The Chairman's View: When is a cure a no cost event?
Equity cures have always been ripe for negotiation; from whether they are allowed at all, to how they are allocated and how many times they are allowed. However, recent deals seem to show that the boundaries are being pushed even further – rendering the cure potentially almost meaningless in certain cov lite deals (disregarding any discussion the level of the generally flat leverage covenant- that’s another topic!).
Equity cures allow an injection of capital to repair or “cure” a breach of a financial covenant. The injection of capital allows the borrowers to avoid the potential consequences of breaching their financial covenant(s) while the Lenders take comfort from the fact that the owners (Sponsors) are prepared to support the business and inject additional funds (equity or shareholder loan) into the group.
As such, the presence of an equity cure has become common in the leveraged loan market. Traditionally lenders required reduction (notional or actual) of the outstanding debt amount to a level where the leverage covenant was in compliance. Then there was a move to EBITDA cures where the cure amount as added (notionally for the test purposes only) to the EBITDA for the period - this required a smaller amount. The Debt Explained 2016 Loan Market Report noted that there was an almost even split of deals containing the EBITDA equity cure versus those that didn’t. In Q1 2017, the number of deals permitting an EBITDA equity cure tipped over 50% and that trend has continued in Q2.
* Please note that the figures for Q2 were drawn from RLT on 23 May, 2017.
Whatever the merits of the equity cure, it has, at least until now, required an amount of additional sponsor support. However, issuers are now pushing the boundaries.
In cov lite deals with a “springing” leverage covenant the covenant only applies when the RCF is utilised above a pre agreed (usually between 30% and 40%) level. Otherwise there is no requirement to comply with the covenant. There have been two deals this year which contained the provision allowing the issuer to use equity cure proceeds to bring its RCF below the springing covenant testing threshold during the “cure period”- in effect curing by removing the obligation to comply with the covenant. Clever you may say - and I agree. Depending on the level of RCF utilisation at the time this can be a very cheap “cure” (requiring minimal funds). But at least the Sponsor still had to inject some new funds even if potentially (depending on restricted payment capacity at the time) the RCF can be redrawn and the injected funds repaid to the Sponsor forthwith.
A quick search through our Representative Loan Terms database shows that there are a total of 15 deals containing a provision allowing the equity cure amount to reduce RCF outstandings. Of these deals the vast majority are above £/$/Eur500m and Sponsor backed.
However we have recently seen a deal in the market which contains a further clever twist. In this case there was no requirement that new sponsor money be used to pay down the RCF and effect the “cure” by reducing the RCF utilisation level to below the trigger level. Instead, the funds can come from within the group and can be redrawn under the RCF after the cure. Everything is as it was, except the breach has gone with no new Sponsor money being injected. Nice work if you can get it.
Whether this latest deal is an anomaly (sometimes even lawyers miss things and while a question might be asked of the lenders lawyers on this deal they will not be named here!) or a precedent that Sponsors will seize upon to push the boundaries even further, remains to be seen. If it is the latter, it is almost certainly the case that the answer to the question “When is a cure free” is unfortunately when the drafting allows the removal of the breach with the consequence that the “cure” only temporarily removes the symptom rather than improving the underlying performance of the borrower.
-- Stephen Mostyn-Williams, Chairman of Debt Explained
Stephen founded Debt Explained in 2009, following a 25 year career in leveraged finance. He has held senior positions at Cadwalader, Wickersham & Taft LLP; Shearman & Sterling LLP and Ashurst. Stephen co-founded the European High Yield Association and served as its chair for the first three years of its existence.
Subscribers to RLT can log in here to search for various data points regarding equity cures including whether it is allowed, the allocation of cures and whether overcures are prohibited. If you need help searching for any of these data points, please contact your account management team for help using RLT.
The information contained (whether transmitted by way of email, report, electronic media or paper or similar means) in this communication ("Information") is subject to the terms and conditions as set out on the Debt Explained website (www.debtexplained.com). Please visit the website if you are not aware of them. For the avoidance of doubt neither Debt Explained Limited, its employees, officers or contractors owe any duty or are liable to you in any manner in relation to the Information which you should verify for yourself. The Information does not constitute legal or investment advice or advice or recommendation of any kind.