Tue 09/12/2023 16:28 PM
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Jeff Brenner, JD
Americas Covenants

Relevant Items:
Covenants Tear Sheet, Debt Document Overviews
Diversified Healthcare Trust’s Debt Documents

Diversified Healthcare Trust is a REIT organized under the laws of Maryland. The company owns medical office and life science properties, senior living communities and other healthcare-related properties throughout the United States. As of June 30, the company wholly owned 376 properties, including five closed senior living communities, in 36 states and Washington, D.C. At June 30, the gross book value of the company’s real estate assets at cost plus certain acquisition costs, before depreciation and purchase price allocations and less impairment write-downs, was $7.1 billion.

As of June 30, Diversified had a fully drawn $450 million credit facility (which, as of a February amendment, could not be redrawn) secured by 61 properties with an appraised value (as of June 23) of $1.05 billion and six series of unsecured notes, two of which are guaranteed.

As discussed in previous reports, the company has reported that its ratio of consolidated income available for debt service to annual debt service was below the 1.5x test required to incur additional debt under its unsecured notes. As a result, the company is “unable to incur additional debt until this ratio is at or above 1.5x on a pro forma basis.” Notably, this includes the ability to refinance the company’s credit facility.

The company has previously advised that it believes that the earliest it may be in compliance with its debt incurrence covenants, which would permit it to refinance debt, is mid-year 2024, which is after $700 million of indebtedness comes due in the first half of 2024. For this reason, management has previously concluded that there is substantial doubt regarding the company’s ability to continue as a going concern.

As previously reported, on April 11, the company entered into a merger agreement with Office Properties Income Trust, or OPI, pursuant to which the company was to be merged with and into OPI, which the company stated would have permitted it to refinance its upcoming maturities. Certain shareholders and bondholders noted their objections or concerns regarding the merger, and on Sept. 1, the company announced that it and OPI had mutually agreed to terminate the merger agreement. Given that the company may not incur additional debt to refinance the debt coming due in 2024, the ability of the company to address those maturities is discussed in greater detail below.

In addition, on June 29, the company announced that a non-monetary event of default had occurred under its credit facility as a result of a reappraisal of the collateral securing the facility at $1.05 billion, below the $1.09 billion threshold required by the agreement. The company was granted a limited waiver from lenders until Sept. 30, originally to permit the company to complete the merger, at which time the revolver was required to be refinanced under the merger agreement. The event of default and potential repercussions in light of the failure to complete the merger agreement are discussed in greater detail below.

The company’s consolidated capital structure as of June 30 is shown below for reference:
Possible Means to Repay 2024 Maturities

The company’s $450 million revolver is due on Jan. 15, 2024, and the $250 million of outstanding 4.75% senior notes are due on May 1, 2024. Because the company may not incur any additional debt due to the restrictions in its unsecured notes, it will need to find other methods to pay the 2024 debt when it matures.

One way the company could raise funds to pay the 2024 maturities would be through the sale of assets. As discussed above, the revolver is secured by 61 properties with an appraised value (as of June 23) of $1.05 billion; as the value of the collateral is already below the minimum collateral requirements of the revolver (discussed in greater detail below), the company would not sell these assets.

However, the company reported that unencumbered total asset value is 264.4% of the company’s unsecured debt as of June 30. Unsecured debt of $2.35 billion as of that date implies an unencumbered total asset value of $6.213 billion. The revolver prohibits the sale of “all or any substantial part of its business or assets”; however, an asset sale to fund the repayment of the 2024 debt would likely not rise to that level. Otherwise, neither the notes nor the revolver have any explicit prohibitions on asset sales.

Even so, the unencumbered assets financial covenants of both the notes and the revolver could present an issue, as could the total debt covenant included in the notes. The unencumbered assets financial covenant in the debt documents require that unencumbered total asset value must be at least 150% of unsecured debt at all times. With $2.35 billion of unsecured debt, this would require that the company maintain $3.52 billion of unencumbered assets (or $3.15 billion pro forma for the repayment of the $250 million of 2024 notes). This means that the company has the ability to sell well over $2 billion of assets to address the 2024 maturities without violating the unencumbered assets financial covenant.

Similarly, the company could be limited by the financial covenant in the revolver requiring that total debt be no more than 70% of total assets at any time. The company has reported that total debt is 37% of total assets as of June 30; with total debt of $2.814 billion, this implies $7.606 billion of total assets. To meet the covenant, the company must maintain about $4.02 billion of assets; this means that the company could sell over $3.5 billion of assets to address the 2024 maturities without violating the total debt financial covenant.

Another alternative would be for the company to issue preferred stock; there are no prohibitions in any of the debt documents on preferred stock issuance.
Event of Default and Possible Repercussions

As previously reported by Reorg, on June 29 the company filed an 8-K stating that a non-monetary event of default has occurred under its $450 million credit facility, which was subsequently waived through Sept. 30 by the required lenders. The non-monetary event of default resulted from the reappraisal of the value of the collateral securing the revolver to $1.05 billion, below the $1.09 billion required by the facility.

Most likely, the company will either increase the collateral under the facility or seek another waiver prior to Sept. 30. However, as discussed in more detail in a previous report, failure to do so could result in acceleration of the revolver if more than 50% of lenders choose to do so.
Covenant Conclusions

Significant issues under the company’s debt documents include the following:
  • Guarantor coverage - The credit facility is guaranteed by each of the subsidiaries whose equity is pledged in connection with the liens securing the credit facility as well as any subsidiary that guarantees any other debt of the company. Only two series of Diversified’s notes are guaranteed: the 9.75% notes due 2025 and the 4.375% notes due 2031 (together, the “Guaranteed Notes”). The Guaranteed Notes are guaranteed by each of the company’s wholly owned domestic subsidiaries other than “Excluded Subsidiaries,” which include (i) subsidiaries that own property subject to liens securing debt that prohibits such a guarantee or (ii) as defined in the issuer’s revolving credit agreement. In addition, RSA Healthcare Inc. is an Excluded Subsidiary. According to the company’s 10-K for the period ended Dec. 31, subsidiaries that are pledged under the credit agreement are included in Excluded Subsidiaries.
  • Financial covenants and liquidity - The company’s credit facility no longer permits the company to reborrow money that it repays. Accordingly, the company’s only sources of liquidity are unrestricted cash and equivalents, which were $338 million as of June 30.

    The credit facility includes a number of financial covenants. Under two of the financial covenants, Diversified’s total debt is limited to 70% of total assets, and secured debt is limited to 40% of total assets. In its supplemental operating and financial data for the period ended June 30, the company reported that total debt was equal to 37% of adjusted total assets and secured debt was equal to 6.1% of adjusted total assets. This implies adjusted total assets of $7.606 billion (compared with reported total assets of $5.585 billion). The company could incur a total of $2.51 billion in debt, all of which could be secured, and remain in compliance with its adjusted total-assets-based covenants.

    The credit facility includes an unencumbered assets covenant (which is also the only financial covenant included in the company’s unsecured notes), which requires the company to maintain unencumbered total asset value of 150% of its aggregate outstanding unsecured debt at all times and is currently in effect. The company’s reported unencumbered total asset value of 264.4% of unsecured debt implies unencumbered total assets of $6.213 billion; this means that the company could incur no more than an additional $1.792 billion of unsecured debt and remain in compliance with the covenant.

    In addition, the credit facility includes minimum liquidity (which was reduced to $100 million from $200 million by the February amendment) and minimum collateral requirements. While the company is meeting its minimum liquidity requirements, it is not meeting the minimum collateral requirements, resulting in the event of default discussed in greater detail above.

    The credit facility included a coverage covenant, which previously required that the company meet an EBITDA-to-fixed-charges ratio of 1.25x. The February amendment waived this covenant through maturity of the facility.
  • Debt and liens - The credit facility includes certain debt covenants that following the February amendment will apply through the maturity of the facility; previously, they only applied during a waiver period. The covenants prohibit the company from incurring any debt other than unsecured notes with a maturity of at least three years from the date of issuance (which must be used to prepay the credit facility), other unsecured debt of the company, or nonrecourse debt of its guarantors if the company is able to meet the financial maintenance covenants or if the credit facility is paid off in full, proceeds of which must be used to repay the credit facility and certain Covid-19-relief-related debt.

    The company’s unsecured notes include incurrence-based debt covenants prohibiting the company from incurring total debt in excess of 60% of total assets, secured debt in excess of 40% of total assets, and debt that would cause the consolidated income available for debt service to annual debt service ratio to exceed 1.5x.

    The notes’ total debt covenant, which is stricter than the credit facility’s 70% of total assets financial covenant, limits the total additional debt the company can incur to $1.792 billion. However, because the company’s reported consolidated income available for debt service ratio is 1.08x, the company is not currently meeting the 1.5x requirement and is prohibited from incurring any additional debt. This includes debt to refinance the credit facility.
  • Dividends and investments - The credit facility includes certain limitations that are effective through the maturity date (prior to the February amendment, they were effective only during a temporary waiver period). The limitations prohibit the company from making investments except for certain specified purposes, including required renovations or improvements and maintenance capital expenditures not to exceed $400 million; acquisitions of AlerisLife equity to maintain an 33.9% ownership; and certain other acquisitions of real property to the extent the company is contractually bound to do so on the amendment date.

    The limitations also prohibit dividends except as required to maintain REIT status under relevant tax law and no prepayments of unsecured debt using proceeds of the credit facility.

--Jeff Brenner
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