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Advanced Negotiation Issues in Financial Covenants

An in-depth analysis of financial covenants used in leveraged and real estate loans

Advanced Negotiation Issues in Financial Covenants Training Course

A half-day live webinar

  • The trainer is a Senior Consultant to Grant Thornton in Debt Advisory has insight into how both borrowers and lenders approach the negotiating financial covenants
  • The trainer was a Senior Consultant with Reorg Debt Explained for 10years advising on financial covenants in large syndicated (Cov-lite) loans which feature springing covenants rather than covenants set out in the LMA leveraged precedent
  • The trainer qualified as a Chartered Accountant (Deloitte) and as a lawyer so is well qualified to understand both the accounting and legal aspects of the financial covenants/ratios
  • The trainer’s career also includes stints in commercial and investment banking so provides further insight from that angle
  • The course has been presented to numerous large law firms and banks (in Europe and Asia Pacific) which reinforces the trainer’s market knowledge 

  • Understanding the financial maintenance covenants and their application – the programme explains the key financial covenants set out in the LMA Leverage precedent and analyses the pros, cons & application of each covenant
  • Fragmented European loan market undermines the ‘traditional’ LMA approach – The European leverage-loan market has fragmented into four segments (e., bilateral loans; club deals, cov-lite deals and unitranche) with differing commercial terms across each deal type. The programme explains the key differences of approach to the financial covenants between these segments including spring covenants fund in cov-lite deals
  • Accounting issues – interpreting the financial covenants requires some knowledge of accounting treatment of certain issues; for example, the treatment of leases (IFRS 16); the meaning of “exceptional items” and “discontinued operations’ (IFRS & UK GAAP pose differing treatment for both these items). The programme explains the key differe4nces and their ramifications
  • Legal issues – the definitions that comprise the financial covenants include various defined terms which are not recognised in formal IFRS/GAAP. This is one of the key negotiating areas and matters to both lenders and borrowers.  “EBITDA” is the most important definition since it is a purely defined term and can be subject to numerous addbacks (e.g., run-rate, pro-forma and various ’synergies’) all of which can undermine the effectiveness of the covenants (from the lender’s perspective). “Senior Secured Net Leverage” is another term of art which may vary across differing credit agreements
  • Market practice – market practice varies across the various segments in relation to a wide range of issues including, which covenants are used, equity cures, covenant headroom/cushion, addbacks. The programme explains the current market practice of these items
  • Negotiating key commercial issues – whilst the market has developed broadly similar approaches within the various market segments there are numerous areas which are subject to negotiation partially in cov-lite and Unitranche deals where borrower-friendly terms can be accommodated (at a price!)
  • Managing covenant pressure & distress – Looming increases in both interest rates and energy costs (hard on the heels of covid) seem likely to trigger a recession and a rise in distressed borrowers. The programme provides guidance on how both borrowers and lenders should approach these situations
  • Analysis of the Financial Maintenance covenants in Real Estate deals –the has published two precedents on real estate deals (portfolio and development companies. The programme reviews and analyses these covenants and the key issues that arise  

Key financial ratios used by Lenders and typical LMA ratios in leveraged deals

  • Market-based financial ratios
  • The four LMA covenants in leveraged deals
  • Leverage ratios (Balance sheet and P&L ratios)
    • Total (Net) Debt / EBITDA
    • Senior (Net) Debt/ EBITDA
    • Senior Secured Net Leverage
  • Interest coverage ratios
    • EBITDA to [Net] Finance Charge
    • EBITDA to Senior [Net] Finance Charges
    • Other variations
  • Cash flow cover (DSCR)
    • Cash flow to Debt Service
  • The Capital Expenditure (capex) covenant
    • LMA vs Market approach
    • Carry forward / carry back amounts - LMA vs Market approach
    • Add-backs – LMA vs Market
  • Springing Leverage covenants (not LMA)
    • Use and application
    • When should the ratio spring
    • Calculating the constituents of the covenants
    • When is the covenant tested
    • Potential problem areas

 Calculation of EBITDA and Cashflow

  • EBITDA
    • Simplistic calculation of EBITDA
    • Consistency of application (Accounting changes under IFRS, GAAP etc.)
    • Exceptional items – LMA approach, UK GAAP vs IFRS
    • Discontinued Operations – LMA, different approaches of UK GAAP vs IFRS
    • Derivative & Financial Instruments - UK GAAP vs IFRS
    • Pension Items - UK GAAP vs IFRS
  • Current trends affecting EBITDA (aggressive add-backs)
    • Anticipated synergies and cost reductions
    • What are the “typical” requirements for “anticipated synergies”
    • Business optimisation expenses
    • Run-rate EBITDA – how is this calculated
  • Definition of “Cash flow”
    • Why ‘cash flow’ is not all it seems in the LMA
    • Typical adjustments
    • Sponsor friendly adjustments
    • Potential problems with “cash-flow”

Calculation of Debt, Borrowings and Finance Charges

  • “Total [Net] Debt” and “Senior Total [Net] Debt”
    • “Borrowings” per the LMA
    • Simplistic calculation of Net Debt
    • Example of net debt items
    • Treatment of PE “Debt”
    • Vendor Loans – do they matter
    • Impact of Debt Buybacks and impact on “Debt”
    • Treatment of “trapped” cash on Debt
    • What does “senior” only exclude?
    • What about PIK loans – should they be included in Total Debt?
  • “Borrowings”
    • Treatment of receivables
    • Redeemable shares
    • “Sweeper” clause
  • Finance charges & Net Finance Charges
    • Impact of “PIK”
    • Hedging impact

Navigating covenants in distress scenarios

  • The Compliance Certificate
    • Typical requirements per LMA Sch 9
    • Current commercial requirements
    • When does the breach occur
  • How should borrower’s react in distress situations
    • Strategies in cov-lite syndicated loans
    • Strategies in bilateral, club or Unitranche deals
    • Relevance of jurisdiction
  • What can lender’s do
    • Revised threshold on due diligence on unrealised EBITDA addbacks
    • Suspension of covenants
    • Minimum liquidly test (in some sectors)
    • Increase in Headroom?
    • What about waivers on some covenants?

 Equity cures

  • Equity cures - What are they, good or bad
  • What should be cured (EBITDA, Cash flow, Debt)
  • Treatment of “overcures”
  • Is the cure EBITDA? And if yes what effect will this have
  • How should the cash be used? (Why repayment of debt is not appropriate)
  • Deemed cures – what are they and are they worth having?
  • Case: Review of recent lessons from Ideal Standard

 Covenants used in Real Estate deals

  • Interest cover – constituents, pros and cons
    • Historical
    • Projected
  • Key differences from the leveraged ratio
    • Calculation periods
    • “Passing Rental” – what is included and what is excluded
    • Difficult / contentious aspects - break clauses, non-rental income, costs/expenses
    • “Finance costs” – treatment of hedging
  • Loan to Value
    • Constituents, pros and cons
    • Items to be netted off
  • COVID issues
  • Is COVID force majeure event in Real Estate deals
  • Can Valuations be relied in as an EoD in a COVID environment

 Appendices (Not covered in the course but included in an appendix the materials)

 Finance Leases v Operating Leases – problem areas

  • Current approach
  • Impact of proposed changes to IFRS
  • Which sectors will be affected by the changes
  • Potential problem areas (& solutions) with the new regime
  • Sectors posing particular problems with operating leases

 Overview of ratios used in Project finance / Infrastructure

  • Annual Debt Service Coverage ratio (“ADSCR”)
  • Loan/Bond Life cover
  • Project Life cover
  • Using the Buffer test

The trainer is a consultant, public speaker and author with expertise in private equity, debt advisory, restructuring and infrastructure. He is a Senior Advisor to KPMG Finland, a Senior Advisor to Reorg EMEA Covenants, the leading provider of information to the European High Yield community, and a Senior Consultant to Grant Thornton UK.

Training programmes are provided to a wide range of blue-chip clients in Europe, Africa, the Middle and Far East, North America and Australasia. In-house clients include banks (BNP Paribas, Société Générale, ING, Barclays Capital, Bank of China, RBS, SEB); lawyers (Baker & McKenzie, Skadden Arps, Sullivan & Cromwell, Cadwalader, Latham & Watkins, Weil, White & Case); advisory firms (Lazard, PWC, M&A International, KPMG, EY, Deloitte); PE firms (Cinven, Advent, Barings Asia, Waterland); corporates (Siemens, Airbus, Turkcell, Candy Crush, Gunvor, Statkraft) and governmental bodies (the UKLA, the EBRD, the ECGD, Omani Oil Corp.)

He qualified in South Africa both as a Chartered Accountant, with Deloitte, and as a lawyer with Hofmeyr where he was involved in structuring a number of high-profile project financings including BMW 3 Series, Ford Sierra, GM, Sappi and Mondi.

When he moved to London and joined Lazard Brothers as a corporate finance executive he was involved in a wide range of public and private transactions. Subsequently he joined Hoare Govett as an assistant director where he acted as an advisor to smaller listed companies and was involved in several syndicated Euro-Equity Initial Public Offerings.

In 1991 he joined ABN Amro’s cross border M&A team prior to being transferred to MeesPierson Corporate Finance as a Director in Cross-Border M&A where he was also involved in a number of deals in Central Europe. During this time he was a member of the EU-PHARE programme and advised the Estonian government on their privatisation programme.

He is the Programme Director at the City Business School, London, for Infrastructure Finance for the M. Sc. programme in Business Administration and Finance.

He is a member of the Institute of Chartered Accountants in England & Wales and the South African Institute of Chartered Accountants. He completed a BA and an LLB at the University of Natal and a B. Compt. (Hons) at UNISA.

The loan market in Europe has bifurcated into two main approaches to loan documentation; smaller club and bilateral deals on the one hand, which broadly follow the more lender-friendly LMA approach, and larger syndicated TLB-style deals on the other hand which are increasingly influenced by high yield bonds and invariably are structured on a cov-loose or cov-lite basis. These larger deals also include a far more eclectic approach to the key definitions comprising the ratios with many add-backs taken copied from high yield bonds.

This programme covers financial covenants in leveraged loans and real estate deals and includes specific reference and analysis of the covenants, terms and definitions in the LMA Senior Facilities Agreement for Leveraged transactions and LMA Real Estate precedents.  The programme uses information from the Reorg Debt Explained database, to review the current trends in the market in the larger syndicated (TLB-style) deals which so often include springing leverage covenants and high-yield-bond style covenant packages.

The larger syndicated TLBs also vary in approach depending on whether they apply English law or NY law (for example, the latter do not usually permit overcures or require prepayment of loans from equity cure cash).  Direct lenders, which typically use the LMA leverage precedent as a starting point, also tend to adopt a more borrower-friendly approach to the terms in the loan and the financial covenants.

Financial covenants are arguably one of the most heavily negotiated aspects of the Loan Agreement.

Too often; some parties fail to understand the key negotiating issues that really matter, for example, they view the financial covenants in isolation rather than appreciating that they must be seen in the context of the particular capital structure. Secondly, too much time is spent on which covenants apply rather than focusing on the key constituents of the key terms in the financial covenant. Finally, many parties fail to appreciate that, even in cov-lite deals, the financial covenants and/or the components of those covenants play an important role as they also affect a wide range of other critical matters in the loan. This usually includes the various “permitted” actions such as debt incurrence (security and guarantees), sponsor payments, cash sweeps, guarantor coverage and grower, scalable and/or builder baskets where these appear.

This course provides a detailed look at commercial aspects of financial covenants and looks under the bonnet at the critical issues that arise in practice. It provides an in-depth look at the covenants as set out in the Loan Market Association precedent together with other covenants that might be used in practice. Reference is made to the Reorg Debt Explained loan database which tracks key terms in the larger syndicated TLB market.

Participants will gain an in-depth view of which covenants should be used together with a detailed analysis of the constituents of the covenants and the sponsor friendly add-backs and other sponsor friendly techniques used by borrowers to manipulate the covenants.

The programme will appeal to practitioners involved in leverage, real estate and infrastructures, such as Lawyers, Private Equity professionals, Bankers in Lending (all departments), Corporate financiers, M&A advisors, Debt Advisory and Restructuring. Accounting professionals looking to expand their knowledge of this topic will also benefit as many of the issues embrace legal /documentary considerations. The programme adopts a pan-European approach to the topic but the presenter is able to discuss issues relevant in the USA in view of his exposure to those markets.

To derive full benefit from the programme, it is essential that attendees have a basic understanding of the main / headline elements of a Profit and Loss account (Sales, EBITDA, EBIT etc.) and a basic understanding of the differences between P&L /Accrual Accounting and Cash accounting. It is emphasised that participants DO NOT require an understanding of IFRS or GAAP.

A short module summarising the key differences between P&L /Accrual Accounting and Cash Accounting is available on request prior to the programme.

The programme will review the draft ECB guidance on leveraged transactions published in November 2016. The course will examine which type of transactions are covered, which lenders are affected, the approach to EBITDA and the potential implications for players in the debt markets. 

Case Study: Participants will be required to:- (a) calculate how to derive the key elements of the various covenants (b) identify some of the more problematic components in the covenants (c) calculate the various covenants and (d) explain the pros and cons of each of the covenants and why they may be appropriate for one deal but not another. The calculations are relatively simple and are designed to explain the basic principles and reinforce learning.

  • The course surpassed my expectations, taking the learning a step further.
  • The course gave a good overview of historical development of covenant practices, as well as current state of the market regarding type and number of covenants. We looked at actual loan agreement wording, which was helpful
Number of places:

£895.00

Per participant
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