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Bond Covenants for Alpha Generation and Risk ManagementPresented to the Government Investment Officers Association – March 21, 2018
This material is copyrighted and may not be duplicated / forwarded to other parties
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New York, New York 10036Tel: 1-212-716-5781
[email protected] www.covenantreview.com
THE AUTHORITY ON BOND AND LOAN COVENANTS
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.
www.covenantreview.com
Remembering Terrors of the Past…The Big Remembering Terrors of the Past…The Big Remembering Terrors of the Past…The Big Remembering Terrors of the Past…The Big
high grade issuer LBO Wave 2006high grade issuer LBO Wave 2006high grade issuer LBO Wave 2006high grade issuer LBO Wave 2006----2008200820082008
The Real Disasters:
- Alltel- Clear Channel- Harrah’s- TXU
The Forgotten Wins:
- B.F. Sault REIT- Hilton- Manor Care- TXU (?)
Aaargh….I’ve come to eat your returns!
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Terrors of the PastTerrors of the PastTerrors of the PastTerrors of the Past
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CCU 7.25% Debentures due 2027 -11/16/06 Announcement
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Alltel 7.875% Notes due 2032 - 05/21/07 Announcement
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Terrors of the PastTerrors of the PastTerrors of the PastTerrors of the Past
81%89.14%
104.55%
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TXU Legacy Bonds - 02/26/07 Announcement
5.55% Sr Notes due 2014, Series P 6.50% Sr Notes due 2024, Series Q
6.55% Sr Notes due 2034, Series R TXU Energy 7% Sr Notes due 2013
Tender Offer
Premium 110.23%
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Harrah's 6.25% Senior Notes due 2016 -10/01/06 Announcement
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Purpose: Grant bondholders the option to get money back if the company gets new owners
Basics: Put right at 101% of par if a “Change of Control” occurs
Change of Control usually includes: Change in majority voting control
But: “Permitted Holders” that do not trigger a Change of Control
Sale of “substantially all assets”
Merger of two public companies (sometimes)
Continuing directors
Change of Control Covenant
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Change of Control “Holding Company” Exception
“Change of Control” definition states: “Notwithstanding the foregoing, a transaction will not be deemed to involve a Change of Control if (1) the Company becomes a direct or indirect wholly-owned Subsidiary of a holding company and (2)(A) the direct or indirect holders of the Voting Stock of such holding company immediately following that transaction are substantially the same as the holders of the Company’s Voting Stock immediately prior to that transaction or (B) immediately following that transaction no person (other than a
holding company satisfying the requirements of this sentence) is the beneficial
owner, directly or indirectly, of more than 50% of the Voting Stock of such holding
company.”
Nobody Wants to Read This
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Heinz LBO: Making Money on CoC Put
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2% Notes of 2016 1.5% Notes of 2017 3.125% Notes of 2021 2.85% Notes of 2022
1) Feb 14, 2013 – Heinz enters acquisition agreement with Berkshire and 3G
Capital. Broker Dealer claims the transaction may circumvent the 101%
Change of Control put for the 2016s, 2017s, 2021s and 2022s because it may
be structured to exploit a holding company exception.
Covenant Review: Is There a Relevant Exception to the Change of Control
Covenant? “We don’t think those arguments should win out.” The bonds
will get a 101% Change of Control put offer; other speculation is wrong.
2013 Heinz LBO by Berkshire Hathaway and 3G Capital
2) Apr 30, 2013 – Heinz
receives shareholder
approval.
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A Post-LBO Capital Structure
Equity Investors
Non-GuarantorSubsidiaries
GuarantorSubsidiaries
Holdco
Issuer
- Mezzanine Loans and/or Holdco PIK Notes
- 1st: Secured Bank Loans – 1st liens and guarantees- 2nd: Secured Bonds – 2nd Liens and Guarantees (new HY)- 3rd: Senior Unsecured Bonds –Guarantees (new HY)- 4th: Senior Unsecured Bonds – No Guarantees (old IG)
Trade creditorsOther debt
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Purpose: Protect seniority position� Limit amount of debt that may be effectively senior
� Don’t want the next senior note deal to be secured
Basics: Two types of “Permitted Liens”: voluntary and involuntary
Permitted Liens usually include:� A specified amount of bank debt or secured debt ratio
� Capital leases / purchase money liens
� Small general basket
� Special concern for carveouts for debt-related liens that do not have specific dollar caps
� Many miscellaneous exceptions for involuntary permitted liens
Liens Covenant
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Liens Covenants – What Has Changed
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Many potential LBO target issuers continue to use legacy Liens covenants that expose holders to significant risks of effective subordination – so there may be a 101% put, but little chance to a consent / tender.
� Some first time issuers have used decent Liens covenants (e.g., Jones Lang LaSalle and Verisk Analytics) and others have not (e.g., FMC Technologies and Flowserve Corporation).
� Few pre-2007 issuers have changed their Liens covenants post-2007.
� Starwood: Made it worse over time.
� US Cellular – Liens covenant does not apply to most assets.
� Clorox – Liens covenant retains old “Principal Property” idea.
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The Credit:
Eastman Chemical $500,000,000 4.8% Notes due 2042
The Problem:
The Liens covenant does not apply to:
� loans, because of the defective definition of “Debt”: “notes, bonds, debentures or other similar evidences of indebtedness for money borrowed”
The Credit:
Analog Devices $400,000,000 5.3% Senior Notes due 2045
The Problem:
The Liens covenant is a sham:
� “We will not, nor will we permit any Subsidiary to, issue, incur, create, assume or guarantee …any debt for borrowed money…. secured by a mortgage…. upon any Principal Property”
� “Principal Property” means any single parcel of real property or any permanent improvement thereon…located in the United States…having a book value…in excess of 3% of our most recently calculated Consolidated Net Tangible Assets.
� Oops: “As of February 3, 2018, we did not have any Principal Properties.”
Liens Covenant
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Halcón Resources: Distressed Exchanges
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12/1/2014 1/20/2015 3/11/2015 4/30/2015 6/19/2015 8/8/2015 9/27/2015 11/16/2015 1/5/2016
9.75% Senior Notes due 2020 8.875% Senior Notes due 2021 9.25% Senior Notes due 2022
3) August 27, 2015 – HK announces privately-negotiated distressed exchanges whereby it agreed to exchange $1.02bn of new third lien notes due 2022 for $1.566bn in face amount of its existing unsecured bonds.
4) August 28, 2015 – Covenant Review: CR publishes follow up report explaining the distressed exchange and how HK could technically have incurred the new debt under the indentures for the unsecured bonds and second lien bonds.
2) May 1, 2015 –HK issues $700m of second lien notes due 2020
1) December 18, 2014 – Covenant Review: CR publishes report highlighting critical Liens covenant flaw and identifying HK’s unsecured bonds as each containing this critical flaw: “E&P bond issuers that have this Liens covenant loophole included in the terms of their bonds could potentially use this provision as a powerful tool to conduct a coercive exchange offer, assuming that they have enough debt capacity to incur the new debt.”
5) November 19, 2015 – HK announces another exchange offer. HK offers to exchange unsecured bonds for up to $150m of new second lien notes due 2022 that will prime the third lien bonds issued in the prior exchange. The offer results in HK issuing $112.8m of the new second lien notes in exchange for $289.6m of unsecured bonds. The two exchanges removed approximately $723m in principal amount of unsecured bonds from HK’s balance sheet.
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Global A&T: Add-on Chaos
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7/10/2013 11/12/2013 3/17/2014 7/20/2014 11/22/2014 3/27/2015 7/30/2015 12/2/2015 4/5/2016
1) Aug 22, 2013 - Moody's announces a change to the ratings outlook for the Global
A&T's B1 Corporate Family rating and the B1 rating of its $625mm 10% First Lien
Notes of 2019 from 'Stable' to 'Negative.' Moody's also affirms the B2 rating on the
existing $543mm Second Lien Facilities of 2015.
2) Sep 30, 2013 - Global A&T announces a
swap of Second Lien loans for as much as
$502mm of additional First Lien Notes.
3) Oct 4, 2013 - Covenant Review: How Might the Exchange Offer Be Justified? We
identify a technical loophole in the Liens Covenant that might allow Global A&T to
make the exchange from an Indenture perspective, but we suspect that the non-public
Intercreditor Agreement has been violated.
4) Oct 9, 2013 - Covenant Review: After reviewing the Intercreditor Agreement,
"We cannot see how any lawyers or bankers involved thought that the exchange
offer was a good idea." Further, we suggest bondholders consider litigation.
5) Feb 11, 2014 – Bondholders file a lawsuit
claiming, among other violations, breach of
the Intercreditor Agreement.
6) Feb 27, 2014 - Covenant Review: Following the initial filing, we analyze
the flawed arguments in the lawsuit and suggest remedies to improve
bondholders' chances of success. We encourage bondholders to litigate.
7) Mar 19, 2014 - Covenant Review:
Bondholders filed an amended
complaint that included our analysis of
the crucial issue of what happens if the
exchange was permitted under the
Indenture but not under the
Intercreditor Agreement, vastly
improving their chances of litigating
successfully.
8) July 14, 2015 – New
York State Supreme Court
dismisses bondholder
claims.
9) May 3, 2016 – Appellate
division modifies portions of
trial court rulings.
10% First Lien Notes due 2019
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Sale / Leaseback Covenant
www.covenantreview.com
What is a “Sale and Leaseback”?
� Duration?
� Intercompany?
Use of proceeds?
Recent debates
� Sprint
� Windstream
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Restricted Payments Covenant
Purpose: Protect bondholders’ interest in the assets of the company by limiting undesirable distributions and asset transfers such as:
� Dividends and equity purchases
� Retiring junior debt ahead of the bonds
� Investments in entities that are not Restricted Subsidiaries
� Guarantees of holding company debt
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Basics:� Company will typically be allowed to use up to 50% of
“Consolidated Net Income” to make payments to those junior to the bondholders in the capital structure (i.e., junior bonds, preferred equity and common equity).
� Typical conditions to using 50% of Consolidated Net Income to make Restricted Payments: (1) no current default and (2) compliance with debt covenant ratio.
� Test is backward-looking – has the company “earned the right” to make payments to equity?
Restricted Payments Covenant
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Common carveouts include:� General Restricted Payment basket
� Joint venture investment carveout
� Unrestricted Subsidiary investment carveout
� Leverage test?
� Check Restricted Payments and Permitted Investments
� Beware J. Crew type risks
Questions: � Can the company buy back / repay other bonds and loans?
� Are there “sneaky” dividend loopholes?
Restricted Payments Covenant
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Rackspace: Make-Whole on LBO
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8/1/2016 8/16/2016 8/31/2016 9/15/2016 9/30/2016 10/15/2016
6.5% Senior Notes due 2024
3) August 26, 2016 – Rackspace announces it
has agreed to be taken private by Apollo. 4) October 17, 2016 - The Preliminary OM
for the new bonds to be issued in
connection with the LBO confirms that the
outstanding bonds will receive a make-
whole premium.
1) August 5, 2016 - Media reports that Apollo is
in talks to acquire Rackspace.
2) August 8, 2016 – Covenant Review: Covenant Review reports that "the
Restricted Payments [for Rackspace's outstanding bonds] limits the Company's
ability to incur debt in connection with an LBO." The Covenant Review report
explains that if the debt financing for the LBO exceeds RP capacity, the bonds will
likely be redeemed at a make-whole.
www.covenantreview.com
Oil States Int’l: Make-Whole Conceded
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Oil States International 5.125% of 2023
Oil States International 5.125% of 2023
3) Jul 30, 2013 – Oil States
announces plans to spin-off their
Accommodations business.
1) Apr 30, 2013 – Jana Capital Partners, in a 13D filing, discloses that it has
built at 9.1% position in the equity of Oil States International. Jana also states
that they had discussions with Oil States’ management on April 26, 2013
regarding a spin-off of its Accommodations business into a REIT.
2) May 13, 2013 – Covenant Review:
“Effecting a large dividend or spin-off of
the Accommodations business to
shareholders would likely require taking
out the bonds at a premium.”
4) May 9, 2014 – Oil States
launches a tender offer for
the 5.125% Notes of 2023 at
$1,146.98.
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B/E Aerospace: Make-Whole on Spin-Off
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BEAV 5.25% of 2022
BEAV 5.25% of 2022
1) May 4, 2014 – B/E Aerospace
announces that it is exploring
strategic alternatives.
2) May 27, 2014 – Covenant Review:
Limited restricted payments capacity
would constrain BEAV’s ability to
consummate a spin-off unless they
redeem the bonds.
3) Jun 10, 2014 – BEAV announces
plans to separate into two
companies. The first will focus on
manufacturing and the second will
focus on services.
4) Oct 22, 2014 – BEAV
announces that in
connection with the spin-
off of the services
business, the Company
intends to redeem the
outstanding bonds.
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First Quantum: Litigating to Win
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Inmet 8.75% bonds due 2020 Inmet 7.5% bonds due 2021
1) Dec 16, 2012 – First
Quantum Minerals
announces its intention to
make an offer to acquire the
equity of Inmet Mining
Corporation for C$5.1
billion.
2) Dec 21, 2012 – CR:
How Would The
Company’s (Inmet’s)
Bonds Be Treated If The
Company Is Acquired?
3) Jan 9, 2013 – First Quantum forms a shell company ("Akubra") solely for the purpose of making a Tender Offer for Inmet’s equity,
executed primarily via a $2.5 billion Facility. The Facility included provisions for Akubra to complete “Target Amalgamation” (i.e., the
merger of Akubra with Inmet) within five days of Akubra’s acquisition of 100% of Inmet’s equity.
4) Apr 2, 2013 – First Quantum announces that 92.7% of Inmet’s common
shares were tendered. The remaining 7.3% can be mandatorily acquired
pursuant to provisions in the Canadian Business Corporations Act,
rendering Inmet a direct wholly-owned subsidiary of Akubra and an
indirect wholly-owned subsidiary of First Quantum.
5) Apr 19, 2013 –
Inmet makes a
Change of Control
offer at 101% for
the Inmet bonds
pursuant to
Change of Control
provisions.
6) Apr 22, 2013 – Inmet is amalgamated with Akubra. The surviving
entity remains the borrower under the Facility, on which
approximately $2.12 billion was drawn in the first quarter of 2013,
net of issue and transaction costs of $22.1 million.
7) May 29, 2013 – Inmet/Akubra prepays all outstanding
amounts owed under the Facility from Inmet cash on
hand. The Facility is amended to provide a $2.5 billion
revolver to Inmet/Akubra, supported by Inmet assets.
8) June 27, 2013 – CR: The
First Quantum Acquisition
May Have Breached the
Inmet Bond Indentures.
9) Jan 27, 2014 – First Quantum
announces an exchange offer to the
bondholders of the Inmet 2020s and
2021s in a negotiated exchange
settlement. Holders of the original
8.75% bonds due 2020 receive $575
of the new 6.75% bonds due 2020
and $575 of the new 7.00% bonds
due 2021. Holders of the original
7.50% bonds of 2021 receive $565 of
the new 6.75% bonds due 2020 and
$565 of the new 7.00% bonds due
2021.
First Quantum / Inmet Acquisition Timeline
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Purpose: Make sure the bonds follow when the assets move
Basics:� Applies to mergers where the Company transfers “all or substantially
all” of the Company’s consolidated assets� Erg…. What does “substantially all” assets mean…?
� High yield often has a leverage metric
Mergers Covenant
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Elan: Make-Whole on Asset Sale
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Elan 6.25% Senior Notes due 2019
Elan 6.25% Senior Notes due 2019
4) Apr 2, 2013 – Closing of
Tysabri transaction and the
irrevocable notice of 118.084%
make-whole announced.
1) Feb 6, 2013 – Elan announces
plans to sell most of their Tysabri
assets to their collaborative
partner Biogen, Inc.
2) Feb 11, 2013 – Covenant Review: Bondholders should demand
Elan address why the transaction is not subject to the Assets Sales,
Mergers or Change of Control covenants. The bonds should be
assumed by Biogen or bondholders could demand a make-whole.
3) Mar 12, 2013 – Elan
announces a make-whole
tender offer for the Notes.
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ITT Breakup: Make-Whole on High Grade
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These are not your Daddy’s loans!
A Glimpse at the Loan Market
Credit Stats Middle MarketLarge
Institutional
Average Adj. EBITDA of Issuers ($MM) $42 $258
Average Tranche Size ($MM) $179 $684
Net First Lien Leverage 4.27x 3.8x
Net Total Leverage 5.10x 4.9x
Data as of: 3/13/2018
EBITDA Adjustments LTM Middle MarketLarge
Institutional
Percentage of Loans with Synergies / “Run Rate” Costs
Savings Adjustment 80% 89%
Percentage of Loans with Uncapped Synergies / “Run Rate”
Cost Savings Adjustment 13% 53%
Average Cap for Synergies / “Run Rate” Cost Savings
Adjustment 20.99% 20.38%
Data as of: 3/13/2018
Financial Maintenance Covenant Stats LTM Middle MarketLarge
Institutional
Percentage of Loans that are Cov-Lite 18% 83%
Percentage of Loans with Springing RC Covenant 18% 54%
Percentage of Maintenance Covenants that are First Lien
Leverage Tests 19% 77%
Data as of: 3/13/2018
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Why Are Indentures So Complicated?
“Modern indentures have a low rating on the scale of popularreading … nobody loves an indenture... The corporate trustindenture is undoubtedly the most involved financial document thathas been devised … and the accusation [is] commonplace that thelawyers are hoping to get paid by the word.”
“It has been remarked that it was devoutly to be wished that somegenius would arise to point the way to a reduction of the text ofsuch [indentures]; but where the opportunity has been afforded todiscuss the subject with such critics, they have been able toindicate little which upon full consideration they would be willing toomit.”
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Further Information
For general information and sample reports, email [email protected].
To reach Covenant Review founder Adam Cohen, email [email protected].
Covenant Review is part of the Fulcrum Financial Data group, which includes:
• CapitalStructure provides insightful first-to-market news and analysis of the sub-investment grade universe, with a focus on special situations. See www.capital-structure.com.
• Covenant Review is the trusted source for the interpretation of corporate bond indentures and leveraged loan credit agreements. See www.covenantreview.com.
• LevFin Insights provides comprehensive real-time news, commentary and data for leveraged loan and high-yield bond market players. See www.levfininsights.com.
• PacerMonitor is the unified, modern and full-featured platform for researching and tracking federal bankruptcy, district, and appellate court cases. See www.pacermonitor.com.
See www.fulcrumfinancialdata.com for more corporate information.
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