Covenants: One size does NOT fit all
I recently spoke with Debtwire about the covenants in Preem’s Senior Notes due 2027. The holdco notes contain a suite of lender friendly provisions designed to preserve the ability of the borrower to pay its obligations on the notes, and therefore contain more restrictions on dividends and debt incurrence than would be considered “market”.
The thoughtful drafting uses a standard high yield covenant package as a template, then artfully pares back flexibility that could impede lenders’ right to be paid coupon and principal at maturity.
During my career as a finance lawyer and covenant expert, I have seen covenants become far more cookie cutter than they were in the past. What was once a tight set of terms made more flexible only through bespoke permissions carefully tailored to the borrower’s business needs has evolved over time into a chimera comprised of the most flexible provisions drawn from other high yield bonds and also leveraged loans, with concepts swapped between the U.S. and Europe.
The result is a “sponsor precedent” that I would argue is no longer fit for purpose – though it depends on your perspective what the purpose of covenant provisions are these days.
Covenants used to be designed to protect lenders’ rights to interest and principal at maturity, to put some guardrails on management’s approach to growing the business, and to restrict sponsors’ ability to enrich themselves during the life of the instrument.
However, as I wrote about in Sleepless Nights OverUnrestricted Subs? [link], covenant provisions are now almost always designedto provide maximum flexibility to the borrower and sponsors, including inrespect of liability management inspired by the now-infamous “J. Crew” transaction.
Preem’s bonds demonstrate that there is no reason covenants can’t still be fit for purpose. The standard framework of the typical leveraged finance covenant package is a fete of financial engineering and legal alchemy which has fuelled massive growth for countless borrowers, and drives returns for lenders for the benefit of their clients.
There are levers to pull that will allow just about any borrower and just about any structure to find buyers in the leveraged finance market – but first you have to know how to find them.
FLT’s Leveraged Finance Covenant Training puts labels on the levers, so any market participant can understand the right one to pull under the particular circumstances and in the precise context of the deal in question.
When students complete the course, they will know their dilution from their subordination, their liens from their guarantees, their permitted payments from their permitted investments. Our LFCT course will equip them with the knowledge to confidently pull the right levers at the right time for the specific borrower, so covenants can become fit for purpose once again.
By Sabrina Fox - FLT Founder