The CEO of Brookfield’s private equity business, Cyrus Madon, gave an insight into how the giant firm is approaching leverage in a low-cost financing environment.
“What we’re focused on is putting non-recourse financing in place, long-term maturities, little-to-no financial maintenance covenants whatsoever, flexible financing,” said Madon during the firm’s quarterly earnings call on July 31, in response to an analyst question. “If we can put that in place and the business can readily withstand the financing costs, we’ll do that all day long as much as we can.”
“If we can put that in place and the business can readily withstand the financing costs, we’ll do that all day long as much as we can.”
Where businesses have more variability in cashflow and higher levels of financing might lead to lenders requiring more financial covenants, then the firm “will throttle back the amount of financing on that type of business,” continued Madon.
When questioned about whether the low cost of financing was having an impact on the firm’s approach to acquisitions – and whether competition for deals was getting fiercer due to the availability of debt – Madon said: “We’ve been in a favorable financing environment for many, many years. I don’t think anything’s changed today as opposed to five years ago, in respect of competition for deals that are driven purely by the financing environment.”
Covenant-lite loans now comprise 80 percent of the Credit Suisse Leveraged Loan Index, which tracks broadly syndicated leveraged loans to speculative grade issuers, wrote two researchers from ratings business Fitch in sister publication Private Debt Investor in July.
Steven Miller, head of leveraged finance intelligence for Fitch Solutions, and Jessica Reiss, head of loan covenant research at the company’s Covenant Review service, outlined four specific documentation features that have emerged as emblematic of the shift to covenant-lite:
- Incremental loan tranches
Most leveraged loans today allow the borrower to add new loans equal to up to 50-100 percent of its pro forma closing EBITDA without the lender’s consent and without meeting any financial tests. This is a sharp departure from loans of the past and allows a borrower to, for example, increase the par amount of a first-priority loan claim against the collateral pool by typically 20-25 percent.
- Asset sales sweep step downs
In the not-too-distant past, when leveraged loan borrowers sold assets, they were invariably required to reinvest the proceeds or use them to pay down loans.
That has started to change at the margin. In the year to April, Covenant Review data show that roughly one-third of syndicated leveraged loans allowed the borrowers to use asset sale proceeds for other purposes provided they had met certain financial tests.
- Loose EBITDA adjustment definitions
Many of the provisions of a loan agreement are tethered to the borrower’s EBITDA. Most loans today allow borrowers to incorporate certain assumptions to adjust them higher – say, for corporate actions not yet completed – thus providing additional flexibility to issue debt or pay dividends.
- Transfer baskets
Loan agreements are riddled with ways for borrowers to transfer assets to units, typically known as unrestricted subsidiaries, that sit outside the lender group and that are therefore beyond the reach of collateral liens. The most notable example of how these provisions can be used to reduce lender value is J Crew. The storied but struggling apparel marketer used a loophole in its document to transfer ownership of its brand name – a valuable piece of intellectual property – to an unrestricted subsidiary. Although the particular loophole in question is rare, showing up in just 11 percent of 2019 new issue loans, many credit agreements in today’s market allow for substantial investments in unrestricted subsidiaries, irrespective of whether they contain that loophole.