Reminiscing
I still remember my first assignment as a young corporate associate – take this giant stack of documents, circle the numbers and put them in a table.
My very first comp table.
This would be used to draft the first set of covenants – the underwriter’s opening play for the borrower to consider alongside their plans for the next 5 years with the sombre warning that if a transaction wasn’t accounted for in the covenants, then it probably wouldn’t be possible without lender consent.
Oh how the times have changed!
The current vintage of covenants will allow borrowers to undertake a far wider range of transactions than in my “baby lawyer days, and they come ready-made for liability management as well."
Modern provisions governing calculations of covenant capacity allow management to make assumptions, projections and pro forma adjustments that freeze time or facilitate travel in it, whichever manoeuvre turns out the larger number.
Probably the most notable difference between covenants now and way-back-when is their vast departure from the fundamental, founding principles that once ran through covenants in every deal – an unspoken bargain struck at the start of the product that broadly read:
"These are highly levered companies, so the debt they issue should subject them to tight restrictions on debt incurrence, dividend distributions and payments to junior stakeholders; strong guardrails on asset sales and affiliate transactions; and robust reporting requirements so lenders won’t be left in the dark."
What happened? Well, a decade of easy money skewed bargaining power so strongly in favour of borrowers and their private equity owners that the evolution of covenants over that period resulted in death by a thousand cuts for investor protections.
Use of this flexibility has not always been bad for lenders– many point to the wave of amend-and-extends that would have emerged in the wake of the pandemic as proof that loose covenants can be in an investors’ interest as well.
It matters not where you stand on this debate – no one can deny that the increased complexity in covenant provisions has resulted in the emergence of a new language in the leveraged finance market:
It’s called legalese.
Those businesses survived, and some of them even thrived, because the flexibility in the docs afforded them with the ability to raise necessary capital to weather the unexpected storm caused by the pandemic.
But times have changed – the challenging market conditions that we are currently experiencing changes the game for lenders. The scales have tipped and the bargaining power now largely lies with them.
The implications of this shift cannot be overstated. Lenders stand at the controls of the time machine now, and where the market for covenant provisions goes from here may well be in their hands.
This comes at a time when most junior to mid-level credit analysts have never picked up an indenture (what’s that?) or reviewed a term sheet, let alone suffered through a restructuring (or two or ten). For the old guard, work-outs were where teeth were cut, where the bite of a loose provision was felt, where lessons were learned that carried into future negotiations and provided real incentive to hold the line.
We don’t have to wait for a wave of restructurings to occur for these lessons to be passed down to the next generation. Let’s teach them how important covenants are now, and guide them through the complex Land of Covenants, until they emerge on the other side, equipped with the knowledge and tools to negotiate better covenant packages.
That’s what our Leveraged Finance Covenant Training is all about – teaching market participants from all sides of the leveraged finance ecosystem how to speak using a common tongue. Our vision is to support more effective engagement on covenant terms both in primary and secondary market transactions.
Knowledge is power – and in today’s market, saves money.