2009 was a tumultuous year for acquisition financing, commencing in the shadows of the credit crisis and ending with early signs of a dramatic recovery. Sellers, buyers (including financial sponsors) and lenders were heavily influenced by their experiences in the aftermath of the 2005-2007 leveraged buyout boom. In light of the busted, renegotiated and litigated deals of 2007-2008, sellers and buyers were focused on deal certainty. Arrangers, remembering the delayed or failed syndications and hung bridges of that period, focused on enhancing flexibility to deal with adverse changes in the market or in the financial condition of their borrowers. A review of some key conditions typically found in loan commitments illustrates how arrangers and borrowers balanced these competing objectives in 2009
Market MACs and flex. The "market MAC" condition, which allows the arrangers to refuse to fund a loan commitment if there has been a material adverse change in the financing markets, did not, as some had predicted, become common in 2009 loan commitments. Instead, arrangers appeared to rely on enhanced "flex" provisions to mitigate market risk. Flex provisions allow arrangers to unilaterally modify (within specified limits) the terms of a proposed financing if a successful syndication cannot be achieved with the initial terms.
Although flex has been a common component of financing commitments for years, the agreed scope of available flex has changed dramatically from the LBO boom. For example, instead of the 25- to 75-basis-point cap on pricing flex typical during the LBO boom, some 2009 financings included pricing flex at levels substantially higher than expected market-clearing prices and with additional adjustments for changes in market indexes. Moreover, because the higher flex caps are often expressed as a weighted average that applies to all debt tranches and facilities, the arrangers are able to allocate the pricing increases to the portions of the financing that they conclude most need it.
Solvency. During the LBO boom, the mere delivery of a customary certificate from the CFO was frequently sufficient to satisfy the solvency condition. As a direct consequence of the experience of lenders in Hexion Specialty Chemicals Inc.-Huntsman Corp. and other recent cases, arrangers have increasingly required that the solvency of the borrower, not just the delivery of a certificate, be a condition to closing.
SunGard limits. SunGard provisions, which arose out of a 2005 transaction involving SunGard Data Systems Inc., are designed to assure buyers and sellers that so long as the conditions to closing under the acquisition agreement are met, the lenders would not have an additional "out" beyond the narrow set of conditions expressly set forth in the commitment letter and a limited set of additional specified representations. SunGard provisions were a hallmark of LBO boom financings and, to the surprise of some, appeared in several 2009 transactions, albeit modified and more heavily negotiated.
Merger agreement-related conditions. Mindful of the litigation and renegotiation of 2007-2008, arrangers are increasingly insistent that there be no material changes (whether or not adverse) to some or any of the provisions of the acquisition agreement prior to closing and are increasingly requiring that the acquisition agreement contain certain provisions that limit lenders' exposure to the seller and grant them the right to enforce those provisions directly
Performance-based conditions. During the LBO boom, performance-based conditions (minimum ratings, minimum Ebitda, maximum leverage) were rare. In 2009, we saw arrangers and borrowers, in consultation with sellers, carefully crafting performance-based conditions tailored to the circumstances of the particular transaction, offering arrangers meaningful comfort without materially affecting deal certainty.
The fundamental tensions in acquisition financings have not changed: Buyers and sellers desire deal certainty and unconditional loan commitments, and arrangers desire flexibility to ensure a successful syndication. In 2009, we saw a continuing evolution in the ways that market participants balanced these competing objectives in light of new market realities and reduced access to credit. As credit conditions continue to improve, one question will be to what extent buy-side loan market participants' appetite for yield and arrangers' appetite for fees will outweigh some of the current focus on structural issues. Finding the right balance will likely occupy a significant amount of participants' time and energy in 2010.
Jason Kyrwood is a partner in the credit group at Davis Polk & Wardwell LLP in New York.
This article originally appeared in The Deal and reprinted with permission.