Mandatory prepayment provisions purportedly require debtors to prepay creditors under certain circumstances, including upon selling material assets or using excess cash flows at the end of the year. However, the latest versions of these provisions would not only never require any prepayment, but they may actually be used to harm creditors more than they help. In a new report Xtract Research examines mandatory prepayments.
Q4 2020 hedge fund letters, conferences and more
The Problems With Mandatory Prepayments
Highlights from the report include:
The Asset Sale Sweep, as the name connotes, requires debtors to use proceeds from certain asset sales to pay down their debt. The most obvious result of the recent changes to the Asset Sale Sweep provisions is that through exceptions, thresholds, and other loopholes, the amount required to be swept is severely decreased.
Historically, many types of asset sales were excluded from the sweep, such as ordinary course sales, sales of obsolete equipment, and sales below a de minimis amount. While the prepayment requirements in bonds have long been limited to sales out of the 75% cash consideration general basket, this narrow application of the sweep is now common in first lien term loans as well.
Typically, immaterial asset sales are excluded from the sweep. However, today’s thresholds are often high and actually grow with EBITDA.
The sweep percentage for asset sales is now typically subject to stepdowns based on delevering from closing date levels. Although lenders have paid attention to and pushed back on this change, it has become increasingly accepted as market, particularly in the loan market.
Neither the Asset Sale Sweep nor the ECF Sweep is likely to require any debt prepayment. Instead, these provisions have been exploited by sponsor technology to increase cash out capacity, including for dividends or investments in unrestricted subsidiaries.
