In another sign of looser creditor protections and greater flexibility for borrowers, a growing number of companies are getting lenders to relax the restricted payment covenants on their debt. In numerous public filings during the past three months, companies have detailed changes to credit agreements that will give them more freedom to return some of the cash on their balance sheets to shareholders and private-equity sponsors. That’s a marked change from two years ago, when many lenders tightened the screws on restricted payments in order to keep borrowers from reducing their cash cushions.
Restricted payment covenants prevent a company from paying dividends, buying back stock, prepaying subordinated debt, or paying management fees to a private-equity sponsor. “They are set up to limit what the company can do with cash or assets it has generated from operations, the idea being that creditors want to preserve the value at the borrower and not see it flow out to third parties in a way that wouldn’t benefit the creditors,” says Vanessa Spiro, a partner in banking and finance at law firm Jones Day.
Prior to the credit crisis, when private-equity firms were easily financing highly leveraged deals, restricted payment covenants were relatively relaxed, says Spiro. Lenders allowed borrowers to pay out a percentage of their excess cash flow or net income to sponsors or other equity holders. “It was a way for private equity to gain a return on its investment rather quickly and easily,” she says. But lenders then changed direction, putting annual or loan-term caps on payments. “It’s one of the first places creditors will look to tighten their protections — it’s where value is leaving the borrower,” says Spiro.
Now lenders appear to be reverting to precrisis form. In early December, for example, TW Telecom Holdings got an amend-and-extend deal from creditors that allows the company to pay up to $50 million annually for dividends, share repurchases, and certain other payments. Dunkin’ Brands, likewise, is in the midst of pursuing an amendment to its $1.25 billion senior secured term loan that would increase the size of its allowable restricted payments, says Standard & Poor’s.
Limits on these restricted payments are often tied to consolidated net income. So instead of trying to get lenders to increase the absolute dollar ceiling on payments, some companies are asking them to modify how they calculate the company’s capacity to make payments.
Last November, for example, Asbury Automotive Group won a concession from lenders to double its restricted payment allowance, or “basket.” But just as important was an amendment that changed the definition of consolidated net income to exclude certain gains and losses. (Asbury Automotive’s restricted payment allowance basket was based on consolidated net income.) The impetus was a $500 million goodwill impairment that blindsided the company in 2008, says treasurer Ryan Marsh. Because the loss flowed through the P&L, “it really hamstrung us coming out of the recession,” he says. But the banks recognized that the goodwill charge didn’t hamper the company’s ability to generate cash, so the net income number defined in the company’s restricted payment covenants now excludes noncash goodwill impairments.
Of course, CFOs have to make a good case to creditors that they should be allowed to release some of their cash. Tasty Baking Co. recently received a waiver on some of its credit facility’s covenants, but the lender kept the payment restriction intact. Banks are still wary, in some instances, of struggling borrowers that want to reward equity holders instead of holding on to cash — the cash that creditors would claim in a potential bankruptcy.