McDermott’s Credit Agreement May Allow Priming Secured Debt With Simple Majority Vote; Out-of-Court Deal or Potential In-Court Restructuring Complicated by Significant LC Exposure

Relevant Document:
McDermott Debt Documents

As McDermott’s capital structure has come under severe pressure following reports of advisor hires by the company and stakeholders, the company, to shore up liquidity, is seeking more than $1 billion of new capital, according to sources, and the focus to date has been on a priming out-of-court deal that would require the company to amend its May 2018 credit agreement and October 2018 letter of credit facility agreement.

According to our analysis, McDermott’s credit and LC agreements could be amended to permit existing secured debt to be subordinated to any new-money financing, with majority consent from lenders. Additionally, a majority vote could allow for release of less than substantially all of the liens on the collateral securing existing bank debt.

Even so, the ability of McDermott to execute an amendment and priming transaction out of court is likely hampered by multiple dynamics, including that the company may breach certain financial covenants under certain debt including LCs, among other various legal and practical challenges.

Separately, we note that if the company ultimately pursues an in-court restructuring, whether because of inability to obtain new money and the required amendments or otherwise, McDermott’s significant LC exposure presents several complications. As detailed below, McDermott’s syndicated LCs would likely accelerate upon a bankruptcy-related default, leading to potentially lower recoveries for secured creditors and adding complexity to the recovery waterfall for creditors.

Background

McDermott’s capital structure, previously under pressure from persistent project write-downs and recently lowered guidance on free cash flow and asset sale proceeds, traded sharply lower after reports that the company hired AlixPartners, Evercore and Kirkland & Ellis, and that its lenders and bondholders have organized. McDermott issued a statement saying that it routinely hires external advisors to evaluate opportunities and intends to improve its capital structure and long-term health of its balance sheet.
 
As of Oct. 11, the company’s bonds were indicated in the mid-20s, according to TRACE, its term loans were quoted in the mid-60s, and its syndicated LC facilities were quoted in the low 70s, according to certain trading desks:
 
Reorg previously reported that the company was seeking to raise new-money financing to “stabilize operations.” While the exact proposed uses of this new financing have not been reported, McDermott, like any E&C business, likely needs significant available liquidity to operate and significant available bonding capacity to perform work on new and existing projects. According to the company, it had $1.023 billion of liquidity as of June 30, split between unrestricted cash and revolver availability; however, we note that 1) the company’s maximum revolver draws intra-quarter year to date were larger than its quarter-end balance, according to its latest 10-Q, 2) it has a minimum liquidity covenant set at $200 million, and 3) not all of the nominally unrestricted cash can be used for general corporate purposes because of currency restrictions and intra-group cash management practices, particularly involving the company’s JVs.
 
On the bonding side, McDermott had approximately $16 million of additional LC capacity under its syndicated LC facilities and $390 million of additional capacity under its short-term uncommitted bilateral facilities. McDermott refers to these facilities as short term. Because of their “uncommitted” nature, it is unclear how much of that $390 million is currently available.
 
As Reorg previously discussed, the company booked a significant amount of new work in the first half of 2019 without a corresponding increase in bonding utilization.
 
Additionally, the company faces certain covenant headwinds, including that after June 30, 2019, it is no longer allowed under its credit and LC agreements to add back anticipated cost savings and synergies from the CB&I acquisition. Although the exact quantum of such addbacks for the LTM period ending June 30 is undisclosed, the difference between the estimated LTM “covenant EBITDA” and reported EBITDA exceeded $1 billion in the first two quarters of the year:
 
The leverage covenant further steps down to 4.00x at the end of the fourth quarter.

Amendments and Consents

The debt and lien covenants of the company’s May 2018 credit agreement and its separate October 2018 LC facility agreement are substantially similar and restrict the amount of additional secured debt the company could incur, including additional amounts of secured financial or performance LCs. Consistent with what we have reported, we focus our analysis on: 1) capacity under the credit and LC agreements to incur debt that primes the existing facilities’ liens, 2) capacity under those agreements for additional secured LCs, and 3) capacity under the unsecured indenture for additional secured debt.

Capacity for priming debt - We estimate that the credit and LC agreements permit at least $250 million of debt secured by a priming lien on collateral and arguably permit an uncapped amount of priming debt in excess of $250 million if a majority of lenders consent under each of the agreements.

As is typical, the agreements contain provisions that provide for specified situations in which the collateral agents can release the facilities’ liens without lender consent (§10.7(b)), such as upon disposition of collateral or the termination of commitments. But in addition to those typically included events, however, the collateral release provisions state:
 
The agreements’ amendment provisions (§ 11(a)) require a consent of all adversely affected lenders to amend the above collateral release provision.

Lien covenant carve-out (l) is a general lien basket that permits liens “securing obligations or other liabilities of the Parent or any Restricted Subsidiary of the Parent” not to exceed the greater of $200 million and 2.5% of total assets, or approximately $250 million as of June 30.

We estimate that the general lien basket is currently unused, and therefore the company can incur $250 million of priming debt if the debt covenant also contains at least $250 million of capacity. We believe that capacity exists. The May 2018 credit agreement and October 2018 LC agreement each contain a $400 million debt basket that we interpret to be a general debt basket. That debt basket could potentially be paired with the $250 million general lien basket to incur $250 million of priming debt without lender consent.

The general debt basket (§ 8.1(d)) is as follows:
 
Although subclause (i) of the basket expressly references certain types of financing transactions, as is typical, the agreement’s interpretation rules (§ 1.4(e)) state that the preposition “including” is not restrictive: “The term ‘including’ when used in any Loan Document means ‘including without limitation’ except when used in the computation of time periods.” Therefore, it would not be unreasonable to interpret that debt basket as a general debt basket that permits $400 million of secured debt. If so interpreted, the general debt basket could be paired with the $250 million general lien basket to incur $250 million of debt that primes the liens of the existing loan and LC facilities, without lender consent.

That would be possible because the collateral release provision discussed above permits a release or subordination of the facilities’ liens to any debt that is secured by a lien incurred under the general lien basket.

That $250 million priming figure could arguably be increased with consent from only a majority of lenders. Whereas an amendment to the above collateral release provision requires the consent of all adversely affected lenders, an amendment to the debt or lien covenants requires only a majority of lenders under each agreement, as is typical. Under the company’s May 2018 credit agreement, “majority” in the case of amendments to the debt and lien covenants would be determined on the basis of the aggregate balance and commitments across all tranches combined.

Therein lies the nuance of the agreements and how McDermott may seek to prime more than $250 million of its existing loan and LC facilities. Because the collateral release provision does not set a cap on the amount of priming debt that can be incurred under the general lien basket and because the size of the general lien basket can be amended with only a consent of a majority of lenders, an amendment to the lien basket with a consent of a majority of lenders would arguably increase the amount of priming debt permitted by the collateral release provision.

Capacity for collateral release - Another avenue McDermott may pursue to effectuate a de facto priming transaction could be to release the liens on a portion of the existing collateral and then grant a lien on those assets to a new-money financing. The agreements’ amendment provisions § 11(a)(ix)) require 100% consent to release “all or substantially all of the Collateral” (emphasis added). That likely means that a collateral release of less than “all or substantially all” of the collateral is a majority consent issue. Therefore, the company could release liens securing a discrete set of assets and subsequently grant a new lien on those assets to any new-money financing, either as an alternative to a more straightforward priming transaction completed by amending the general lien basket, or in combination with it.

According to McDermott’s latest 10-Q, the assets of its technology segment were $2.73 billion as of June 30, or approximately 27% of consolidated total assets (inclusive of eliminations). McDermott said it received unsolicited approaches for this business that valued it at more than $2.5 billion.

Capacity for additional secured LCs - Our covenants tear sheet published Oct. 1 sets forth our estimates under the loan and LC agreements to “lien-up” LCs and similar arrangements. We estimate that the company has more flexibility to secure letters of credit than it does funded debt. But, as stated above, the debt and lien covenants can be amended with consent of a majority of lenders. Therefore, if McDermott seeks to raise more than $250 million of priming debt, it would likely seek lender consent to change those amounts to the extent needed.

Likewise, a priming transaction could make it more difficult to comply with financial covenants contained in the credit and LC agreements, such as each agreement’s leverage covenant and fixed charge coverage covenant. The leverage covenant of each of the credit and LC agreement and the LC agreement’s coverage covenant could be amended with consent of a majority of lenders under the applicable agreement (under the May 2018 credit agreement, including the term loan lenders). However, amendments to the May 2018 credit agreement’s coverage covenant require consent from a majority of that agreement’s LC and RCF lenders and exclude term loan lenders from the consent process. If McDermott requires an amendment to that credit agreement’s coverage covenant, the overall deal dynamics will be further complicated, as the LC and RCF lenders would wield more negotiating leverage than the term loan lenders, as further illustrated below.
 
Capacity under the indenture - The indenture that governs McDermott’s unsecured notes does not distinguish between lien priority, and we estimate that the indenture contained about $1.22 billion of additional secured debt capacity as of June 30, assuming a fully drawn revolver. Any additional secured debt in excess of that amount would require consent of a majority of noteholders, or more than $650 million of the $1.3 billion of outstanding notes.

Potential challenges - As with any priming transaction for a distressed issuer, the capacity under the debt documents is only one part of the equation. An out-of-court deal is likely to face significant statutory and practical challenges:
 

• Getting a “simple” majority of a $4.67 billion multitranche facility is not a simple task, given the likely disparate holder base across tranches;
   
• Regardless of any new-money financing raised, the company could require amendments to its financial covenants; the constituents that need to consent to amend the coverage covenant in particular (RCF and LC facility lenders) are different from the constituents that need to agree to the collateral subordination/release (all lenders), and this makes the threshold level even more difficult to obtain;
   
• Any financing in excess of $1.22 billion would likely also require a majority consent from the unsecured noteholders, further increasing the quantum of debt requiring amendment;
   
• Given the apparent financial distress, any grant of new liens would be subject to avoidance risk under either preference or fraudulent conveyance theories;
   
• Any of the collateral release strategies described above may also be challenged not only by avoidance theories but also by parties arguing that the release constituted a release of “all or substantially all” collateral.

Remedies Upon an Event of Default

The company’s contingent LC exposure and its potential treatment in any in-court restructuring has been another key focus for the market. While treatment of undrawn letters of credit in bankruptcy raises a number of legal questions that we discuss briefly below but are otherwise beyond the scope of this article, the events of default and remedies language in the company’s May 2018 credit agreement and October 2018 LC agreement makes it clear that the entire LC exposure (both drawn and undrawn) will effectively be accelerated upon bankruptcy, as discussed in more detail below.

Section 9.1(f) of the May 2018 credit agreement provides that an insolvency event affecting parent McDermott International Inc., any of the borrowers under the credit agreement, or any material subsidiary (defined as a restricted subsidiary contributing more than 5% of EBITDA or total assets or a group of restricted subsidiaries contributing more than 10% of EBITDA or total assets) constitutes an event of default:
 
Section 9.2 governs remedies upon an event of default and provides for standard automatic acceleration upon a bankruptcy event of default of not just funded debt obligations but also all outstanding LCs:
 
“LC Facility Letter of Credit Obligations” is defined as “the aggregate amount equal to the sum of (a) the LC Facility Reimbursement Obligations at such time (or, for any LC Facility Reimbursement Obligations in any Alternative Currency, the Dollar Equivalent thereof at such time) and (b) the LC Facility Undrawn Amounts at such time.” In turn, “LC Facility Reimbursement Obligations” refers to reimbursement or repayment obligations payable with respect to amounts drawn under the facility LCs, and “LC Facility Undrawn Amounts” means the aggregate undrawn amount of outstanding LCs under the facility. Therefore, the agreement states that the entire outstanding amount under the credit agreement’s LC facilities will become due and payable even if that amount is currently undrawn.

In addition, section 9.3 of the credit agreement requires that:
 
The relevant provisions of the October 2018 LC agreement substantially mirror those of the May 2018 credit agreement.

Upon a bankruptcy filing, the precise treatment of McDermott’s letters of credit under its May 2018 credit agreement and October 2018 LC agreement is uncertain. It is likely that McDermott would either be required to cash collateralize the outstanding portion at 105% or LCs would be subject to the automatic stay, resulting in a claim against the debtors’ estates.