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Bond Covenants for Alpha Generation and Risk ManagementPresented to the Government Investment Officers Association – March 21, 2018

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[email protected] www.covenantreview.com

THE AUTHORITY ON BOND AND LOAN COVENANTS

THE AUTHORITY ON BOND AND LOAN COVENANTS

This presentation is for discussion purposes only. The information contained herein does not constitute legal or investment advice.

www.covenantreview.com

Remembering Terrors of the Past…The Big Remembering Terrors of the Past…The Big Remembering Terrors of the Past…The Big Remembering Terrors of the Past…The Big

high grade issuer LBO Wave 2006high grade issuer LBO Wave 2006high grade issuer LBO Wave 2006high grade issuer LBO Wave 2006----2008200820082008

The Real Disasters:

- Alltel- Clear Channel- Harrah’s- TXU

The Forgotten Wins:

- B.F. Sault REIT- Hilton- Manor Care- TXU (?)

Aaargh….I’ve come to eat your returns!

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Terrors of the PastTerrors of the PastTerrors of the PastTerrors of the Past

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CCU 7.25% Debentures due 2027 -11/16/06 Announcement

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Alltel 7.875% Notes due 2032 - 05/21/07 Announcement

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Terrors of the PastTerrors of the PastTerrors of the PastTerrors of the Past

81%89.14%

104.55%

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TXU Legacy Bonds - 02/26/07 Announcement

5.55% Sr Notes due 2014, Series P 6.50% Sr Notes due 2024, Series Q

6.55% Sr Notes due 2034, Series R TXU Energy 7% Sr Notes due 2013

Tender Offer

Premium 110.23%

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Harrah's 6.25% Senior Notes due 2016 -10/01/06 Announcement

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Purpose: Grant bondholders the option to get money back if the company gets new owners

Basics: Put right at 101% of par if a “Change of Control” occurs

Change of Control usually includes: Change in majority voting control

But: “Permitted Holders” that do not trigger a Change of Control

Sale of “substantially all assets”

Merger of two public companies (sometimes)

Continuing directors

Change of Control Covenant

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Change of Control “Holding Company” Exception

“Change of Control” definition states: “Notwithstanding the foregoing, a transaction will not be deemed to involve a Change of Control if (1) the Company becomes a direct or indirect wholly-owned Subsidiary of a holding company and (2)(A) the direct or indirect holders of the Voting Stock of such holding company immediately following that transaction are substantially the same as the holders of the Company’s Voting Stock immediately prior to that transaction or (B) immediately following that transaction no person (other than a

holding company satisfying the requirements of this sentence) is the beneficial

owner, directly or indirectly, of more than 50% of the Voting Stock of such holding

company.”

Nobody Wants to Read This

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Heinz LBO: Making Money on CoC Put


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2% Notes of 2016 1.5% Notes of 2017 3.125% Notes of 2021 2.85% Notes of 2022

1) Feb 14, 2013 – Heinz enters acquisition agreement with Berkshire and 3G

Capital. Broker Dealer claims the transaction may circumvent the 101%

Change of Control put for the 2016s, 2017s, 2021s and 2022s because it may

be structured to exploit a holding company exception.

Covenant Review: Is There a Relevant Exception to the Change of Control

Covenant? “We don’t think those arguments should win out.” The bonds

will get a 101% Change of Control put offer; other speculation is wrong.

2013 Heinz LBO by Berkshire Hathaway and 3G Capital

2) Apr 30, 2013 – Heinz

receives shareholder

approval.

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A Post-LBO Capital Structure

Equity Investors

Non-GuarantorSubsidiaries

GuarantorSubsidiaries

Holdco

Issuer

- Mezzanine Loans and/or Holdco PIK Notes

- 1st: Secured Bank Loans – 1st liens and guarantees- 2nd: Secured Bonds – 2nd Liens and Guarantees (new HY)- 3rd: Senior Unsecured Bonds –Guarantees (new HY)- 4th: Senior Unsecured Bonds – No Guarantees (old IG)

Trade creditorsOther debt

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Purpose: Protect seniority position� Limit amount of debt that may be effectively senior

� Don’t want the next senior note deal to be secured

Basics: Two types of “Permitted Liens”: voluntary and involuntary

Permitted Liens usually include:� A specified amount of bank debt or secured debt ratio

� Capital leases / purchase money liens

� Small general basket

� Special concern for carveouts for debt-related liens that do not have specific dollar caps

� Many miscellaneous exceptions for involuntary permitted liens

Liens Covenant

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Liens Covenants – What Has Changed


Many potential LBO target issuers continue to use legacy Liens covenants that expose holders to significant risks of effective subordination – so there may be a 101% put, but little chance to a consent / tender.

� Some first time issuers have used decent Liens covenants (e.g., Jones Lang LaSalle and Verisk Analytics) and others have not (e.g., FMC Technologies and Flowserve Corporation).

� Few pre-2007 issuers have changed their Liens covenants post-2007.

� Starwood: Made it worse over time.

� US Cellular – Liens covenant does not apply to most assets.

� Clorox – Liens covenant retains old “Principal Property” idea.

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The Credit:

Eastman Chemical $500,000,000 4.8% Notes due 2042

The Problem:

The Liens covenant does not apply to:

� loans, because of the defective definition of “Debt”: “notes, bonds, debentures or other similar evidences of indebtedness for money borrowed”

The Credit:

Analog Devices $400,000,000 5.3% Senior Notes due 2045

The Problem:

The Liens covenant is a sham:

� “We will not, nor will we permit any Subsidiary to, issue, incur, create, assume or guarantee …any debt for borrowed money…. secured by a mortgage…. upon any Principal Property”

� “Principal Property” means any single parcel of real property or any permanent improvement thereon…located in the United States…having a book value…in excess of 3% of our most recently calculated Consolidated Net Tangible Assets.

� Oops: “As of February 3, 2018, we did not have any Principal Properties.”

Liens Covenant

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Halcón Resources: Distressed Exchanges

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12/1/2014 1/20/2015 3/11/2015 4/30/2015 6/19/2015 8/8/2015 9/27/2015 11/16/2015 1/5/2016

9.75% Senior Notes due 2020 8.875% Senior Notes due 2021 9.25% Senior Notes due 2022

3) August 27, 2015 – HK announces privately-negotiated distressed exchanges whereby it agreed to exchange $1.02bn of new third lien notes due 2022 for $1.566bn in face amount of its existing unsecured bonds.

4) August 28, 2015 – Covenant Review: CR publishes follow up report explaining the distressed exchange and how HK could technically have incurred the new debt under the indentures for the unsecured bonds and second lien bonds.

2) May 1, 2015 –HK issues $700m of second lien notes due 2020

1) December 18, 2014 – Covenant Review: CR publishes report highlighting critical Liens covenant flaw and identifying HK’s unsecured bonds as each containing this critical flaw: “E&P bond issuers that have this Liens covenant loophole included in the terms of their bonds could potentially use this provision as a powerful tool to conduct a coercive exchange offer, assuming that they have enough debt capacity to incur the new debt.”

5) November 19, 2015 – HK announces another exchange offer. HK offers to exchange unsecured bonds for up to $150m of new second lien notes due 2022 that will prime the third lien bonds issued in the prior exchange. The offer results in HK issuing $112.8m of the new second lien notes in exchange for $289.6m of unsecured bonds. The two exchanges removed approximately $723m in principal amount of unsecured bonds from HK’s balance sheet.

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Global A&T: Add-on Chaos


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7/10/2013 11/12/2013 3/17/2014 7/20/2014 11/22/2014 3/27/2015 7/30/2015 12/2/2015 4/5/2016

1) Aug 22, 2013 - Moody's announces a change to the ratings outlook for the Global

A&T's B1 Corporate Family rating and the B1 rating of its $625mm 10% First Lien

Notes of 2019 from 'Stable' to 'Negative.' Moody's also affirms the B2 rating on the

existing $543mm Second Lien Facilities of 2015.

2) Sep 30, 2013 - Global A&T announces a

swap of Second Lien loans for as much as

$502mm of additional First Lien Notes.

3) Oct 4, 2013 - Covenant Review: How Might the Exchange Offer Be Justified? We

identify a technical loophole in the Liens Covenant that might allow Global A&T to

make the exchange from an Indenture perspective, but we suspect that the non-public

Intercreditor Agreement has been violated.

4) Oct 9, 2013 - Covenant Review: After reviewing the Intercreditor Agreement,

"We cannot see how any lawyers or bankers involved thought that the exchange

offer was a good idea." Further, we suggest bondholders consider litigation.

5) Feb 11, 2014 – Bondholders file a lawsuit

claiming, among other violations, breach of

the Intercreditor Agreement.

6) Feb 27, 2014 - Covenant Review: Following the initial filing, we analyze

the flawed arguments in the lawsuit and suggest remedies to improve

bondholders' chances of success. We encourage bondholders to litigate.

7) Mar 19, 2014 - Covenant Review:

Bondholders filed an amended

complaint that included our analysis of

the crucial issue of what happens if the

exchange was permitted under the

Indenture but not under the

Intercreditor Agreement, vastly

improving their chances of litigating

successfully.

8) July 14, 2015 – New

York State Supreme Court

dismisses bondholder

claims.

9) May 3, 2016 – Appellate

division modifies portions of

trial court rulings.

10% First Lien Notes due 2019

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Sale / Leaseback Covenant


What is a “Sale and Leaseback”?

� Duration?

� Intercompany?

Use of proceeds?

Recent debates

� Sprint

� Windstream

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Restricted Payments Covenant

Purpose: Protect bondholders’ interest in the assets of the company by limiting undesirable distributions and asset transfers such as:

� Dividends and equity purchases

� Retiring junior debt ahead of the bonds

� Investments in entities that are not Restricted Subsidiaries

� Guarantees of holding company debt

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Basics:� Company will typically be allowed to use up to 50% of

“Consolidated Net Income” to make payments to those junior to the bondholders in the capital structure (i.e., junior bonds, preferred equity and common equity).

� Typical conditions to using 50% of Consolidated Net Income to make Restricted Payments: (1) no current default and (2) compliance with debt covenant ratio.

� Test is backward-looking – has the company “earned the right” to make payments to equity?


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Common carveouts include:� General Restricted Payment basket

� Joint venture investment carveout

� Unrestricted Subsidiary investment carveout

� Leverage test?

� Check Restricted Payments and Permitted Investments

� Beware J. Crew type risks

Questions: � Can the company buy back / repay other bonds and loans?

� Are there “sneaky” dividend loopholes?


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Rackspace: Make-Whole on LBO

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8/1/2016 8/16/2016 8/31/2016 9/15/2016 9/30/2016 10/15/2016

6.5% Senior Notes due 2024

3) August 26, 2016 – Rackspace announces it

has agreed to be taken private by Apollo. 4) October 17, 2016 - The Preliminary OM

for the new bonds to be issued in

connection with the LBO confirms that the

outstanding bonds will receive a make-

whole premium.

1) August 5, 2016 - Media reports that Apollo is

in talks to acquire Rackspace.

2) August 8, 2016 – Covenant Review: Covenant Review reports that "the

Restricted Payments [for Rackspace's outstanding bonds] limits the Company's

ability to incur debt in connection with an LBO." The Covenant Review report

explains that if the debt financing for the LBO exceeds RP capacity, the bonds will

likely be redeemed at a make-whole.


Oil States Int’l: Make-Whole Conceded


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Oil States International 5.125% of 2023

Oil States International 5.125% of 2023

3) Jul 30, 2013 – Oil States

announces plans to spin-off their

Accommodations business.

1) Apr 30, 2013 – Jana Capital Partners, in a 13D filing, discloses that it has

built at 9.1% position in the equity of Oil States International. Jana also states

that they had discussions with Oil States’ management on April 26, 2013

regarding a spin-off of its Accommodations business into a REIT.

2) May 13, 2013 – Covenant Review:

“Effecting a large dividend or spin-off of

the Accommodations business to

shareholders would likely require taking

out the bonds at a premium.”

4) May 9, 2014 – Oil States

launches a tender offer for

the 5.125% Notes of 2023 at

$1,146.98.

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B/E Aerospace: Make-Whole on Spin-Off


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BEAV 5.25% of 2022

BEAV 5.25% of 2022

1) May 4, 2014 – B/E Aerospace

announces that it is exploring

strategic alternatives.

2) May 27, 2014 – Covenant Review:

Limited restricted payments capacity

would constrain BEAV’s ability to

consummate a spin-off unless they

redeem the bonds.

3) Jun 10, 2014 – BEAV announces

plans to separate into two

companies. The first will focus on

manufacturing and the second will

focus on services.

4) Oct 22, 2014 – BEAV

announces that in

connection with the spin-

off of the services

business, the Company

intends to redeem the

outstanding bonds.

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First Quantum: Litigating to Win


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Inmet 8.75% bonds due 2020 Inmet 7.5% bonds due 2021

1) Dec 16, 2012 – First

Quantum Minerals

announces its intention to

make an offer to acquire the

equity of Inmet Mining

Corporation for C$5.1

billion.

2) Dec 21, 2012 – CR:

How Would The

Company’s (Inmet’s)

Bonds Be Treated If The

Company Is Acquired?

3) Jan 9, 2013 – First Quantum forms a shell company ("Akubra") solely for the purpose of making a Tender Offer for Inmet’s equity,

executed primarily via a $2.5 billion Facility. The Facility included provisions for Akubra to complete “Target Amalgamation” (i.e., the

merger of Akubra with Inmet) within five days of Akubra’s acquisition of 100% of Inmet’s equity.

4) Apr 2, 2013 – First Quantum announces that 92.7% of Inmet’s common

shares were tendered. The remaining 7.3% can be mandatorily acquired

pursuant to provisions in the Canadian Business Corporations Act,

rendering Inmet a direct wholly-owned subsidiary of Akubra and an

indirect wholly-owned subsidiary of First Quantum.

5) Apr 19, 2013 –

Inmet makes a

Change of Control

offer at 101% for

the Inmet bonds

pursuant to

Change of Control

provisions.

6) Apr 22, 2013 – Inmet is amalgamated with Akubra. The surviving

entity remains the borrower under the Facility, on which

approximately $2.12 billion was drawn in the first quarter of 2013,

net of issue and transaction costs of $22.1 million.

7) May 29, 2013 – Inmet/Akubra prepays all outstanding

amounts owed under the Facility from Inmet cash on

hand. The Facility is amended to provide a $2.5 billion

revolver to Inmet/Akubra, supported by Inmet assets.

8) June 27, 2013 – CR: The

First Quantum Acquisition

May Have Breached the

Inmet Bond Indentures.

9) Jan 27, 2014 – First Quantum

announces an exchange offer to the

bondholders of the Inmet 2020s and

2021s in a negotiated exchange

settlement. Holders of the original

8.75% bonds due 2020 receive $575

of the new 6.75% bonds due 2020

and $575 of the new 7.00% bonds

due 2021. Holders of the original

7.50% bonds of 2021 receive $565 of

the new 6.75% bonds due 2020 and

$565 of the new 7.00% bonds due

2021.

First Quantum / Inmet Acquisition Timeline

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Purpose: Make sure the bonds follow when the assets move

Basics:� Applies to mergers where the Company transfers “all or substantially

all” of the Company’s consolidated assets� Erg…. What does “substantially all” assets mean…?

� High yield often has a leverage metric

Mergers Covenant

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Elan: Make-Whole on Asset Sale


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Elan 6.25% Senior Notes due 2019

Elan 6.25% Senior Notes due 2019

4) Apr 2, 2013 – Closing of

Tysabri transaction and the

irrevocable notice of 118.084%

make-whole announced.

1) Feb 6, 2013 – Elan announces

plans to sell most of their Tysabri

assets to their collaborative

partner Biogen, Inc.

2) Feb 11, 2013 – Covenant Review: Bondholders should demand

Elan address why the transaction is not subject to the Assets Sales,

Mergers or Change of Control covenants. The bonds should be

assumed by Biogen or bondholders could demand a make-whole.

3) Mar 12, 2013 – Elan

announces a make-whole

tender offer for the Notes.

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ITT Breakup: Make-Whole on High Grade

www.covenantreview.com 23


These are not your Daddy’s loans!

A Glimpse at the Loan Market

Credit Stats Middle MarketLarge

Institutional

Average Adj. EBITDA of Issuers ($MM) $42 $258

Average Tranche Size ($MM) $179 $684

Net First Lien Leverage 4.27x 3.8x

Net Total Leverage 5.10x 4.9x

Data as of: 3/13/2018

EBITDA Adjustments LTM Middle MarketLarge

Institutional

Percentage of Loans with Synergies / “Run Rate” Costs

Savings Adjustment 80% 89%

Percentage of Loans with Uncapped Synergies / “Run Rate”

Cost Savings Adjustment 13% 53%

Average Cap for Synergies / “Run Rate” Cost Savings

Adjustment 20.99% 20.38%

Data as of: 3/13/2018

Financial Maintenance Covenant Stats LTM Middle MarketLarge

Institutional

Percentage of Loans that are Cov-Lite 18% 83%

Percentage of Loans with Springing RC Covenant 18% 54%

Percentage of Maintenance Covenants that are First Lien

Leverage Tests 19% 77%

Data as of: 3/13/2018

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Why Are Indentures So Complicated?

“Modern indentures have a low rating on the scale of popularreading … nobody loves an indenture... The corporate trustindenture is undoubtedly the most involved financial document thathas been devised … and the accusation [is] commonplace that thelawyers are hoping to get paid by the word.”

“It has been remarked that it was devoutly to be wished that somegenius would arise to point the way to a reduction of the text ofsuch [indentures]; but where the opportunity has been afforded todiscuss the subject with such critics, they have been able toindicate little which upon full consideration they would be willing toomit.”

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Further Information

For general information and sample reports, email [email protected].

To reach Covenant Review founder Adam Cohen, email [email protected].

Covenant Review is part of the Fulcrum Financial Data group, which includes:

• CapitalStructure provides insightful first-to-market news and analysis of the sub-investment grade universe, with a focus on special situations. See www.capital-structure.com.

• Covenant Review is the trusted source for the interpretation of corporate bond indentures and leveraged loan credit agreements. See www.covenantreview.com.

• LevFin Insights provides comprehensive real-time news, commentary and data for leveraged loan and high-yield bond market players. See www.levfininsights.com.

• PacerMonitor is the unified, modern and full-featured platform for researching and tracking federal bankruptcy, district, and appellate court cases. See www.pacermonitor.com.

See www.fulcrumfinancialdata.com for more corporate information.

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