Wed 10/05/2022 13:00 PM
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Relevant Items:
Updated Credit Agreement Flex Scale and Summary
Loyalty Ventures Debt Documents

Two months ago, Reorg Covenants initiated coverage on Loyalty Ventures, which became a public company in November 2021 following a spinoff from Alliance Data Systems. In our prior article, we discussed the falling price of the company’s term loan B, or TLB, which had dropped from close to par as of Jan. 1 to 74.8 as of July 29.

Since then, Loyalty Ventures has amended its credit agreement and released financials for its second quarter. Reported adjusted EBITDA for the six months ended June 30 was down 27% on a year-over-year basis, and the company recorded a $423 million goodwill impairment, which reduced the BrandLoyalty goodwill to zero. According to an investor presentation, the “persistence of higher logistics costs, mismatch of previously planned campaigns with luxury/aspiration rewards and consumers’ economic concerns are heavily impacting 2022 performance.”

On Aug. 22, Moody’s downgraded the company’s corporate family rating to B2 from B1 and changed the outlook to negative. S&P Global Ratings followed suit on Sept. 15, lowering Loyalty Ventures’ issuer credit rating to B- and revising its outlook to negative. On Sept. 27, the Wall Street Journal reported that Loyalty Ventures has hired PJT Partners as a restructuring advisor.

In response to these events, the TLB price has continued to drop. As of the close of business on Monday, Oct. 3, it was at 34.1.

The company’s capital structure as of June 30 is shown below:
Credit Agreement Amendment

The primary purpose of the first amendment to the credit agreement is to loosen the gross leverage ratio financial maintenance covenant. Before the amendment, the financial covenant required a gross leverage ratio of 5x, dropping to 4.5x in the quarter ending Dec. 31, 2022, and to 4x in the quarter ending Dec. 31, 2023. As revised, the ratio has been raised to 5.75x beginning with the quarter ending Sept. 30, 2022. It will slowly decrease over time until hitting 4.75x for the quarters ending June 30, 2025, and thereafter.

Although the company was in compliance with the existing covenant for the quarters ending March 31 and June 30 (with a gross leverage ratio of 4.4x for both quarters), it did not have sufficient capacity under the covenant to fully draw on its revolving facility. Given adjusted LTM EBITDA as of June 30, the company had only $85 million of additional capacity under the financial covenant. Using the 5.75x threshold and adjusted LTM EBITDA as of June 30, the company can incur $195 million of additional debt, which is sufficient to fully draw on its $150 million revolving credit facility.

Although the revised financial covenant permits the gross leverage ratio to remain above 4.75x until the quarter ending June 30, 2025, starting with the quarter ended Sept. 30, 2022, the revolver commitment will be automatically decreased by $2,812,500 per quarter unless the company can meet a 4.75x leverage ratio.

In addition, the company will not benefit from the higher financial covenant ratios in its debt and restricted payment, or RP, covenants. Prior to the amendment, to incur incremental debt or ratio debt and to make permitted acquisitions, the company had to be in pro forma compliance with the financial covenant. As amended, however, “Pro Forma Compliance” now requires that Loyalty Ventures be in compliance with the original thresholds of 5x, 4.5x or 4x rather than the new higher thresholds. The amendment also added the Pro Forma Compliance requirement to the non-loan party debt basket and the general RP basket, and it added a limitation that the general debt basket can only be used to incur pari debt if the gross leverage ratio is 4.75x.

These changes reduce Loyalty Ventures’ flexibility to incur additional pari debt, incur structurally senior debt and make restricted payments.
Options to Raise Liquidity

Distressed companies often look for ways to raise additional liquidity outside of their existing credit agreement debt. Loyalty Ventures may struggle to do so, however, as its credit agreement is highly restrictive. Below we discuss a few routes that have worked for other companies.
Transfers Outside of the Credit Group

Some credit agreements contain significant flexibility for the borrower to transfer assets outside of the credit group, including by permitting unlimited investments in nonguarantor restricted subsidiaries or by turning unrestricted subsidiary investment baskets into general baskets through J.Crew-style proceed baskets.

Loyalty Ventures’ credit agreement, however, does not even contain the restricted/unrestricted subsidiary concept, meaning that negative covenants apply to all subsidiaries. Investments outside of the credit group are limited to the greater of $40 million and 20% of EBITDA using a general investment basket, unless the company is in compliance with a 3.5x gross leverage ratio.

The company’s ability to transfer assets through restricted payments is also highly restricted, with a $30 million general RP basket that is only available if the company is in Pro Forma Compliance, which will require a gross leverage ratio of 4.5x starting with the quarter ending Dec. 31, 2022.
Asset Sales

Most credit agreements permit unlimited asset sales subject to certain requirements, including that the net proceeds of such sales be used to pay down the credit agreement debt. The general asset sale exception in Loyalty Ventures’ credit agreement, however, caps the total net book value of assets sold per year at $30 million. In addition, the intercompany asset sale exception does not permit any loan party to transfer any assets to a non-loan party.
Uptier Exchange

Serta Simmons, Boardriders and TriMark have participated in uptier debt exchanges pursuant to which consenting lenders exchanged their term loans for newly issued term loans under superpriority term loan facilities. A similar transaction would not be possible under Loyalty Ventures’ credit agreement, however, because amendments that result in lenders’ liens being subordinated require consent from each lender “directly and adversely affected.”
Structurally Senior Debt

Although nonguarantors do have some debt capacity under Loyalty Ventures’ credit agreement, such capacity is not significant. As discussed above, because there are no unrestricted subsidiaries, all subsidiaries of Loyalty Ventures are subject to the debt covenant. They can use three baskets to incur debt:
  1. A general debt basket equal to the greater of $60 million and 35% of EBITDA;
  2. A non-loan party debt basket of $25 million that is only available if the company is in Pro Forma Compliance; and
  3. A ratio debt basket that for unsecured debt requires only Pro Forma Compliance.
Because the non-loan party basket is only available if the company is in Pro Forma Compliance (a change made by the first amendment), such basket no longer provides additional capacity if the company is using the ratio debt basket. As of June 30, only $145 million of structurally senior debt was permitted, and such amount would be further limited by the 5x gross leverage ratio covenant.

--Alisha Turak
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