How to Analyse the Change of Control Covenant
A borrower’s ownership is a fundamental aspect of the risk assessment for any lender. A company’s operations are determined by those with controlling ownership interests, and as such both high yield bonds and leveraged loans contain contractual provisions relating to a “Change of Control”.
For U.S. leveraged loans, a Change of Control will trigger an Event of Default (which can be waived), and in Europe it’s a mandatory prepayment event (at par). High yield bonds and TLBs with incurrence-style covenant packages require the borrower to offer to buy back bonds at 101% (also known as a Change of Control Offer).
Many sponsor deals in the European high yield bond market, and some in the U.S., contain an exception to the Change of Control put requirement if the borrower can meet a specified leverage ratio, known colloquially as “portability”. Some TLBs may also contain this feature, though it is usually subject to additional requirements.
Here’s how to analyse this provision, step-by-step:
First, check what triggers a “Change of Control”:
- This should include a change in majority beneficial ownership and a sale of all or substantially all of the borrower’s assets.
- Note whether there is a “Public Holding Company” exception, as this would allow the borrower to be acquired by a widely-held public company without triggering a Change of Control (e.g., Refinitiv’s acquisition by the LSEG).
Another key defined term to check is “Permitted Holder” and related definitions like “Initial Investor”, as the beneficial ownership trigger will contain an exception for firms and individuals enumerated here.
- The sponsor and its “Affiliates” will be on the list, and the sponsor’s portfolio companies should be carved out.
- You run the risk of a management buyout if management is listed here but this is not limited to management in place at the ime of the acquisition.
To find out if a portability clause is present, a neat hack is to ctrl-F for “Specified Change of Control Event means”, as this will take you right to the defined term:
- What level is the leverage ratio set at vis-à-vis opening leverage? Will any deleveraging be required, or is the feature available on day one?
- How many times can the provision be used? Is it one-time-only, or can it be used multiple – and potentially an unlimited –number of times?
- For TLBs, what other requirements are present? These may relate to the identity of the buyer, KYC, and time limits, among others.
Finally – and critically – how is the ratio calculated? Check the definition for the following:
- Are there mechanics in place giving management discretion to choose how and when the calculation can be made? If so, how flexible are these provisions?
- Can significant categories of debt be excluded from the ratio calculation? This could include debt incurred under Permitted Debt baskets on the date the calculation is made, RCFs, and working capital facilities, among others.
- Ctrl-F for “Excluded Amounts” in deals using a net leverage ratio, as this provision is designed to guard against borrowers injecting cash to meet the ratio and then building Restricted Payments capacity to round-trip the proceeds right back out again (though note that this provision won’t prevent the borrower from using other existing Restricted Payments capacity to accomplish the same thing).
Follow these steps and you’ll have a solid grasp of the borrower’s options in the event of a Change of Control. We have also published a step-by-step video lesson that pairs with this blog, and we hope you find it helpful!