliates

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Other Covenants - Example Facebook provisions: Debt – no cap on unsecured subdebt,

other debt capped at $8 Billion Restricted Junior Payments – dividends

and stock repurchases capped at 50% of Consolidated Net Income for all fiscal years (2012+) taken as a single period

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Covenant-Medium? Covenant-lite concepts can creep into non-

covenant-lite loans No cap on debt or acquisitions as long as comply

with Consolidated Leverage Ratio (3:1) Permit dividends and repurchases in any fiscal

year in an amount not to exceed 15% of Consolidated Net Income

Permit payments on sub-debt if no default If obtain investment grade rating, some covenants

will drop out, but not leverage test

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Contact info: My book:

Susan Alker Partner Reed Smith LLP (213) 457-8069 [email protected]

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www.covenantreview.com www.covenantreview.com

Market Dynamics and Covenant Lite Loans This material is copyrighted and may not be duplicated / forwarded to other parties

Adam B. Cohen 19 West 44th Street, Suite 1401 New York, NY 10169 Tel: 1-212-716-5780 [email protected] www.covenantreview.com

THE AUTHORITY ON BOND AND LOAN COVENANTS

This presentation is for discussion purposes only. The information contained herein does not constitute legal or investment advice.


2005-2007: Covenant lite became viewed as normal

What was the genesis of that anyway? Also “lite-ish” deals like First Data

2008-2010: Less than $10 billion of covenant lite loans

Anemic issuance period: 2008-2010 combined less than the $535 billion issuance in 2007

2011: $40 billion of covenant lite loans

$373 billion of leveraged loan volume

Covenant lite is returning

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Refinancing was purpose of the majority of 2011 borrowings

Refinancings – 54% Strategic acquisitions – 17% LBOs – 14% Dividends – 7% Other – 8%

Why more covenant lite?

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Low default rates

Less than 0.5% default rate in 2011 (!) Lagging around 0.5% - fantastically low

Hawker Beechcraft, Bicent - $1.7 billion in April Compare: 10.81% at November 2009 Why such vicissitudes?

Covenant lite issuers have lower default rates OK, but what should that mean to a lender?


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Low interest rates

10 year Treasuries in 2011: 3% 2% Loans much juicer

B rated: L+520 B+ rated: L+429 BB- rated: L+411

Plus, impact of spread compression for total return 2010: approximately 10% 2011: approximately 1.5%


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Deal flow – who has time to analyze?!?

$31 billion of leveraged loans marketed in the first two weeks of May 43 separate credits to analyze (and 74 tranches) in just 2 weeks!


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http://www.jegi.com/sites/default/files/Credit_Markets_2011_Review_and_2012_Outlook.pdf

Marketing Period Borrower

Amount ($mm) Tranche Borrower

Amount ($mm) Tranche

5/7/2012 Air Lease Corp. 853 Revolver 5/1/2012 Kite Realty Group Trust 115 Term 5/3/2012 Allstate Corp. 1000 Revolver 5/1/2012 Kite Realty Group Trust 200 Revolver 5/7/2012 AmWINS Group Inc. 75 Revolver 5/3/2012 Lennar Corp. 410 Revolver 5/7/2012 AmWINS Group Inc. 295 Term 5/7/2012 Lord & Taylor 450 Term 5/7/2012 AmWINS Group Inc. 350 Term 5/7/2012 LyondellBasell Industries NV 2000 Revolver 5/1/2012 Arch Coal Inc. 1000 Term 5/1/2012 National Health Investors, Inc. 200 Revolver 5/1/2012 Arch Coal Inc. 1000 Term 5/1/2012 National Health Investors, Inc. 80 Term 5/8/2012 Ares Capital Corp. 900 Revolver 5/1/2012 National Health Investors, Inc. 40 Term 5/7/2012 Ascend Learning 330 Term 5/8/2012 NCI Building System Inc. 250 Term 5/3/2012 Beasley Broadcast Group Inc. 20 Revolver 5/8/2012 NEP II Inc. 60 Revolver 5/3/2012 Beasley Broadcast Group Inc. 130 Institutional 5/8/2012 NEP II Inc. 460 Term 5/7/2012 CAMP International Holding Co. 30 Revolver 5/8/2012 NEP II Inc. 160 Term 5/7/2012 CAMP International Holding Co. 230 Term 5/3/2012 Nixon Inc. 25 Revolver 5/7/2012 CAMP International Holding Co. 115 Term 5/3/2012 Nixon Inc. 175 Term 5/7/2012 CEVA Logistics Inc. 150 Term 5/8/2012 NuStar Logistics LP 1500 Revolver 5/1/2012 CF Industries Holdings, Inc. 500 Revolver 5/9/2012 Pacific Architects and Engineers 150 Revolver 5/1/2012 Compass Minerals International Inc. 150 Term 5/9/2012 Pacific Architects and Engineers 50 Term 5/3/2012 Constellium Holdco BV 350 Term 5/7/2012 Pacific Architects and Engineers 150 Revolver 5/1/2012 Ebix, Inc. 100 Revolver 5/7/2012 Pacific Architects and Engineers 50 Term 5/7/2012 Elo Touch Solutions 15 Revolver 5/8/2012 RGIS LLC 215 Term 5/7/2012 Elo Touch Solutions 180 Term 5/4/2012 Roofing Supply Group LLC 290 Term 5/7/2012 Elo Touch Solutions 90 Term 5/10/2012 Roofing Supply Group LLC 175 Revolver 5/3/2012 Esselte 200 Term 5/10/2012 Roofing Supply Group LLC 175 Revolver

5/10/2012 F&H Acquisition Corp. 72.5 Term 5/8/2012 Roofing Supply Group LLC 290 Term 5/10/2012 F&H Acquisition Corp. 7.5 Revolver 5/8/2012 SS&C Technologies Inc. 175 Term 5/8/2012 Formula One 50 Revolver 5/9/2012 Sykes Enterprises, Inc 245 Revolver 5/8/2012 Formula One 450 Term 5/7/2012 Taminco Group Holdings 350 Term 5/8/2012 Formula One 1300 Term 5/2/2012 Trans World Entertainment Corp. 100 Revolver

5/10/2012 Generac Power Systems Inc. 800 Term 5/2/2012 Unifrax I LLC 385 Term 5/8/2012 Generac Power Systems Inc. 800 Term 5/7/2012 Verso Paper Corp. 150 Revolver

5/10/2012 Gibson Energy ULC 650 Term 5/3/2012 Verso Paper Corp. 50 Revolver 5/4/2012 Hawker Beechcraft, Inc. 400 Revolver 5/9/2012 West Pharmaceutical Services, Inc. 300 Revolver 5/4/2012 Hearthside Food Solutions LLC 30 Revolver 5/9/2012 Wolverine Healthcare Analytics 50 Revolver 5/4/2012 Hearthside Food Solutions LLC 30 Term 5/3/2012 Wolverine Healthcare Analytics 525 Term 5/4/2012 Hearthside Food Solutions LLC 340 Term 5/9/2012 Wolverine Worldwide 200 Revolver 5/1/2012 Hologic Inc. 300 Revolver 5/9/2012 Wolverine Worldwide 400 Term 5/1/2012 Hologic Inc. 1000 Term 5/4/2012 Wolverine Worldwide 500 Term 5/1/2012 Hologic Inc. 2000 Term 5/4/2012 World Acceptance Corp. 483 Revolver


CLO Pickup

Leveraged loan defaults in CLOs 2007 to 2012: 13% 2006: $120 billion of CLO issuance 2011: $11 billion of CLO issuance 2012: Q1: $5.83bn; $5.1 billion just in April 2012 – maybe

$20bn+ year Credit analysis by CLOs?

• How do they choose?


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Investor convergence between loans and bonds

Who holds?

Fee incentive?

Trading mechanisms?

Upside / downside variance between loans and bonds?


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Some changing relativity of buyers

Banks CLOs Insurance companies Institutional non-bank Hedge funds Mutual funds Pension funds


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What kinds of borrowers get covenant lite? 99 Cents Only Stores Bausch & Lomb Go Daddy Harbor Freight Tools Rexnord Roofing Supply (LBO) Taminco Toys “R” Us

Better rated issuers


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What about European borrowers? They generally cannot get covenant lite in Europe Come to the U.S.!

Grohe (refinance of incurrence bonds) Ineos Misys Schaeffler

Who holds? Fee incentive? Upside / downside variance between loans and bonds?

Europe default rate higher than U.S: 4.1% in 2011, and LTM now 4.7%


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He who has the gold, does not always make the rules

The market does not learn for long

Human nature does not change

In sum, why more covenant lite?

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•The line between “lite” and just bad covenants can be blurry

Clear Channel: EBITDA addbacks for projected cost savings and restructuring costs – rating agencies said CCU was heading to default First Data: Secured debt to EBITDA ratio included all of the EBITDA of the Merchant Services JV, even though FDC only owned 48.5% of the stock Ideal Standard International: “equity cure” right New Chesapeake loan

Market trades on covenant lite

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Adam B. Cohen Founder and Managing Member Practicing attorney with 14 years experience 212-716-5780 [email protected]

Adam B. Cohen graduated from the University of Florida in 1993 and from Georgetown University Law School in 1997, where has was on the Georgetown Law Journal. He was a corporate securities attorney with Latham & Watkins in New York for six years and an investment banker for Lehman Brothers in Hong Kong for two years. At Latham, Adam represented investment banks and sponsor-backed issuers on dozens of high yield debt offerings for significant transactions that included Calpine, Magnachip, and XM Satellite Radio.

Adam founded Covenant Review in 2005 as the world’s first boutique research firm focused on corporate bond covenants providing institutional investors with perspectives on their rights as bondholders as seen through the eyes of experienced practicing lawyers. He was one of seven contributors to the ABA’s Model Negotiated Covenants and was instrumental in drafting the Credit Roundtable’s “White Paper” for model investment grade covenants. Adam has been quoted and/or published in publications such as Barron’s, Bloomberg, Credit Magazine, Grant’s Interest Rate Observer, High Yield Report, International Financial Law Review, and Leverage World, and lectures regularly on covenant issues to investment professionals and attorneys. He is widely considered to be the leading commentator on corporate bond covenants and has been cited by the Delaware Chancery Court on indenture interpretation.

Biographies

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COVENANT-LITE LOANS

ELEMENTS OF COV-LITE LOANS POST-CREDIT CRUNCH

Jamie Knox, DLA Piper LLP (US)

May 2012

May, 2012 Covenant-Lite Loans 35

Covenant-Lite Loans have had a strong resurgence since the credit crunch

The Credit Crunch did not show that Covenant-Lite Loans always put lenders in a substantially worse position Default rate statistics—Are they meaningful? Total return statistics Post-signing ratings performance

Supply and Demand factors driving lender appetite for more Covenant-Lite loans Thirst for yield

Competitive sources of capital for borrowers post-credit crunch High yield bonds


Loan Terms Post-Credit Crunch

Similarity of cov-lite terms pre-crunch and post-crunch

Substantial convergence of term loan cov-lite structures with high yield bond indenture terms Incurrence-based covenants

Flexible, growing negative covenant baskets

Substantial convergence of cov-lite revolver terms with traditional ABL terms Springing financial covenant(s)

Reasons for Term Loan/Revolver differences Who lends

When they lend


Case Study

Acquisition of 99 Cents Only Stores in an LBO led by Ares and CPPIB Merger Agreement signed in October, 2011

Closed January, 2012

Capital Structure at Closing $175 million Cov-Lite ABL Revolver

$525 million Cov-Lite Term Loan

$250 million Senior Notes

Sponsor Equity (40% of total capitalization)


Case Study – Loan Structure

Separate Credit Agreements for Revolver and Term Loan

Revolver Availability governed by Borrowing Base

Key Terms Financial Covenants Revolver: Springing Fixed Charge Coverage Ratio of 1:1

when Availability falls below specified levels Equity cure right in the event of a financial covenant default

Term Loan: None

Debt Covenant Both Agreements: Unsecured debt up to 4.5x total

leverage ratio


Case Study – Loan Structure, Continued

Restricted Payments Both Agreements: Available Amount building basket

(also available for investments, prepayments of junior debt)

Cross-Default Both Agreements: No cross default until earliest of

(x) 30 days elapsed, (y) acceleration or (z) exercise of remedies

Conclusions


Contact Information

Jamie Knox

DLA Piper LLP (US)

212-335-4992

[email protected]

covenant-lite loans: emerging trend in the syndicated loan...

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