Working in financial services is certainly different than it was two years ago. A significant development — but not one the mainstream media has necessarily noticed — is that people involved with syndicated financing have been forced to change the way they put together deals.
The formation of syndicates is critical to our economy. Major, economy-buttressing, job-creating transactions require syndicates to finance them. Otherwise, it's simply not possible to raise such large amounts of capital. The recent downturn created challenges for that market.
In 2008, standard documentation proved inadequate to address some of the unprecedented problems that arose. Among other things, Libor and base-rate pricing became inverted. Liquidity was at a premium and trading debt in both the primary and secondary markets was affected. Different members of syndicates suddenly had different objectives. But perhaps the most startling issue was that many credit facilities had defaulting lenders such as insolvent financial institutions in the syndicate, which either could not or did not live up to their funding obligations. Additional lenders appeared to be at risk each day.
Suddenly, borrowers weren't sure they'd be able to access the capital they needed to operate. The agents who often serve as the bank that issues letters of credit and short-term swingline loans to the borrower in syndicated financings had serious concerns too — they rely on their fellow lenders to share risk, and those lenders looked shaky. Suddenly, they were drafting and adopting amendments to address the problem, such as:
- Limiting the amount of payments to be received by defaulting lenders (both fees and certain principal repayments).
- Limiting voting rights of defaulting lenders.
- Requiring borrowers to prepay the defaulting lenders' swingline obligations and provide cash collateral for the defaulting lenders' letter of credit risk participations.
- Reducing the total amount of the commitment to the borrower to effectively force out defaulting lenders.
- Allowing the agent to replace defaulting lenders entirely or assign their unused commitment.
This new environment required a new level of rigor when it came to syndicated financing — standard loan documentation needed to address the new realities.
With little liquidity in the primary syndicated market and a significant amount of debt trading on the secondary market at below-par prices, many borrowers sought to take advantage of the low prices of their own debt on the secondary market in order to de-lever their balance sheets by buying back their debt significantly below par and canceling the repurchased debt. This became a tool in distressed situations, but also an opportunity for healthy borrowers.
Although there are obvious benefits for borrowers who have sufficient liquidity to take advantage of below-par buybacks, these borrowers need to have their eyes wide open to potential tax issues relating to the cancellation of their debt. They also need to be aware that it could adversely affect their debt ratings. For the lenders looking to sell debt, this exchange could have the benefit of providing them with better pricing than the secondary market would otherwise offer. However, the same issues that face borrowers — borrower liquidity, adverse borrower tax consequences and downward pressure on ratings — could also impact the value of the debt. Borrowers and the lenders in their syndicates must consider the consequences carefully.
Possibly because of those consequences, there are various provisions in typical loan documents that prohibit a borrower — or even an equity sponsor of a borrower — from buying back debt.
In many instances, an amendment to allow a borrower buyback requires the approval of all lenders in a syndicate, making such an amendment very hard to pass. Amendments to allow a sponsor or other affiliate of the borrower to purchase the borrower's debt typically do not require all of the lenders' approval and may be easier to accomplish. However, when such affiliate buybacks are permitted, agents and lenders may require the affiliate to agree to refrain from participating in bank meetings, to vote in proportion to other lenders and in rare cases even to subordinate its debt to the debt held by nonaffiliates.
It's still too early to tell which of these aspects of buyback provisions will become standard and which will fall by the wayside. If borrowers are put off by the tax complications and if rating agencies take a dim view of borrower buybacks, they may go out of favor again. But particularly in sponsor deals, the sponsors may want to know that borrower or sponsor buybacks remain an option and may continue to push for them — or for amendment provisions that can accomplish a buyback without approval of all lenders.
As deal volume is starting to rebound, borrower-friendly pre-recession terms are creeping back into the market. However, certain types of the protections that were necessitated by the downturn are going to stay in place. And that's a good thing.
A few simple, forward-looking actions when syndicates are formed will create smart, largely noninvasive safety features that will make syndicated financing stronger.