Last week we learned how to analyse the capital structure and credit support in a deal to determine Point A, or day one subordination risk and the collateral package. Today we are diving into the analysis of Point B – how this position could change over time.
Charting the course to Point B requires us to determine the following:
- The maximum amount of debt the borrower could incur,
- On what basis (senior, parity, junior),
- What type of subordination we could be facing (contractual, effective, structural), and
- The degree of dilution risk we are dealing with.
This analysis will take us on the long and winding road through the Debt Covenant and the Liens Covenant with important stops at the Permitted Collateral Lien and Permitted Lien definitions.
Starting with the Debt Covenant, answer the following questions:
- What is the Ratio set at? Is it a Fixed Charge Coverage Ratio, or Consolidated Leverage Ratio, or both?
- How much Credit Facility Debt is available? Can it (or any portion of it) be secured on a super senior basis? (Check Permitted Collateral Lien definition for the words “super senior”)
- What other debt capacity is available? (Look for any basket with a monetary figure attached to it, make a note of the clause number/letter, and add them up.) We will come back to this step.
- Which of these debt baskets can be incurred by non-guarantors? This reflects your structural subordination risk. (Check for provisions that cap such debt either altogether or in the aggregate across several baskets.)
Moving to the Liens Covenant, note the following points:
- For a secured deal, it will likely restrict any liens on non-Collateral assets apart from Permitted Liens (these are your effectively subordination risk), and on Collateral apart from Permitted Collateral Liens (this is your dilution risk)
- This covenant doesn’t include the key information about what a Permitted Collateral Lien and Permitted Lien actually are, so you’re getting off this highway after a pretty short drive.
Looking at the Permitted Collateral Liens / Permitted Liens definitions, follow these steps:
- Remember that list of Permitted Debt Basket clause references you made before? Pull that out and get ready to read your contract like a lawyer because you’re cross-referencing now…
- Which of the Permitted Debt Baskets are referenced in the Permitted Collateral Liens definition? Add them up, that’s your dilution risk.
- Which of the Permitted Debt Baskets are referenced in the Permitted Liens definition? Add those up too, that’s your effective subordination risk.
And with that, we have arrived at Point B with a clear picture of how our day one position in the capital structure, and quality of our credit support, could change over time due to the borrower’s ability to incur and secure additional debt.