Presenting a live 90-minute webinar with interactive Q&A Structuring Financial Covenants, EBITDA, and Events of Default to Maximize Borrower Protection and Lender Remedies THURSDAY, OCTOBER 27, 2016 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Paul W. Hespel, Partner, Pepper Hamilton , New York Alexandra Margolis, Partner, Nixon Peabody , New York The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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AGENDA Purposes of financial covenants and ratios Financial maintenance covenants Covenant-lite loans Incurrence covenants Balance sheet and cash flow based financial covenants Financial definitions • Consolidated Net Income • Consolidated EBITDA • Consolidated Fixed Charges Financial information in credit agreements Borrower’s response to financial maintenance covenants • Springing covenants • Equity cure rights Excess cash flow sweep Events of default and remedies 5
PURPOSES OF FINANCIAL COVENANTS AND RATIOS • Monitor the borrower’s financial performance on a regular basis – maintenance covenants • Limit the borrower’s ability to take certain actions – incurrence covenants • Interest rate margins and commitment fees • Mandatory prepayment stepdowns – excess cash flow, asset sales 6
FINANCIAL MAINTENANCE COVENANTS • Require borrower to achieve certain financial performance tests on a periodic basis • Cash flow lending - leverage ratios, interest coverage ratio, fixed charge coverage ratio • Performance levels typically tied to borrower’s model provided to lenders before commitment • Consequences of breach of a financial maintenance covenant • Failure to comply results in an event of default (no grace period) • Borrower loses access to revolving credit facility • May trigger a cross- default under borrower’s other indebtedness • Lenders have right to accelerate loans and exercise remedies 7
COVENANT-LITE LOANS • Covenant-lite loans contain only incurrence based financial covenants • Covenant-lite is prevalent in large cap market and higher end of middle market • Typically available when credit market conditions favor borrowers • Highly rated leveraged borrowers and private equity sponsors have greater ability to negotiate favorable terms • Absence of financial maintenance covenants reduces borrower’s risk of default 8
INCURRENCE COVENANTS • Incurrence based covenants are not tested periodically but must be satisfied, giving pro forma effect to the relevant action, to enable the borrower and its subsidiaries to take certain actions otherwise prohibited • Ratio baskets: • Debt • Liens • Restricted payments • Junior debt prepayments • Permitted acquisitions and other investments • Debt incurrence – debt covenant baskets and incremental facilities • Ratio debt – pro forma compliance with maximum leverage ratio (first lien, secured, total) or minimum fixed charge coverage ratio or interest coverage ratio 9
INCURRENCE COVENANTS • Debt incurrence • (xxvi) Indebtedness incurred to finance a Permitted Acquisition; provided that either (i) the Interest Coverage Ratio after giving Pro Forma Effect to the incurrence of such Indebtedness and such Permitted Acquisition is either (x) equal to or greater than 2.0 to 1.0 or (y) equal to or greater than the Interest Coverage Ratio immediately prior to the incurrence of such Indebtedness and such Permitted Acquisition for the most recently ended Test Period as of such time or (ii) the Total Leverage Ratio after giving Pro Forma Effect to the incurrence of such Indebtedness and such Permitted Acquisition is either (x) equal to or less than 5.0 to 1.0 or (y) equal to or less than the Total Leverage Ratio immediately prior to the incurrence of such Indebtedness and such Permitted Acquisition for the most recently ended Test Period as of such time …. • Grower baskets • The greater of $___ or __% of Consolidated EBITDA • Enables upsizing of baskets in connection with acquisitions without need for amendment 10
BUILDER BASKETS • “Available amount” builder baskets for investments, restricted payments and junior debt prepayments • Starter basket (fixed dollar, sometimes with grower component) + retained excess cash flow or 50% consolidated net income • Plus: • Declined mandatory prepayments • Equity injections and issuances • Returns on investments • Net proceeds of sales of Unrestricted Subsidiaries • Net proceeds of debt and disqualified equity issuances that are converted into qualified equity • Leverage test for use of builder basket for dividends (sometimes investments) 11
BALANCE SHEET AND CASH FLOW BASED FINANCIAL COVENANTS Balance sheet based financial covenants are determined • taking into account balance sheet items, i.e. , components of assets, liabilities and shareholders’ equity. • Net Worth (Assets minus Liabilities) • Tangible Net Worth (Tangible Assets (excluding intangibles such as intellectual property rights and goodwill) minus Liabilities) • Debt-to-Equity Ratio (Liabilities divided by Stockholders’ Equity) 12
BALANCE SHEET AND CASH FLOW BASED FINANCIAL COVENANTS Cash flow based financial covenants attempt to measure • excess cash generated by the borrower/issuer to service or “cover” payment obligations/liabilities. EBITDA in most cases being a proxy for such excess cash. • Leverage Ratio (Ratio of Debt to EBITDA) • Interest Coverage Ratio (Ratio of EBITDA to Interest Expense) • Fixed Charge Coverage Ratio (see below for definition) Various credit facilities where balance sheet and cash flow • based financial covenants are used. • Investment grade debt • Highly leveraged borrowers • Covenant-Lite and Covenant-Wide 13
FINANCIAL COVENANTS MOST TYPICALLY USED IN LEVERAGED LOAN FACILITIES Maximum Total Leverage Ratio/First Lien Leverage • Ratio/Secured Leverage Ratio: • Total/First Lien/Secured Funded Debt to EBITDA • What is included in Funded Debt ? • "Net Debt" approach ( i.e. , calculation "net of unrestricted borrower cash and cash equivalents") is common. Negotiation typically revolves around caps and thresholds with respect to cash/cash equivalents which is netted from the debt calculation, including whether such cash needs to be maintained through controlled deposit arrangements. 14
FINANCIAL COVENANTS MOST TYPICALLY USED IN LEVERAGED LOAN FACILITIES Minimum Interest Coverage Ratio (in any case, above 1.00 to • 1.00) • Ratio of EBITDA to Interest Expense • Interest Expense computed in accordance with GAAP, with adjustments, most typically, for: • interest income • gains or losses on swaps or other derivatives to hedge interest rate risk • fees and costs related to financings, including debt issuance costs and debt discounts • non-cash interest expense Minimum Fixed Charge Coverage Ratio • • Ratio of EBITDA to Fixed Charges (see below for definition) 15
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