The Lending and Secured Finance Review: USA


The current US corporate lending market is sophisticated, extremely large and highly varied, having numerous types of borrowers, loan products and lenders. According to Thomson Reuters LPC, leveraged loans to corporate borrowers in the United States accounted for approximately US$808 billion in 2019, the lowest volume in four years. Borrowers span every industry, and the loan markets they can access depends in large part on their capitalisation and credit profile. Loan products span from unsecured revolving credit facilities for investment-grade companies and widely syndicated covenant-lite term loan facilities for large-cap leveraged loan borrowers to more traditional 'club deal' senior secured credit facilities for middle-market borrowers (generally defined as borrowers with less than US$500 million in annual sales or less than US$50 million in earnings before interest, taxes, depreciation and amortisation (EBITDA)). Lenders include traditional banks, finance companies and institutional investors such as collateralised loan obligations (CLOs), hedge funds, loan participation funds, pension funds, mutual funds and insurance companies.

While loan issuance volume fell in 2019, it has remained high in recent years from a historical perspective, although there has also been increased volatility. According to the twice annual Financial Stability Report, issued in November 2019, of the Federal Reserve (the Fed) the share of new, large leveraged loans going to companies with poorer credit profiles or that already have elevated levels of debt now exceeds peak levels reached previously in 2007 and 2014. Although the Fed acknowledges that default rates on these loans have remained low, it has warned that 'any weakening of economic activity could boost default rates and lead to credit-related contractions to employment and investment among these businesses'. The US loan market has continued to benefit from a recent relaxation of a number of US banking regulations – in particular, the leveraged lending guidelines issued by federal regulators in March 2013, which were further clarified in November 2014 by a FAQ issued on the guidance and had previously had a strong influence on the loan markets, have been significantly curtailed, as discussed in more detail below. Additional developments over recent years had the effect of easing certain components of the risk retention rules and the Volcker Rule.

Leveraged loan issuance levels related to mergers and acquisitions (M&A) decreased significantly during 2019. Thomson Reuters LPC noted that leveraged loan issuances related to M&A fell by 33 per cent in 2019, and leveraged buyout (LBO) activity (which accounted for approximately 49 per cent of all M&A loan issuances in 2019) was down 20 per cent. Thomson Reuters LPC also reports a significant shift in the market from refinancing activity, which declined by 59 per cent in 2019, to institutional new money loans, which decreased by 30 per cent. Additionally, as a result of the arrival and persistence of the coronavirus (covid-19) in the first quarter of 2020, the leveraged loan market nearly collapsed in March 2020.

The US leveraged loan market remains relatively favourable for borrowers, in a multi-year trend that has persisted since the recovery from the financial crisis. For example, the market share of covenant-lite loans, which depends on incurrence-based covenants rather than maintenance covenants, has been increasing consistently since the hiatus during the financial crisis. Other borrower-favourable terms that remain prevalent in the US leveraged loan market include soft-call prepayment premiums, the ability to incur refinancing facilities, the ability to buy back loans in the market on a non-pro rata basis, covenant baskets that can grow over time based upon a percentage of adjusted EBITDA or consolidated total assets, and loosened collateral requirements. In addition, many borrowers, especially those owned by large financial sponsors, have continued to take the lead in drafting loan commitments and definitive loan documentation, and have obtained committed covenant levels and baskets at the commitment stage. Some market participants question whether this borrower-favourable trend will swing back towards a middle ground until the leverage loan market recovers from the impact of covid-19.

Legal and regulatory developments

From the aftermath of the 2007 financial crisis until recently, federal regulators had increased their focus on the US corporate lending market, and leveraged lending in particular (though it appears that this trend may be starting to reverse in the current US regulatory climate). In March 2013, federal regulators issued new leveraged lending guidelines to address concerns that lenders' underwriting practices did not adequately address risks in leveraged lending with appropriate allowances for losses. These guidelines apply to federally supervised financial institutions that are substantively engaged in leveraged lending activities. Compliance with the guidelines was required by May 2013, but the full force of their impact only started being felt by the market in 2014, particularly in the fourth quarter. In November 2014, regulators released an FAQ on the guidance, and in their Shared National Credit Report issued the same month, they chastised lenders for non-compliance. Most of the attention concerning federal guidance is focused on their assertion that 'a leverage level . . . in excess of 6x Total Debt/EBITDA raises concerns for most industries'. In addition to contributing to sharp reductions in lending activity in certain segments of the market, this guidance had an effect on the average debt-to-EBITDA levels, which had consistently climbed in the years leading up to 2014 before dropping and flattening out near the six times mark in 2016 for broadly syndicated LBO transactions, according to Thomson Reuters LPC. In February 2018, these guidelines were declared by the chair of the Fed and the head of the Comptroller of the Currency not to be legally binding on federally supervised financial institutions that are substantively engaged in leveraged lending activities. According to Thomson Reuters LPC, for LBO transactions completed in 2019, 74 per cent had average debt-to-EBITDA levels of 6× or higher. The Shared National Credit Report issued in January 2020 found that banks' credit risk exposure to leveraged loans is still too high and many loans contain terms that are too risky. The report recommended that banks ensure they are capable of managing economic downturns and confirm their risk management practices and stress testing processes are strong enough to survive 'changing market conditions' and that banks make appropriate assumptions when analysing credits and underwriting leveraged loans.

In December 2013, the final Volcker Rule was issued, which limits the number of trading and investment activities of banking entities. Banking entities will also be required to comply with extensive reporting requirements in respect of permitted trading and investment activities. The Volcker Rule compliance period began in July 2017, and the reporting requirements became effective in June 2014. In December 2016, risk retention rules that were made applicable to CLOs came into effect, initially casting a large shadow over the leveraged loan market (given that CLOs are a prominent source of capital for leveraged lending transactions), but a federal court decision in February 2018 invalidated the rules insofar as they apply to open-market CLOs. In January 2020, five regulatory agencies approved a proposal recommending that senior AAA CLO debt liabilities that meet certain requirements should no longer be considered equity-like 'ownership interests' under the Volcker Rule, and that the 'loan securitisation' carve-out from the definition of 'covered funds' should allow a small holdings of non-loan assets, such as bonds. These changes would benefit the CLO and loan markets. It remains to be seen whether the federal agencies will adopt the proposal as a final rule. Also in 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act was enacted and exempted smaller institutions, and regulators have also proposed for comment changes to the Volcker Rule that appear to have the intended effect of simplifying and removing certain compliance burdens while keeping the overall purpose of the rule intact.

Federal regulators have also continued to enforce sanctions and anti-corruption and anti-terrorism laws, and have recently reinvigorated their efforts. As a result, and in response to ever-increasing fines for violations, lenders have expanded the compliance terms included in credit documentation. These efforts have included broader representations and warranties with fewer materiality and knowledge qualifiers, as well as affirmative and negative covenants that require compliance with sanctions regulations and anti-bribery laws, and restrict borrower activities in restricted countries or with restricted entities to the extent that such activities would involve loan proceeds.

US banks also continue to address the Basel III requirements. Basel III requires banks to meet a number of capital requirements to strengthen a bank's liquidity and contain its leverage. Among other things, Basel III requires banks to increase their holdings of Tier 1 capital to at least 7 per cent of their risk-weighted assets to meet additional liquidity and capital requirements. In December 2014, the Fed proposed that the eight largest US banks should comply with capital requirements that are even more restrictive than those outlined by Basel III, including an additional capital cushion. According to the Fed, most of the firms should already meet the new requirements, and all are taking steps to meet them by the end of a phase-in period that runs from 2016 to 2019.

Tax considerations

The US corporate lending market is subject to various federal tax considerations, most of which can be addressed with careful planning and drafting.

i Tax considerations applicable to US borrowers

The initial determination in any US corporate lending transaction will be whether the debt will be respected as debt for federal income tax purposes or characterised as equity. Interest on debt is generally deductible by the borrower (subject to an overall limit that interest deductions may not exceed 30 per cent of a payor's taxable income, except for tax years beginning in 2019 and 2020 where interest deductions may not exceed 50 per cent of payor's taxable income (determined without taking into account interest expense and subject to certain other adjustments)), whereas dividends are not. Debt terms that raise the question of whether it may be characterised as equity include a long term to maturity (e.g., in excess of 30 years), subordination to other instruments in the capital structure, a high debt-to-equity ratio at the borrower and, in some circumstances, the right to convert into the stock of the borrower.

Another determination to be made is whether the debt will be treated as giving rise to 'phantom interest' that must be taken into account by the borrower and lender even when no payments are made. In general, a debt instrument sold with the original issue discount will result in unstated interest equal to the difference between the issue price and the stated redemption price at maturity, and that interest will be taxed on an economic accrual basis pursuant to the original issue discount (OID) rules. The OID rules also apply to payment-in- kind and similar instruments. The OID rules will not apply if the original issue discount is less than a statutorily defined de minimis amount.

Borrowers subject to US tax laws must also be careful to address the applicable high-yield discount obligation (AHYDO) rules, which substantially restrict interest deductions for debt characterised as an AHYDO. An AHYDO is any debt instrument with a term of more than five years, having a yield that exceeds the applicable federal rate at the time of its issuance by five percentage points or more, and that has 'significant original issue discount'. Debt will have significant OID if, at the end of any accrual period ending after the fifth anniversary of its issuance, the aggregate amount of interest and discount required to be included in income by a holder exceeds the amount of interest and discount actually paid in cash by more than one year's yield on the instrument. AHYDO rules may be avoided by incorporating a savings clause in the loan documentation that requires the borrower to pay the minimum amount of principal plus accrued interest on the loan necessary to prevent the deduction of any of the accrued and unpaid interest and OID from being disallowed or deferred.

US companies are generally not required to pay US taxes on the earnings of non-US subsidiaries, including upon the actual distributions of the earnings. The provision of a guarantee or the pledge of assets by a non-US subsidiary to support the loan obligations of a US parent until very recently, however, would often have resulted in an inclusion in gross income for the US parent of an amount of earnings of the non-US subsidy up to the amount of the credit support. In addition, a pledge by the US parent of two-thirds or more of the voting stock of a non-US subsidiary is considered tantamount to a pledge of that subsidiary's assets and would therefore have been subject to the same rules. For the foregoing and other reasons, such as guarantee fees in non-US jurisdictions, as well as the complexity and cost of obtaining security in other jurisdictions, loan documents in the US often provide that a non-US subsidiary of the borrower will neither guarantee the loans nor pledge its assets, and the pledge of the subsidiary's voting stock will be limited. In May 2019, the Treasury Department released final regulations under Section 956 of the US Internal Revenue Code of 1986, as amended, which have the effect of removing the US federal income tax impediment to a controlled foreign corporation, providing credit support with respect to debt issued by its parent US corporate borrower. This development will likely result in lenders pushing for guarantees and security from subsidiaries in non-US jurisdictions, and the negotiation will likely focus on weighing the costs of providing the guarantees and security to the US borrower against the benefits to the lenders.

ii Tax considerations specific to non-US lenders

There are a number of US tax considerations specific to US borrowers and non-US lenders in corporate lending transactions. For example, if a lender is an offshore fund, it is not likely to join a syndicate in a US loan transaction until after initial funding has been made by other lenders. This is because doing so could trigger tax filing and payment obligations in the United States for the fund or its investors. In contrast, trading in outstanding securities acquired in the secondary market will not result in such obligations.

iii US withholding taxes

In general, the United States does not require withholding tax on interest payments to US lenders, but it will require withholding tax on interest payments to non-US lenders in the absence of an available exemption. This tax is generally equal to 30 per cent of the gross amount of the payments made to the non-US person and is required to be withheld by the borrower.

Lenders that are otherwise subject to the withholding tax may avail themselves of one of three exemptions to reduce or eliminate this tax: (1) the 'portfolio interest exemption'; (2) treaty eligibility; and (3) effectively connected income.

The portfolio interest exemption is available to a non-US person that is not a bank if certain conditions are met, many of which can be satisfied by including certain non-controversial provisions in the loan documentation, together with the submission of certain federal tax forms to the borrower certifying that the person is not a US person. In addition, if a non-US lender is resident in a country that has an income tax treaty with the United States, the provisions of the treaty may reduce or even eliminate withholding taxes. Finally, a non-US lender that makes a loan through a US branch that is engaged in a US trade or business will be exempt from US withholding taxes, but not US federal income taxes (imposed on a net basis), on interest payments made by the borrower. Most US loan documentation provides contractual protection against withholding by requiring the borrower to 'gross up' interest payments if withholding becomes payable, although this requirement is often limited to withholding that results from a change in law after the effective date of the credit agreement.


The Foreign Account Tax Compliance Act (FATCA) requires non-US financial institutions with US customers and non-US non-financial entities with substantial US owners to disclose information regarding the US taxpayers. FATCA became effective on 1 July 2014. If an institution or entity does not comply with FATCA, a 30 per cent withholding tax is triggered, and responsibility for collecting the tax generally falls on the US borrower. The tax is applicable on all payments normally subject to US taxation, such as dividends, as well as to income that is traditionally excluded, such as bank interest and capital gains. Payments of principal were also scheduled to become subject to FATCA withholding tax beginning as early as 1 January 2019, but in December 2018, the Treasury Department issued proposed regulations that would remove the requirement to subject payments of principal to FATCA withholding and noted in the proposal that companies could rely on the proposed regulations until the final regulations are adopted. Borrowers acting as withholding agents that fail to withhold will be subject to financial penalties. As such, loan documentation in the United States now usually requires a lender to provide information to the borrower upon request to prove compliance with FATCA, and that in any event FATCA withholding obligations will not benefit from any gross-up provisions.

Credit support and subordination

i Security

Taking a security interest in assets that are located in the United States is relatively streamlined and is governed in most instances by Article 9 of the Uniform Commercial Code (UCC). In general, a security interest will attach if the collateral is in the possession of the secured party pursuant to agreement or if the borrower has signed a security agreement that describes the collateral, value has been given and the debtor has a right to the collateral. If all three of these conditions are met, the security interest 'attaches' and is enforceable. Notably, in the United States a single security agreement can effectively create a security interest in substantially all of the assets of a borrower. However, unless that security interest is 'perfected', it may not come ahead of other security interests taken in the same collateral, and perfection can differ depending on the assets comprising the collateral. Under the UCC, a lender may perfect its security interest in collateral by satisfying the requirements for perfection outlined in the UCC and once perfected, that security interest will take priority over all other security interests that are not perfected or that have been perfected subsequently. Each state has adopted variations from the standard UCC, so although they are generally very similar, the UCC adopted by the relevant state should be referred to when taking a security interest.

The most common way to perfect a security interest in assets covered by the UCC is to file a UCC-1 financing statement in the appropriate filing office. The UCC-1 financing statement generally requires the names of the debtor, and the secured party or its representative, and a description of the collateral. The description can be as general as 'all assets' but will more often track the description of the collateral found in the related security agreement. UCC filing fees are typically small, and there are few, if any, other costs related to taking security interests in the property covered by UCC filings. For borrowers that are US corporations, limited liability companies or registered partnerships, the appropriate filing offices will be their respective jurisdictions of organisation. For non-US entities that do not have a filing system for perfection in their home jurisdictions (which is most other jurisdictions besides provinces of Canada other than Quebec), the appropriate filing office would be the District of Columbia. Although a UCC-1 filing will serve to perfect most collateral, certain kinds of UCC collateral, most notably deposit accounts and cash, can only be perfected by control or possession, most often by housing the account with the agent or another lender, or by entering into a control agreement with the bank where the account is located. In addition, some assets may be perfected by more than one method under the UCC, although one method may be preferable to another. For example, perfection by possession of a stock certificate will take priority over a UCC-1 financing statement that was filed earlier and covers the same stock.

In addition to deposit accounts, cash and stock noted above, there are a number of assets that are governed by special rules relating to perfection and priority or other special considerations. These include, but are not limited to, agriculture; aeroplanes; fixtures; intellectual property; letters of credit; vehicles; oil and gas, and other mineral rights; railcars; real property; satellites; ships; and warehoused inventory. The laws governing taking security interests in real property, for example, vary from state to state, generally take longer to satisfy and can involve significant costs. There are often recording taxes and fees imposed by state and local laws, which can be excessive, so lenders sometimes take assignment of mortgages in connection with new financings rather than enter into new ones. Loans secured by mortgages may be limited to the value of the property rather than the amount of the loan to avoid onerous mortgage taxes. To secure interests in intellectual property, such as registered trademarks, copyrights and patents, federal filings will be required that specifically list each item, and these filings must be updated for any property acquired afterwards.

ii Guarantees

Guarantees are commonly provided by parents, subsidiaries and side-by-side subsidiaries of a common parent in the US corporate loan market. In large-cap transactions, parent guarantees are often limited in recourse to the stock of the subsidiary borrower, although this is less often the case in middle-market loans. Subsidiary guarantees are typically full and unconditional, but they are often limited to guarantees from domestic subsidiaries to avoid adverse tax consequences to the borrower of a non-US guarantee (discussed in Section III) and may be limited to wholly owned domestic subsidiaries. Guarantees may be supported by security interests in the guarantors' assets to the same extent that the loans are secured by the borrower's assets.

iii Priorities and subordination

There are three primary methods of achieving priority in US corporate lending transactions:

  1. possessing a prior, perfected security interest in the assets of the borrower or being the beneficiary of an intercreditor agreement establishing priority in liens;
  2. being 'structurally senior' to the other debt; and
  3. being the beneficiary of a subordination agreement.

When a lender obtains a first priority perfected security interest in the assets of the borrower in a US loan, the lender obtains the right to receive a priority distribution equal to the proceeds of sale (or value) of that asset to the exclusion of any other creditors (except for holders of certain statutory liens). This means that in the event of a foreclosure, bankruptcy or other liquidation, the secured lender will be entitled to be paid out of the proceeds of the assets securing the loans before any lender having a junior security interest or no security interest in the asset may be paid. Priority in liens is typically established by perfection, as discussed in Section IV.i, but it can also be established contractually by an intercreditor agreement. Lenders under a senior secured credit agreement may agree to allow the borrower to incur additional first lien indebtedness or second lien indebtedness, and enter into an agreement with the lenders of that indebtedness as to priority in security, as well as to how remedies will be enforced in respect of the collateral, among other things.

While achieving structural seniority in the US corporate loan market, like other markets, depends entirely on lending to a level within the borrower's capital structure that is below the level to which another lender extends credit, contractual seniority is established by a subordination agreement. Contractual subordination is achieved by an agreement in which the subordinating creditor agrees that in the event of a bankruptcy or other distribution of assets of the debtor, any amounts otherwise distributable to the subordinating creditor will instead be paid to a specified creditor or class of creditors holding 'senior debt' until they are paid in full. The class of 'senior debt' is usually defined as all indebtedness for borrowed money whether now existing or incurred hereafter, as well as capital leases. It is not necessary that the subordination agreement be between the subordinated creditor and the senior creditor, and often the senior creditor is the third-party beneficiary of an agreement between the borrower and the subordinating creditor. Subordination terms in the United States also typically provide that if there is a payment default on the senior debt, no payment may be made on the subordinated debt until the default is cured or the senior debt is paid in full. In addition, many subordinated debt provisions state that, in the event of a non-payment default on the senior debt, there will be no payments on the subordinated debt for a specified blockage period, which typically runs between 90 and 180 days. Although subordinated debt issuances were common in the US market in the 1990s, they are relatively rare in the current US corporate loan market.

Legal reservations and opinions practice

i Legal reservations

There are no financial assistance laws in the United States, but a federal bankruptcy court can void a guarantee or the pledge of assets by a subsidiary or parent of the borrower if the guarantee is deemed a 'fraudulent transfer', meaning that the guarantor was insolvent at the time of the guarantee or was rendered insolvent, and the guarantee and the guarantor received 'less than reasonably equivalent value' for the guarantee. Given that both aspects of this test must be met for a guarantee to be deemed a fraudulent transfer, as long as a guarantor is solvent at the time of the guarantee, it does not have to receive equivalent value. Most states have similar fraudulent transfer laws, which can also be applied by the bankruptcy court to void the guarantee. This is less of a concern for parent guarantees than subsidiary guarantees, as a parent is typically deemed to have benefited from the loan to its subsidiary through its equity ownership.

ii Opinions practice

It is typically the borrower's counsel that provides a legal opinion in respect of loans to the loan arrangers or agent on behalf of the initial lenders. The opinion will usually cover the following:

  1. the authority of the obligors to enter into the loan documents;
  2. the execution and delivery of the loan documents by the obligors;
  3. the enforceability of the loan documents;
  4. conflicts with laws;
  5. organisational documents and material agreements;
  6. the creation and perfection of security interests in collateral, which may be perfected by filing a UCC-1 financing statement;
  7. possessory stock pledges; and
  8. sometimes, collateral consisting of real estate, intellectual property, or deposit and securities accounts.

Depending on the jurisdictions in which the borrower and the guarantors are organised, there may be opinions as to authorisation, execution and delivery of loan documents, as well as to conflicts with organisational documents and perfection, by various local counsel.

iii Choice of law and enforcement of foreign judgments

In general, courts in the United States recognise choice of law provisions in contracts (sometimes subject to the requirement that the choice of law has a substantial relationship with the contract and the transactions contemplated by the contract) so long as the application of the chosen law would not be contrary to a fundamental policy of another jurisdiction with a materially greater interest in the determination of a particular issue and the application of the chosen law would not threaten public policy or violate any fundamental principle of justice. Similarly, US courts will enforce final judgments of foreign jurisdictions so long as, among other things, the judgments were rendered under systems that provide impartial tribunals and procedures compatible with the requirements of due process of law, the other court had personal jurisdiction and jurisdiction over the subject matter, and the cause of action was not repugnant to public policy.

Loan trading

Loan trades are made by either assignment or participation. Lenders typically trade in syndicated loans over the dealer desks of the large underwriting banks. In assignments, an investor becomes a party to the loan documents and participates as a 'lender' under the loan documents, including with respect to voting rights. As such, assignments are typically subject to a minimum threshold and will require the consent of the administrative agent and the borrower, which may not be unreasonably withheld. If an event of default, which is sometimes limited to payment and bankruptcy defaults, is continuing, a borrower will lose its consent right. Investors may also purchase participations by entering into a participation agreement with a lender to take a participating interest in that lender's commitment. The selling lender remains the holder of the loan. Consent is rarely required, and the participant has the right to vote only on items such as the rate, terms and release of all or substantially all of the collateral. Guarantees and security are granted to the administrative agent on behalf of all of the lenders, present or future, so new lenders benefit from them to the same extent as if they had been part of the original syndicate without the need for the guarantor to sign or otherwise approve the transfer documentation. Loan derivatives common in the US corporate loan markets include loan credit default swaps (LCDS), in which the seller is paid a spread in exchange for agreeing to buy a loan at par, or some other pre-negotiated price. If the loan defaults, the LCDX, an index of 100 LCDS obligations that are traded over-the-counter, and total rate of return swaps, in which case a purchaser buys the income stream from a loan with a 10 per cent down payment that serves as collateral and a loan from the seller, and is obligated to purchase the loan at par or cash, and settle the position upon a default.

Other issues

Many of the current trends in the US corporate loans market are borrower-favourable terms that were popular at the height of the economic boom in 2006–2007. When these features largely disappeared from the market during the financial crisis, many believed it would be several years before these terms would return, yet these terms have again become widely available to borrowers. In the current market, borrowers negotiating credit agreements have been aggressive in testing the limits of what the market will bear. It remains to be seen if this trend will continue or if there will be a temporary or lengthy reversal of this trend in the aftermath of the covid-19 pandemic.

i Covenant-lite

Covenant-lite deals remain a strong part of the US leveraged loan market. Some covenant-lite deals contain no financial covenants, but otherwise resemble traditional credit agreements. Other covenant-lite loans, in addition to lacking maintenance covenants, also have high-yield style incurrence tests allowing unlimited debt, liens, investments, restricted payments and acquisitions upon pro forma compliance with applicable incurrence ratios, providing the ability to reallocate previous transactions from fixed dollar baskets to ratio baskets, and providing for the incurrence of ratio basket without taking into account a simultaneous use of a fixed dollar basket. Covenant-lite credit agreements also allow for restricted payments, investments or payment of junior debt subject to grower baskets based increasingly on a percentage of adjusted EBITDA. In a growing number of covenant-lite deals, asset-based lending (ABL) structures are becoming more common, with a stand-alone term loan lacking maintenance covenants, and a stand-alone ABL revolver having a 'springing' fixed-charge coverage ratio tested only if borrowing availability falls below a specified level. In these structures, term loans usually have cross-acceleration to the ABL, rather than cross-default, which prevents the term lenders from indirectly benefiting from the ABL's financial covenant. In addition, ABL financial covenants have trended toward higher thresholds before testing is triggered, excluding outstanding letters of credit for purposes of testing the trigger and setting covenant levels at higher cushions over the financial model for the borrower.

If there is a cash-flow revolver instead of an ABL, the covenant-lite documentation has typically contained a financial covenant that applies only to the revolver and, in many cases, only if the revolver exceeds a specified threshold of outstanding borrowings. Breach of the financial covenant will not result in a breach of the term loan or will only result in a breach of the term loan if the revolving lenders have not waived the default by the end of a 45- to 90-day standstill period. Until the expiry of the standstill, the revolving lenders will have exclusive rights to waive or amend the financial covenant or exercise remedies in respect of the breach.

ii Convergence of leveraged loans and high-yield markets

There is a continued convergence in the US leveraged loan and high-yield bond markets, resulting in term loan B facilities with high-yield style terms. Trends contributing to this convergence include the tendency for the same company to raise capital in both the leveraged loan and high-yield bond markets, a switch by loan arrangers to a fee-based business model, a shift in the emphasis from holding loans to syndication and trading, and the increased influence in the loan market of institutional investors, hedge funds and other investors familiar with the covenant structure of the bond market. High-yield style terms being adopted in the loan market include incurrence-based covenants and builder baskets as discussed above, as well as greater refinancing flexibility.

iii Refinancing facilities

In addition to incremental facilities, which have been common to US loan agreements for some time, credit agreements in many large-cap deals now include refinancing facilities. Refinancing facility provisions permit the borrower to refinance a portion of its existing credit facility with either new tranches of loans under the credit agreement or additional debt incurred outside the credit agreement. Debt incurred outside the credit agreement may be secured on a pari passu basis or by junior liens, in each case subject to an intercreditor agreement. This development allows the borrower to refinance loans with debt that is outside the credit agreement but still shares in the collateral, without requiring the consent of the lenders. Unlike incremental facilities, refinancing facility provisions rarely contain most favoured nation provisions affecting pricing.

iv Soft calls

If a prepayment premium is included for term loans in a large-cap deal, and even in some middle-market transactions, it now tends to be a 'soft call', meaning it is only payable if there is a 'repricing event'. Repricing events occur when there is a refinancing at a lower interest rate or an amendment to reduce the interest rate. The soft call is typically priced at 1 per cent of the amount refinanced or repriced in the first six months or year of the loan. Some loans contain exceptions for refinancings where the primary purpose is not repricing, such as change of control transactions, qualifying initial public offerings and transformative acquisitions, investments and dispositions.

v Stronger commitment terms

In underwritten financings, borrowers with strong market power, including portfolio companies of strong equity sponsors, have been successful in obtaining committed financial covenant levels and agreement upon detailed financial definitions in the term sheet stage. Increasingly, other significant terms once reserved for negotiation in the definitive loan documentation are being agreed up front in the commitment papers, including material debt and lien baskets, restricted payment carveouts, builder baskets and other negative covenant carveouts. In many cases, these borrowers have controlled the commitment documentation, often using the sponsor's 'form', and requiring the committing lenders to agree to a prior sponsor precedent as the guiding documentation for all items not specified in the term sheet.

vi Loosened collateral requirements

Commitment letters have started relaxing the scope of the collateral requirements that need to be satisfied at closing. They have begun to allow lien searches (sometimes excluding UCC liens) to be included in the list of items that can be delivered post-closing, and they have limited perfection of collateral at closing to those items that may be perfected by the filing of UCC-1 financing statements and to the delivery of certificated securities of US subsidiaries only, or even material US subsidiaries only. Large-cap deals now often eliminate the requirement for bank account control agreements, except in the ABL context, and an expansive list of excluded collateral has become standard, including excluding owned real estate valued below a specified threshold, all leaseholds, non-US collateral, assets securing receivables financings and any liens resulting in adverse tax consequences, among others.

Outlook and conclusions

As a result of the covid-19 pandemic, the US and world economies are in significant distress in early 2020, and the future of the US leveraged loan market remains unclear. However, some borrowers will continue to try to access the market to take advantage of potential strategic opportunities and historically low interest rates. The trend of borrower-friendly debt terms may swing back towards a middle ground or terms may turn lender-favourable in the near, or even long, term. Although some believe it may be a long time until the leveraged loan market stabilises, borrowers and lenders are hoping that it will reopen quickly.



1 Monica K Thurmond is a partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP.

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