The builder basket in the Restricted Payments covenant over time becomes a company's most significant source of Restricted Payments capacity. In our latest in the Primary Market Education Series, Sabrina Fox, founder of Fox Legal Training, highlighted significant differents in how this provision can appear using as an example Stada's latest bond offering.
The Evolution of Builder Basket Formulations
Method 1: Traditional Approach
Traditionally, the builder basket allowed companies to use 50% of Consolidated Net Income (CNI) for restricted payments, reduced by 100%of losses. This method ensured a balance between rewarding profitability and accounting for losses, allowing borrowers to send half of their profits out to junior stakeholders but requiring that this be reduced by any losses.
Method 2: Zero Floor Provision
As the market evolved, some issuers introduced a zero floor provision. This prevented the basket from going negative, effectively stopping at zero when losses occurred.
Method 3: No Negative CNI
The most recent formulation, seen in Stada's latest deal, considers CNI as zero for any quarter where it's negative. This means the builder basket never decreases due to losses.
Implications of the Different Formulations
Using Fox Legal Training's Covenant Calculation Excel, we can illustrate the drastically different results from these methods:
- Traditional Method: Borrower must dig out of losses before building capacity.
- Zero Floor: Prevents negative basket values but still decreases from losses until the basket reaches zero.
- No Negative CNI: Allows continuous basket growth, ignoring losses.
Concerns and Market Reactions
The newest formulation (Method 3) contradicts the original agreement between borrowers and lenders. It allows dividend payments even during loss-making periods, which has led to some lender backlash against excessive dividend capacity, resulting in a change to Sammotana Italia’s builder basket formulation last week.
Conclusion
Understanding these formulations is crucial for both issuers and investors. While some companies like Stada may have adopted looser terms in recent deals, they must still comply with tighter provisions in earlier dated bonds unless refinanced or amended.
For those interested in deepening their understanding of leverage finance covenants, Fox Legal Training offers an on-demand online courses that teach you how to analyze covenants like a pro. Visit www.foxlegaltraining.com to find out more and to sign up for our flagship Leveraged Finance Covenant Training course.