Cross-Border Financing Report 2017: US
Ari Blaut, Sullivan & Cromwell
SECTION 1: Market overview
1.1 Please provide an overview of the cross-border financing market in your jurisdiction.
The US loan and debt capital markets represent one of the deepest sources of capital for cross-border financings. Liquidity has remained strong in both markets, given historically low interest rates, low default rates, investor appetite for yields and a technical imbalance between supply and demand, which has created a strong environment for borrowers and issuers.
Financial institutions continue to be the primary arrangers and underwriters of loan and debt capital market financings in the US. However, over the past five years, private credit providers have played an increasing and significant role in both arranging and providing bank debt financing for acquisitions (including cross-border financings). The growth of these private credit providers has been one of the most significant changes in the acquisition financing market over the past couple years.
The type of debt financing depends on the credit rating of the borrower. For investment grade acquirers, unsecured bridge loans coupled with a bond take-out and potentially a permanent term loan tend to be the most common financing structure. For sub-investment grade acquirers, first lien/second lien bank financings have been more common, although a first lien bank financing with an unsecured bond is also another common financing structure.
1.2 What have been the key trends or developments in cross-border financing in your jurisdiction over the past 12 months?
The US loan and debt capital markets have remained buoyant and continue to offer attractive terms to foreign and domestic borrowers and issuers. Recent transactions have generally been characterised by low interest rates and borrower-friendly covenant packages. In the leveraged loan market, covenant-lite (cov-lite) term loans remain common in the US.
In addition, borrowers and issuers, particularly sponsors in acquisition financings, have been successful in pushing aggressive terms, including: increases in maximum first lien leverage ratio above 6x; unlimited restricted payments subject to a specified leverage ratio; springing financial maintenance covenants (limited to revolving credit facilities only); increases in or elimination of caps on EBITDA addbacks; deterioration in most favoured nation (MFN) protection; use of EBITDA as the gauge for incremental facilities; and grower baskets or starter amounts in builder baskets.
1.3 Have there been interesting changes in the structure of the banking sector in your jurisdiction?
There has been a significant increase over the past five years in private credit providers directly participating in the debt financing markets. These providers compete directly against banks for lending mandates for all loan sizes or collaborate with banks to arrange loans which banks would be unable to underwrite alone.
SECTION 2: Financing structures
2.1 Briefly outline some recent notable transactions involving your jurisdiction, highlighting any interesting aspects in their structures and what they might mean for the market.
The $40 billion bank acquisition financing for the AT&T/Time Warner merger was documented with a credit agreement rather than traditional commitments. For large investment grade buyouts, there have been a couple of recent examples of going to credit agreements directly.
As noted above, the growth of private credit providers is increasingly causing disruptions in the banks' traditional dominance of the large leveraged buy-out market. For instance, Ares Capital, a private credit provider, provided a $1.1 billion unitranche loan to Thorma Bravo for its acquisition of Qlik Technologies. Historically, a deal of this size would have been underwritten by traditional financial institutions.
2.2 Have there been any significant developments in the way cross-border financing transactions are structured or in the way borrowers and/or lenders are participating in the market?
The increased flexibility afforded by cov-lite loans and continued convergence between the term loan B and high yield bond markets have caused many corporates and sponsors to opt for loan financing, rather than bond financing, or refinancing existing bonds with loans, due to the covenant flexibility afforded in loans (previously confined to the bond market) and the lack of call protection and disclosure requirements.
SECTION 3: Legislation and policy
3.1 Describe the key legislation and regulatory bodies that govern cross-border financing in your jurisdiction.
The Securities Act of 1933 and the Securities Exchange Act of 1934, together with the rules and regulations promulgated thereunder by the Securities and Exchange Commission (SEC), govern, among others, the issuance of debt securities in the US.
With respect to syndicated loans, in 2013, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance company released the Interagency Guidance on Leveraged Lending to assist financial institutions in providing leveraged lending to creditworthy borrowers in a "safe-and-sound" manner. The Guidance provided items for banks to consider in terms of establishing an internal risk management framework around highly leveraged loans, such as underwriting standards, valuation standards, reporting and analytic practices and other similar items. The Guidance provided a significant hurdle to investment banks' abilities to underwrite transactions, particularly those with high leverage and aggressive EBITDA adjustments.
A number of institutions regulate financial institutions in the US at the federal level, including the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, the National Credit Union Administration, and the Office of Thrift Supervision. There are also regulators at the state level.
3.2 Have there been any recent changes to regulations or regulators that may impact the cross-border financing market and what impact do you expect them to have?
See above for the 2013 Interagency Guidance on Leveraged Lending.
3.3 Are there any rules, legislation or policy frameworks under discussion that may impact lenders or borrowers involved in cross-border financing in your jurisdiction?
The Trump administration has signalled an intention to undertake a substantial overhaul of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Any changes which pulls back securities and banking regulation is also likely to impact the behaviour and participation of regulated financial institutions involved in cross-border financing, which could result in greater competition for loan and bond products and in turn lead to more borrower/issuer-favourable terms.
SECTION 4: Market idiosyncrasies
4.1 Please describe any common mistakes or misconceptions that exist about the financing market in your jurisdiction.
In secured transactions involving assets located in the US, it is important for borrowers and lenders to understand that the creation and perfection of security interests in the US is not governed by a uniform system but depends on the type of asset and the relevant state. While the attachment and perfection of security interests in most types of personal property are governed by Article 9 of the Uniform Commercial Code, a model statute that has been largely enacted in each state, there are important variations among states. In addition, security interests in real estate are governed by state real estate laws which are non-uniform across state and the perfection of security interests in other assets is specifically excluded from the Uniform Commercial Code and is governed by other federal or state laws.
4.2 Are there frequently asked questions or often overlooked areas from parties involved in cross-border financings in your jurisdiction?
In the bond market, the US federal securities laws provide extensive disclosure requirements in connection with an issuer's business and operations, which often goes significantly beyond what issuers in capital markets transactions are required to disclose under financial regulatory regimes in their own jurisdictions. In addition to implications this may have on timing for the capital markets transaction, substantial resources would also be required to ensure that the information included in any offering document or to the market generally meet the applicable disclosure standards.
4.3 Are there any classes of assets over which security cannot be taken or regulations specific to your jurisdiction governing the taking of security over certain classes of assets that lenders should be aware of?
The assets of regulated entities are typically subject to regulatory regimes which limit their ability to provide collateral or require regulatory approval to grant security over their assets. Examples include telecommunications providers, broker-dealers and casino-gaming companies.
In addition, there may be potential tax issues in instances where the borrower's corporate structure includes non-US corporate entities. Section 956 of the US Internal Revenue Code could result in undesirable US federal tax implications if the transaction is not structured appropriately.
4.4 What measures should be taken to best prepare for your market idiosyncrasies?
It is important to understand that, despite the convergence between the two markets, there are significant differences between the syndicated loan market and the debt capital market, particularly around disclosure requirements, liability standards and market standard terms. The US debt markets are well developed and experienced when dealing with debt offerings by foreign borrowers. Both lenders and local borrowers/issuers should be advised by competent and experienced advisers and counsel when undertaking cross-border financing.
SECTION 5: Practical considerations
5.1 Briefly explain the downstream, upstream and cross-stream guarantees available in your jurisdiction, with reference to any specific restrictions or limitations.
Restrictions on guarantees are generally governed by state corporate law, federal bankruptcy law and the organisational documents of the guarantor. For guarantors incorporated in the US, it is important to review the applicable state law of the relevant guarantor, as jurisdictions differ on the permissibility of certain types of guarantees and whether board or shareholder approval is required. For example, in Delaware (a popular jurisdiction for incorporating corporations), the Delaware General Corporation Law (which governs corporations) expressly permits a Delaware corporation to provide downstream, upstream and cross-stream guarantees to the extent such guarantee is "necessary or convenient to the conduct of the corporation's business". Upstream and cross-stream guarantees may be subject to potential vulnerabilities including the possibility that the guarantee may be set aside by US courts as fraudulent conveyances on the grounds that it may be more difficult to demonstrate that the guarantor has received reasonably equivalent value for its guarantee.
5.2 Are there any specific issues creditors should be mindful of regarding a bankruptcy and restructuring situation?
The filing by a debtor for bankruptcy under the US Bankruptcy Code triggers an automatic stay, automatically stopping substantially all acts and proceedings against the debtor and its property. The automatic stay has a broad scope and applies to all creditors, whether secured or unsecured, and to all of the debtor's property, wherever located. It prohibits creditors from pursuing both formal and informal actions and remedies against the debtor and its properties, including filing proceedings against the debtor to collect a prepetition claim, enforcement a prepetition judgment against the debtor or property of the estate, obtaining possession or control over the estate property, creating, perfecting or enforcing a lien against the property, collecting, recovering or assessing a prepetition claim against the debtor and setting off mutual prepetition debtors arising from different transactions. There are a number of judicial and statutory exceptions to the automatic stay.
Creditors should be aware a debtor-in-possession or bankruptcy trustee has broad powers to set aside or avoid certain pre-bankruptcy transfers of the debtor's assets to third parties. The most important of these are fraudulent transfers and voidable preferences.
5.3 Do foreign debt quotas apply in your jurisdiction and is offshore financing to domestic entities monitored?
No. Foreign lenders (other than lenders in jurisdictions that are the target of broad US economic sanctions) may generally make loans in the same manner as US based lenders.
5.4 Describe your jurisdiction's relationship with non-performing loans (NPLs), including volume of outstanding NPLs and techniques/challenges in managing them.
SECTION 6: Outlook
6.1 What are your predictions for the next 12 months for cross-border financing in your jurisdiction? How do you expect legal practice to respond?
The current environment of historically low interest rates and investor demand for yield is likely to continue to drive repricing and refinancing transactions, particularly in the leveraged finance market, until borrowers and issuers no longer perceive interest rates as at all-time lows. Combined with the demand/supply imbalance and barring any significant market disruptions, borrower and issuers – particularly well-known active borrowers such as large private equity sponsors – are likely to be able to push for even more favourable terms and pricing and greater flexibility in their covenant packages.
Legal practitioners will continue to be called upon by sponsors to provide creative solutions that provide borrowers and issuers with increased flexibility. Those with sophistication and familiarity with different types of financing at all levels of the capital structure will be favoured.
About the author
Ari B Blaut
Partner, Sullivan & Cromwell
New York, USA
T: +1 212 558 1656
F: +1 212 558 3588
Ari Blaut is a partner in Sullivan & Cromwell's finance and restructuring group. Blaut maintains a broad corporate practice advising clients on a wide range of financing transactions, including bank financings, high yield bond issuances, PIPE transactions, debt restructurings, liability management and creditor representations. He has particular expertise in leveraged finance, acquisition finance and private credit transactions, with recent clients including AT&T, Andeavor, Ares Management, Oaktree, Eastman Kodak, CyrusOne, Forest City and Canada Pension Plan Investment Board (CPPIB), among numerous others.
Blaut has published a number of articles for several legal outlets, including M&A Lawyer, Law360, Lexology and Deal Lawyers. He is also a member of the New York City Bar Association Committee on Commercial Law and Uniform State Laws.