Credit Agreements and Covenants Questions

How can covenants increase the chance of capital gains for bondholders

They force the company to -Deleverage: by limiting the company's ability to re-leverage -Reinvest Earnings(Typically retain a certain percentage and allows the rest to be paid out in dividends)

Who is liable for payments between restricted and unrestricted subsidiaries?

The restricted subsidiaries because they're pledging their assets

Incurrence Covenants

-Covenants that limit cash flows outside the ordinary course, such as major investments, dividends, and transactions with affiliates -Limits the borrower taking on more debt --These help to control the amount of cash or assets that leave the system and also limits the amount of additional debt that a borrower can incur ---Limitations on spending or payments, the subordinated debt payments, investments

What is a covenant?(Agreement)

-Limit the actions of the borrower to assure investors that the creditworthiness of the borrower will remain satisfactory. -Ensures that lenders get paid back -Every covenant package must be tailored to reflect the specific needs of the borrower/issuer and the specific risks perceived by the debt holders

On a bond indenture what is grouped together as a "Limitation in Restricted Payments"

-Limitations on Dividends/Distributions -Limitation on Subordinated Debt Repayments -Limitations on Investments (Including acquisitions)

Maintenance Covenants

-Ratios that the borrower needs to maintain for a quarterly basis check -May include Limitation on capital expenditures --Designed to provide right and remedies for the lenders without having to wait for an actual payment default --- Provides the lender Maximum Total leverage, interest coverage, capex, senior secured leverage

Give us an example of some things that equity holders may want to do if covenants aren't in place?

-Start demanding dividends

What are some of the ways that creditors could lose value in their investment without covenants?

-The company can start expanding beyond its means -Changes in line of business -Over leveraging (Having more debt then they can handle) -Loss of seniority position in the capital structure

What does Covenants Lite mean?

A loan agreement that has fewer covenants to protect the lender and fewer restrictions on the borrower regarding payment terms, income requirements and collateral.(Refers to a credit facility without maintenance covenants) -These loans are typically used for leveraged buyouts and other large, sophisticated loan transactions -Provides the Borrower with higher level of financing than a traditional loan

What is a guarantor?

A person, organization, or thing that guarantees something.

What is a lien?

A right to keep possession of property belonging to another person until a debt owed by that person is discharged.

Where do Maintenance covenants appear?

Almost all Credit Facilities

Why might a credit investor want to limit the amount and size of acquisitions a company makes?

Because its cash that could be going to them instead

Where do Incurrence Covenants

Both Credit Facilities and High Yield Bonds

How does a bank basket differ from high yield basket?

High Yield Covenants will often provide much greater flexibility than bank covenants

Are covenants designed to give creditors more or less wiggle room? Why or why not?

More wiggle room since they are able to limit the actions, as a way to stay high on the capital structure and also allows creditors to keep the risk well balanced.

Explain to me the difference between negative, and financial covenants. Give me examples of both

Negative covenants require that the obligatory of the debt must refrain from doing certain specific things (Restrictions on the sale of assets, mergers, Limitations on indebtedness) There are two types of financial (maintenance) covenants -maintenance and incurrence, maintenance financial covenants are included in bank credit agreements and incurrence financial covenants are included in bond indentures. (Minimum interest coverage, maximum senior and total leverage, min. fixed charge coverage, min. net worth)

What does it mean to default?

Non-compliance with negative or affirmative covenants, a covenant default, or failure to pay interest or principal

What is a restricted subsidiary?

Subsidiary that is subject to covenants

Why are bond covenants looser?

The indenture is "Carved in stone" upon issuance and there is little chance to fine tune the covenants over the 7-10 year life of the bonds