Emboldened by strong technical conditions in the second quarter, U.S. leveraged loan issuers are asking for more aggressive covenant terms, along with tighter interest rates and new-issue discounts.
They are also pressing again for something called most-favored-nation sunset provisions. According to Covenant Review, the share of issuers seeking an MFN sunset provision over the past month has spiked to 43%, or 12 of 28 transactions the firm reviewed, from 21% earlier in the year.
In the leveraged loan market, a most-favored-nation provision resets the yield of an existing loan to the rate of a new loan the issuer undertakes, so the existing loan remains “on market.” A sunset provision would allow the MFN protection to expire after a set period of time. (You can read more about MFNs here).
The fact that more issuers are testing the waters is, in itself, a sign of the times. All the same, most of these more aggressive asks are likely to go unanswered. Indeed, in the year to date, among first-lien loans for which Covenant Review analyzed the final documents, 41% of covenant flexes favored investors on one of the following dimensions: MFN sunset, size of the free-and-clear-incremental tranche, and restricted payment basket flexibility.
Meanwhile, there were no issuer-friendly flexes for these terms. Of course, it’s tough to gain additional covenant concessions from investors even in the best of markets. Moreover, of the loans for which there was no change, only four leveraged loan issuers left a proposed MFN sunset intact.
LCD, an offering of S&P Global Market Intelligence, has flagged four surviving sunsets in 2016: Samsonite (12 months), McGraw-Hill Education (18 months), Leidos (12 months), and J.D. Power (18 months). Tellingly, all four transactions were sold in the second quarter, as market technical conditions turned in favor of issuers. All were heavily oversubscribed, and commanded issuer-friendly revisions, including tighter pricing.
Those deals notwithstanding, MFN sunset provisions remain the sacrificial lamb of documentation. They are routinely singled out in “subject to” commitments from investors, even as issuers push for ever-more-aggressive features. In recent days, for example, Leonard Green & Partners had to back away from a proposed six-month MFN sunset provision on its $770 million term loan backing the buyout of ExamWorks Group, according to LCD, which noted that the issuer nevertheless wrested lower pricing out of lenders while giving in on a series of investor-friendly document changes.
Looking at free-and-clear incremental tranches, all the flexes favored investors as well, Covenant Review found. Of the loans analyzed by Covenant Review, no fewer than 19% saw free-and-clear tranches trimmed during syndication (this number may increase as more deals move to final terms).
Even in a hot market, such changes can occur in the context of a successful deal like ExamWorks or SRS Distribution, which in June won tighter pricing on its dividend recap loan, but capitulated to investors on numerous documentation points, according to LCD News, which also reported that changes to SRS included a cap on cost-saving synergies adjustments, scaled back incremental facilities, and tighter restricted-payment and investment baskets.
Aggressive pushback against loosening terms reflects that—while yields rise and fall with market technicals—managers are loath to give on what amounts to the final line of defense, in the form of MFN, in today’s pervasive covenant-lite/covenant-loose environment. Further, given today’s lower clearing levels, players note that MFN is even more important to managers in shielding value from potential issuance if (1) market conditions erode; or (2) the financial performance of an issuer deteriorates. — Chris Donnelly/Steven Miller
Covenant Review recently introduced a monthly report that puts a lens on benchmark statistics for loan covenants, cutting the data by rating, sector, and sponsor where appropriate. Steven Miller can be reached at smiller@covenantreview.com.
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This story first appeared on www.lcdcomps.com, LCD’s subscription site offering complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here.