(Clarifies story to show Moody’s report was on bonds in 14th para.)
By Max Bower
LONDON, June 19 (LPC) - Investors are winning concessions on leveraged loan documents on large buyout deals, including those from Danish telecoms group TDC and French cyber security firm Exclusive Group, but these are small victories as the pressure to invest is allowing documentation to become more aggressive overall.
Several recent buyout loans have undergone rafts of changes to their documents after vigilant investors pushed back against private equity firms wanting greater flexibility to manage their investments.
TDC made several changes to its recent €3.9bn equivalent buyout loan, including updating the most favoured nation clause, which allows companies to raise additional debt; adding margin ratchets; and capping Ebitda add-backs at 25% of the initial figure.
Exclusive Group’s €500m Term Loan B also had “pages and pages” of changes, a person close to the deal said, after the buyside objected to terms that are typically reserved for larger, more liquid deals.
The changes affected everything from the MFN clause to restricted payments and the ability to incur incremental debt.
They get a couple of changes to make themselves feel better but it’s still terrible,” a head of leveraged finance said.
Investors are becoming more aware of the potential consequences of overlooking certain terms (often couched in dense legalistic language and well hidden in loan documents) due to the work of research firms, including Covenant Review and Debt Explained.
While private equity firms are assuring investors that they will never use the provisions, investors are suspicious that aggressive terms could eventually be triggered, as many European deals contain portability clauses that can transfer the financings to new owners if companies are sold.
“Some investors have actually said to me they only now appreciate the consequences of certain docs, even after playing several deals that had them,” the head of leveraged finance said. “That was shocking to learn, as we’ve often been trying to push back on their behalf.”
Investors cited the recent incremental term loan deal for financial software firm ION Trading as particularly alarming. An MFN clause allowed the issuer to raise a further €1.8bn-equivalent of debt that paid 100bp and 50bp more than the existing facility, without increasing interest payments to existing debt holders.
“ION pissed everyone off,” a London-based portfolio manager said.
Investors may need more deals like ION to fully appreciate the flexibility that weak lending terms now give private equity sponsors, even though awareness has been rising for some time, the first investor said.
“Loan investors still can’t really take a principled stand,” the head of leveraged finance said. “There’s more pressure to invest still compared to bonds.”
Moody’s said last week that the presence of “non-quantifiable carve-outs” for bonds has evolved rapidly this year. Carve-outs often increase an issuer’s ability to drain cash out of secured entities before investors can respond.
This can be done by loosening leverage and asset sale covenants, or manipulating Ebitda figures higher, and is commonly referred to as the “J Crew trapdoor” after the US clothing retailer first used the clause. The value of Ebitda add-backs on a recent deal was larger than that of the acquisition it funded, a London-based lawyer said.
Despite investors’ concessions, the assault on lending standards is accelerating as precedents get ever more aggressive. Documents are “deteriorating faster than our ratings scale can catch up,” a managing director at a ratings agency said.
The length and density of documents is making lending terms so convoluted that they could give even more flexibility than was initially targeted, even in today’s market. A partner at a law firm in London said that the sheer size and complexity of many lending agreements today is making them incomprehensible.
“We have seen some transactions where the documentation literally didn’t make sense,” he said.
Bankers are calling for help to push back against private equity firms’ more aggressive requests. Standardised guidelines on documentation, similar in style to the leveraged lending guidelines rolled out by the US Federal Reserve and ECB, would be useful, but currently look unlikely, the leveraged finance head said.
“The next best thing would be if the process was more public so it was more difficult for sponsors and lawyers to get away with this,” he said. (Editing by Christopher Mangham)