Hi,
Appreciate if someone could answer my questions regarding financial covenants for LBO/corporate loans:
While originating the loan deal, what is the thought process behind the selection of the type of financial covenants?
How would you determine the headroom of the financial covenants?
Thank you!
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Best way to structure is to look at comps. LBO loans are generally TLBs, in which case there are few covenants these days (most TLBs are cov-lite). In terms of corporate loans, banks will often have some kind of internal policies. They might be based around risk rating thresholds...if the bank will have to downgrade the corporate loan if a certain threshold is breached, then they might put the covenant around there. But remember, banks are often price takers rather than price makers. This means that they will accept the market covenants, rather than impose their own covenants on the market (since they won't get any deals done if they do). Comps are the best way to determine what the covenants should be.
Headroom: 30% as benchmark
Investment grade:
Typical case
1) total leverage
2) interest coverage: 3.0x
Otherwise:
3) debt / Cap: 60%
capital intensive business or Ex: oil n gas, utilities, cruise ship, CVS/Walgreens, etc
Leveraged - BB (RC/TLA - lenders are banks)
1) total leverage
2) interest coverage: 3.0x
BB - TLB
1) cov-lite
Leveraged - NR/NR, middle market
1) total leverage
2) FCCR: 1.2x (Fixed Charge Cov)
Leveraged - Direct lending
1) total Lev (heavy step downs)
2) FCCR: 1.1x to 1.2x ish
3) EBITDA min
4) Liquidiity (Cash)
5) Capex
If a software deal, nay get done as
1) Recurring Revenue covenant initially, evolving to above
Leveraged B/B2 (typical LBO) - TLB
1) cov lite
Leveraged (typical LBO) - TLB - but small middle market/ no rating, under $200 in deal size
1) total leverage covenant
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