February 19, 2020 / 5:51 PM / 2 months ago

Auto-cures casts shadow over private debt market

NEW YORK, Feb 19 (LPC) - A provision that loosens restrictions on a private equity-owned company’s ability to remedy an event of default is raising concerns among many in the private debt market.

Known as an auto-cure, the feature has started appearing in some of the large unitranche loans. It is an addition to documentation highlighting the continued weakening of lenders’ protections.

Auto-cures allow private equity sponsors to put more capital into a company in the event of a default outside the traditional default cure period. The feature buys borrowers time to assess the reaction of a lender in a default situation, whether they pursue a foreclosure or amendment, and then make the cure, effectively pushing the default further down the road.

“It’s popping up in some of the big unitranches. It’s problematic and it’s something we hope that does not become a trend,” said Ian Walker, an analyst at credit research firm Covenant Review.

Such a provision was included in the US$1.6bn unitranche financing of MRI Software led by Golub Capital announced in February, according to two sources familiar with the deal.

Golub Capital declined to comment.

GREEN SHOOTS

The use of auto-cures is raising alarms among lenders and market analysts that say it further erodes lenders’ protections at what could be the end of the economic cycle.

“When the credit is troubled, that is when lenders’ antennas should be up. This is the very thing you’re trying to protect against as a lender and that leverage is being taken away,” Walker said.

It is, however, a “relatively new term,” according to Stephen Gruberg, a partner at law firm Proskauer.

“Still seldom seen in the direct lending market” the feature remains “the exception not the norm,” he said.

In the direct lending market, where covenant-lite loans are unusual, questions remain about how such a provision would be utilized when the borrower trips a financial covenant. The feature applies to situations specifically outside the customary allotted time for borrowers to cure such breaches – usually 10 to 15 business days.

“Private equity borrowers could argue that meeting the required leverage level at any time following a breach in the financial covenant would cure the event of default, but lenders could argue that an event of default could never be cured because the financial covenant is tested as of a specific date, not some date in the future,” Gruberg said.

The increased focus on the new clause may be a sign of borrowers’ fear that debt investors are taking creative approaches to collect remedies from companies facing difficult situations. The legal battle over a financing package for homebuilder Hovnanian that required it to skip an interest payment resulting in a payout to CDS buyers is a template for sponsors’ fears about borrower’s actions. That lawsuit was settled in 2018.

Net-short provisions, for instance, have been tightened in recent months in the leveraged finance market in reaction to this, as well as limiting the time for making a claim after a borrower enters a default.

“The headline to me is that we have been through a decade-long bull run in the leverage finance market. As a result, there has been a relentless march of sponsor and borrower-friendly terms that have afforded borrowers ever greater flexibility and weakened traditional creditor protections,” said Jason Kyrwood, a partner at law firm Davis Polk.

“Now, partly in response to recent debt activism, some borrowers are pushing to impose limits on traditional creditor remedies,” he said. (Reporting by David Brooke. Editing by Michelle Sierra and Kristen Haunss)

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