What have been the key areas of negotiation between borrowers and lenders in the last two years?
Private Equity (2nd edition)
In the last two years there is very limited access to finance for businesses in Greece. As a result, lending activity in the Greek market was mostly limited to refinancing and rescheduling transactions. In this context, the main negotiations are related to financial covenants and repayment schedules as well as the provision of additional security.
The scope of representations and covenants remain a hot topic in many finance deals. In that respect, more covenant-lite credit agreements are now being seen on the market.
Although the level of negotiation strongly varies per transaction, the key areas of negotiation in most transactions evolves around the general undertakings (even more so for buy-and-build companies), the financial covenants (in particular the use of equity cures and the scope of EBITDA normalisations) and financial reporting. We do see the leveraged loan market, including traditional banks, becoming more accepting of looser covenants as a result of increased competition in the market.
The general trend is that covenants tend to get lighter in most acquisitions financings. In particular, financial covenants remains a key area of negotiations, with borrowers continuously pushing for lighter covenants. That said, the key terms of a Norwegian financing are still quite far less sponsor/borrower friendly as compared with UK and European deals. In addition, lenders are frequently seeking to increase their ability to transfer their commitments without the consent of the borrower.
Depending on which side of the party is involved in the negotiations, the approach may be different.
From a lender's perspective the important issues are:
a. increased costs related to the introduction of new European regulations in this area, such as Basel II and Basel III, on the basis of which new costs may be generated in the future;
b. transfer of rights clause enabling the lender to transfer financing to another entity.
From a borrower's perspective the important issues include:
a. clauses relating to negative pledges, non-disposal of assets, financial indebtedness, merger and acquisitions(depending on the borrower's business requirements);
b. material adverse change (MAC) clause allowing the lender to qualify practically any event as an event of default under the loan agreement;
c. clauses referring to possible future changes in law that would increase the cost of financing for the borrower.
They vary on a deal-by-deal basis, based on our experience, mandatory prepayment and (financial and other) covenants are heavily negotiated recently.
We have seen an increase in negotiations relating to extension options in loan agreements (primarily a three year option with an optional one plus one year extension). We have also seen somewhat of an increase in negotiations relating to sanctions in the past couple of years which has led to a new, more borrower friendly, market standard.
The key areas of negotiation are, similar as in other jurisdictions, the financial covenants, certain fund mechanism, clean-up concept, prepayment provisions, security package, debt push down and flexibility in terms of future facility increases. From a Swiss tax law perspective, substantive negotiations take place around provisions to mitigate withholding tax risks which may result in the restriction of transfers to new lenders, the limitation of the use of proceeds in Switzerland or an obligation to obtain tax rulings.
Although the level of negotiation strongly varies per transaction, the key areas of negotiation in most transactions evolves around the general undertakings (even more so for buy-and-build companies), the financial covenants (in particular the use of equity cures and the scope of EBITDA normalisations) and financial reporting. We do see the leveraged loan market, including traditional banks, becoming more accepting of looser covenants as a result of increased competition in the market (so-called “cov-lite loans”).
Financial leverage covenants, EBITDA add-backs and, to a lesser extent, equity cure provisions (which are now broadly accepted) are commonly negotiated.
The key areas of negotiation between borrowers and lenders include, inter alia, the loan amount, loan term, interest rate, calculation and settlement of the loan, guarantee, interest on late payments, fees, remedies, etc. As credit default of the company bonds occurred more frequently in recent two years, lenders tend to pay more attention on the terms of guarantee and remedies. The number of credit default of the company bonds is 278, and the accumulated amount of which is about RMB 239.6 billion from January 1, 2018 to November 19, 2019, approximately three times of the sum of the credit default amount from 2015 to 2017.
For large and mid cap transactions, there is a general trend in the acquisition finance market to only put in place a Term Loan B to take into account the weakening of banking monopoly prohibitions and covenant lite documentation. In addition, sponsors often obtain provisions of a springing covenant whereby the financial ratios are tested only when a certain percentage of the revolving credit facility is drawn.
However, for small and mid cap transactions, acquisition amortizable term loansrobert are still widely used.
For all type of financings, there also has been an increase in negotiations relating to the following items:
- sanctions and anti-money laundering provisions;
- transfer provisions, with negotiations resulting in restrictions as to (i) any free transfer by a lender of its participation under a facility, such free transfer being now usually limited to the occurrence of limited events of default (i.e. payment default, insolvency and breach of covenants) and (ii) an express prohibition of transfer to “Loan to own” distressed funds; and
- due to the recent changes with respect to the reference rates transition, the insertion of replacement screen rate provisions.
Financial sponsors are insisting on more favourable terms in credit agreements, including higher leverage levels and more relaxed loan terms such as grower baskets, a reduced number of restrictions and more flexible permissions relating to disposals, acquisitions and other key commercial parameters. In particular, covenant lite / covenant lose credit agreements provide reduced risk alert protection for term loan lenders and springing financial covenants for revolving lenders only. Similarly, cure rights for financial covenants are primarily EBITDA cures to increase the borrower's EBITDA rather than decrease their debt. Thus, providing a significantly enhanced commercial outcome.
The EBITDA calculation often accounts for cost savings and synergies from acquisitions (or other initiatives), even on an uncapped basis. Especially in large deals, credit agreements are regularly incorporated into a New York notes style covenant section.
Many credit agreements allow for additional debt, subject to a financial ratio test and often for a specified amount that can be incurred at all times. Assignments and transfers under credit agreements are increasingly tightened to occur only with the borrower’s consent, excluding transfers to competitors or loan-to-own investors from the onset.
Financing deals in Mexico have traditionally been negotiated on a “take it or leave it” basis, with certain provisions being subject to little room for negotiation. That said, in recent years borrowers have pushed for more protection in key areas, including with respect to early maturity, assignment by lender requiring consent, cure periods on default, limiting default scenarios, among others. In addition, commercial terms (interest rates, breakage costs, etc.) are highly negotiated as well.
Restricción y Denuncia provisions (discretionary reduction of the credit line and discretionary termination of the facility by the lender) that were considered market in Mexican loans, have recently been negotiated by borrowers to limit them to certain and specific scenarios.
Negotiations over the last two years have continued to focus heavily on the definition of EBITDA in leveraged finance transactions both in the loan and high yield bond markets. EBITDA is not only relevant to calculating maintenance covenants but it also remains the benchmark for incurrence covenants and is fundamental to the calculation of basket thresholds as many of such baskets grow as EBITDA increases. Uncapped addbacks for projected cost savings and synergies are regularly resisted by lenders, and 2019 has seen a decrease in the proportion of deals that permit this.
The ability to incur incremental debt on a senior secured, junior secured and/or unsecured basis either inside or outside the day one finance documentation is also a key area of negotiation. While borrowers have successfully negotiated broad flexibility in this area, lenders continue to push for key structural protections including, maturity and amoritsation limitations, non-obligor debt caps, intercreditor accession thresholds and most-favoured-nation protection.
The rise of EBITDA cures has accompanied the prevalence of cov-lite loans. Borrowers expect to be able to add cure amounts to EBITDA and this flexibility together with the extent of the ability to make consecutive cures, overcures and RCF prepayment cures have consistently featured as negotiation points in recent years.
Negotiations tend to be around financial covenants, event of defaults, security packages and other business-related terms.
The key negotiating terms in a typical debt financing transaction involves clauses relating to negative covenants (such as, debt to equity ratio, restriction on merger/amalgamations, restriction on change in control), commercial terms, event of defaults and consequences, indemnities and manner of securing the finances. Specifically, in the past two years, we have seen that the Reserve Bank of India is focusing on compliance of end-use of facilities by the borrowers.
Over the last two years, the key areas of negotiation include financial covenants (and cures to any covenant breaches), associated baskets around the use of cash, mandatory prepayment triggers and assignment and transfer provisions (and, in particular, the scope of white/black lists). Accordion facilities are quite common features, as well as options to extend the term and the mechanics around exercising these options tend to be closely scrutinised.
In contrast to the UK, the local Irish market has not embraced cov-lite transactions, although in recent deals we are starting to see a relaxation of permissions around use of cash. Consequently, transactions involving local Irish banks will typically include substantial covenant protections. As a result, certain Irish borrowers have sought financing from foreign banks or the bond markets.
Hannes Snellman: Referring to Question 19, the key areas of negotiation in credit agreement negotiations depend on the outcome of the term sheet negotiations. Overall, borrowers and lenders have had detailed discussions of thresholds for covenant trigger events and on covenants as a whole, as well as on collateral and security packages. Reflecting general trends in other markets, the number and strictness of covenants, permitted-clauses and grower baskets as well as the required collateral and the extent of security packages demanded have been decreasing in Finnish transactions as well. Further, it has become customary over the last few years in private equity deals for financial sponsors, as lessees, instead of lessor banks (which overwhelmingly provide debt financing in Finland) to draft the credit agreement.
The key areas of negotiation between borrowers and lenders are:
- Precedent conditions;
- Affirmative and Negative Covenants (including financial covenants);
- Representations and Warranties; and
- Events of Default.
The key areas of negotiations between borrowers and lenders have been:
These are usually heavily negotiated at principal level.
Debt providers typically request security interests not only in the assets of the acquisition vehicle but also in the assets of the target and all operating subsidiaries. For the acquisition vehicle, this typically includes security interests in:
- the target's shares;
- the rights and claims under the acquisition documents.
For the target and the operating subsidiaries, this typically includes security interests in:
- bank accounts;
- intellectual property;
- real estate;
In light of the financial assistance legislation (please see question 18 above), all upstream (or sidestream) securities given by an Austrian corporation need to be given subject to limitation language referring to the mandatory legal provisions. This limitation language is usually subject to negotiations between the parties.
Security realization principles
Borrowers usually try to agree on realization processes which make higher sales proceeds more likely.
Events of default
Events of default are usually negotiated in detail between lenders and borrowers.
The loan agreement typically provides for positive and negative covenants to ensure a certain conduct of business by the target group. In addition, the loan agreement usually provides for regular financial testing, reporting and information covenants. Exclusive lender clauses and intercreditor arrangements are entered into to address structural subordination of debt, priority and rights upon the occurrence of an enforcement event.
Given increased competition for deal origination among market participants, the middle market in particular has experienced an importation of financing terms that, up until about two years ago, tended to be found primarily in large cap financings. For example, in recent years private equity sponsors have been able to successfully negotiate for portfolio company borrowers to have the ability to incur additional debt either within or outside the credit facility as well as via "ratio debt" provisions which originated from the high-yield market. In a similar vein, there continues to be intense negotiation around incremental facility provisions (e.g., "most favored nation" pricing protections).
The scope of the collateral package, regarding which collateral will be required in addition to the shares of the target, is among the most heavily negotiated issues in financing documents.
Among the deal specific provisions in a loan agreement, the representations and warranties, covenants, conditions precedent, and events of default are the most heavily negotiated provisions. With respect to the covenants, in addition to financial covenants, those covenants which would place restrictions on the business operations of the target company (such as any restriction on capital expenditure by the company) are the most heavily negotiated.