Advanced Negotiation Issues in Financial Covenants

Course Overview:

This programme covers financial covenants in Loan Agreements and includes specific reference and analysis of the terms and definitions as used in the LMA Senior Facilities Agreement for Leveraged transactions.

Financial covenants are arguably one of the most heavily negotiated aspects of the Loan Agreement. Too often some parties fail to understand the key issues that really matter, for example, they view the financial covenants in isolation rather than appreciating they must be seen in the context of each particular capital structure. A second pitfall is to spend too much time on which covenants apply rather than focusing on the key constituents of the key terms in the financial covenant.

This course provides a detailed look at commercial aspects of financial covenants and looks under the bonnet at the critical issues that arise in practice. This course provides an in-depth look at the covenants as used in the Loan Market Association precedent together with other covenants that might be used.

Participants will gain an in-depth view of which covenants should be used and why together with a detailed analysis of the constituents of the covenants and the sponsor friendly add-backs and other sponsor friendly techniques used by borrowers to manipulate the covenants.

The programme is aimed primarily professionals involved in Leveraged deals, such as Lawyers, Private Equity professionals, Bankers in Lending (all departments), Corporate financiers, M&A advisors, Debt advisory and Restructuring. Accounting professionals looking to expand their knowledge of this topic will also benefit as many of the issues embrace legal /documentary considerations. The programme adopts a pan-European approach to the topic but the presenter is able to discuss issues relevant in the USA in view of his exposure to those markets.

To derive full benefit from the programme, it is essential that attendees have a basic understanding of the main / headline elements of a Profit and Loss account (Sales, EBITDA, EBIT etc) and a basic understanding of the differences between P&L /Accrual Accounting on the one hand and Cash accounting on the other.

For those attending, a short module will be provided in advance of the course which forms part of the pre-course reading. It is to be emphasised that participants DO NOT require an understanding of IFRS or GAAP as the programme is designed to enable attendees to have enough basic knowledge to identify the key commercial issues.

Course Content:

Interaction of capital structure & financial covenants
Types of instruments & impact on the financial covenants
Structuring parameters - creating an appropriate financial structure (overview)
• Percentage senior, junior and equity in debt capital structure
• EBITDA multiples
• Target returns for PE & Mezz Funds
Impact of Capital Structure on Financial Covenants
• Bullet loans
• Impact of PIK

Key financial ratios used by Lenders / covenants for Loans (per LMA)
Leverage ratios (Balance sheet and P&L ratios)
• Total Debt / EBITDA
• Senior Debt/ EBITDA
Interest coverage ratios
• EBITDA / Total interest
• EBITDA / Senior Interest
• EBITDA / Cash interest
• [EBITDA – Maintenance Capex] / Cash Interest
• [EBITDA – Capex] / Cash Interest
Cash flow cover (DSCR)
• CADS / Total Debt Service
• CADS / Senior Debt service
Capex ratios / baskets
Other ratios
• Net Asset Value
• Fixed Charge cover ratio

A closer look at the key constituents of the ratios
EBITDA (note: is a defined term in the Loan Agreement, it is not a GAAP or IFRS term)
• Simplistic calculation of EBITDA
• Consistency of application (dealing with Accounting changes under IFRS, GAAP etc)
• Exceptional items
• Sponsor friendly add-backs
Total [Net] Debt and Senior Total [Net] Debt
• “Borrowings” per the LMA
• Simplistic calculation of Net Debt
• Example of net debt items
• Treatment of PE “Debt” and Vendor Loans
• Impact of Debt Buybacks and impact on “Debt”
• Treatment of “Trapped” cash on Debt
Finance charges & Net Finance Charges
• Tricky issues
Financial Indebtedness & impact on the covenants
Topical matters affecting the covenants
• Impact of Leasing on EBITDA (Operating vs Finance Leases)
• Forthcoming changes in IFRS & impact on covenants
• Capitalising costs
• Forex gains/losses on Intra-group transactions
• Debt buy-back gains & impact on EBITDA
• Restructuring costs
• Exceptional, extraordinary items & other “one-off”, non-recurring items
• Related party income

Pros & cons of the Financial Covenants & typical application
Cashflow cover – pros, cons and application
Interest cover – pros, cons and application
Leverage ratios - pros, cons and application
Capex ratios -– pros, cons and application

Other considerations
How many covenants are needed
Which companies should be included
• Definition of “Group”
• Adjusted EBITDA (effect of acquisitions & disposals)
Dealing with “Short” periods (i.e. Less than 12 months post the deal)
• Periods shorter than 12 months
• Typical pitfalls to avoid
Frequency of application: When should the ratios be tested
• Historic TTM/LTM, forecast, both (quarterly, monthly)
• 2 options per LMA
• What level of “Headroom” is appropriate
• Impact of Clean-ups
Additional role of the financial covenants on the Deal
• Margin ratchets
• Guarantor Coverage Test
The Compliance Certificate
• Requirements per LMA Sch 9
• Current commercial requirements
• When does the breach occur
• Ramifications of the breach for Lender (traps to avoid)
Equity cures
• Equity cures - What are they, good or bad
• What should be cured (EBITDA or Debt)
• Treatment of “overcures”
• Is the cure EBITDA? And if yes what effect will this have
• How should the cash be used? (Why repayment of debt is not appropriate)
• Review of recent topical case law

The Guarantor coverage test
• What percentages shall apply to Guarantors
• Which “guarantors” are included
• What items should be included in the test – gross assets, net assets, sales

Inter-creditor issues
Financial covenants for mezzanine and second lien and interaction with senior debt
Cross default and interaction of convents laminated structures (Loans, Bonds and junior debt)


Discounts available for multiple participants:

3-4 participants: 15% discount per participant
5-6 participants: 20% discount per participant
7-8 participants: 25% discount per participant
9 or more participants: 30% discount per participant

Delivering this course in-house for you to a number of participants could be very cost effective.