How to Analyse Restricted Payment Capacity and Potential Value Loss
When it comes to analysing potential value loss, there are two important analyses to keep in mind. One relates to the Debt and Liens covenant, which can impact your day one position in the capital structure (and which we wrote about in this blog).
The other key analysis relates to value loss risks inherent in the Restricted Payments and Asset Sales covenants, which can impact the value of your collateral, and the business as a whole, over time. In this blog we will walk through the Restricted Payments analysis, step-by-step. Today’s video is designed to complement the material.
Charting potential risks inherent to assessing Point B for value loss requires us to determine the following:
- The maximum capacity for Restricted Payments(and Permitted Investments),
- At what point access to this capacity might be blocked due to a default, event of default, or inability of the borrower to meet a ratio test, and
- To what degree the Asset Sales covenant will generate Restricted Payments capacity (which we will examine in Part 2 of this Analysing Point B series).
This analysis will take us on the long and winding road through the Restricted Payments covenant, the Permitted Investments definition, with a key detour to the Asset Sales covenant (which we will chart a course to next week).
Starting with the Restricted Payments covenant, answer the following questions:
- What is the definition of “Restricted Payment”?[1]Anything carved out will not be restricted by the covenant,
- How is the build-up basket calculated (50% CNI less100% of losses, or EBITDA less a multiple of interest expense), and are all losses deducted, or only until the builder hits zero, or are losses omitted altogether?
- Is there a starter amount, available on day one? Is there some interplay with the Asset Sales covenant (e.g., Declined Proceeds)?
- What conditions must the borrower meet to access the builder basket – no default, or Event of Default, or only Material Events of Default? Is there a ratio test condition? Importantly, do these conditions apply to all Restricted Payments, or only some of them?
- Add up the borrower’s “Permitted Payments” capacity – and remember to include the leverage-based Restricted Payments carveout and look out for Asset Sale cross-references (think “Leveraged Excess Proceeds, for example)
Moving to the “Certain Definitions” section of the document:
- Add up “Permitted Investments” capacity – again, remember to include the leverage- based Permitted Investments carveout,
- Check whether any of the material baskets are blocked on a default (or event of default).
- Remember that all Permitted Payments and Permitted Investments capacity can be used to invest in Unrestricted Subsidiaries, which could provide flexibility for the borrower to conduct drop-down transactions a la J. Crew.
Finally, make a note of any calculation mechanics, like reclassification or tricks in the ratio calculations (we go into more detail on this in a separate blog).
And with that, we have arrived at Point B (Part 1)with a good sense of how our day one assessment of the value of our credit support and the borrower’s asset base could change due to potential value loss over time.
We hope you enjoy our step-by-step video lesson that pairs with this blog! Stay tuned for Point B (Part 2), when we will complement this analysis with a consideration of the Asset Sales covenant.
[1] Note for a high yield bond and HYB-style TLB, this will include dividends, repurchases of capital stock, repayments of subordinated debt and restricted investments. For some BSLs, this may be split amongst three covenants, one for dividends and stock repurchases (the Restricted Payments covenant), one for repayments of subordinated debt (the Junior Debt Repayments covenant), and one for Restricted Investments (the Investments covenant), though capacity can often be shared amongst them so it’s a distinction without a difference).
By Sabrina Fox