Firm Forwards Memo to Treasury on Loan Amendment Fees

From: Leslie SAMUELS

Attached is a copy of a background memorandum that follows up on our call with John Harrington, John Harrell and David Shapiro.

We hope this memorandum will be useful to you. If you have any questions, please call me. Regards

• Amendment fees are amounts paid by the borrower under a syndicated loan to the lenders to secure the lenders' consent to a proposed amendment to the loan's terms (or a waiver of the borrower's compliance with those terms).

• • Amendments and waivers may generally only be made in respect of a syndicated loan agreement if holders of a certain percentage (typically greater than 50 percent) of the outstanding principal amount or commitment amount of the loan give their consent.

• Amendment fees are designed to induce lenders to give consent to an amendment or waiver. As such, they are generally payable only to the lenders that consent, and only if the amendment or waiver is adopted.¹ If an amendment or waiver passes, however, all lenders are subject to its terms regardless of whether they provide consent or receive the fee.

• Amendments and waivers of the covenants under a syndicated loan agreement are the transactions that most commonly give rise to amendment fees.

• • Syndicated loan agreements typically have more restrictive covenants than bonds.

  • In some cases, borrowers are more willing to agree to restrictive covenants in a syndicated loan agreement because they expect to be able to obtain amendments and waivers of those covenants relatively easily.

  • Over the term of a syndicated loan, it is not unusual for a borrower to obtain a number of amendments and waivers.

• By agreeing to the amendment or waiver of a covenant, the lenders are in most cases agreeing to forego a right of acceleration that they would otherwise have in the event that the covenant remained in force and was breached.

• Borrowers also sometimes seek amendments of a purely "technical" nature (e.g., to clarify definitions, add or change subsidiaries that are parties to the agreement, cure inadvertent borrower breaches, make conforming changes, or correct documentation errors).

• Some amendments and waivers give rise to relatively small fees (or no fees at all). For example:

• • purely "technical" amendments;

  • one-time waivers requested when a covenant prevents a borrower from taking advantage of a particular commercial opportunity, such as a sale/leaseback, receivables financing, or unanticipated acquisition; and

  • one-time waivers requested when a borrower makes a "foot fault" (e.g., when it breaches a covenant to provide financial statements by a specified date).

• Other amendments may give rise to larger fees. For example:

• • amendments to financial covenants as a result of a significant deterioration in a borrower's financial condition; and

  • amendments to significantly extend the maturity of a loan.

• Amendments may be made, and amendment fees paid, in respect of a fully funded loan, a partially drawn revolving or drawdown loan, or an undrawn loan.

• In order to obtain an amendment or waiver, a borrower will first contact its administrative agent to discuss the parameters for the proposed amendment or waiver and the likely receptivity of the market. The administrative agent will assist the borrower in structuring the terms of the amendment or waiver and will advise the borrower about the fee that lenders might require to approve it.

• Once the terms of the proposed amendment or waiver and the size of the proposed fee (if any) have been agreed between the administrative agent and the borrower, the entire syndicate will be informed of the terms of the proposed amendment or waiver, the deadline for submission of approving votes, and the fee structure (i.e., whether and how the amendment fee will be paid to consenting lenders).

• • Lenders are typically given 5 or more business days to return their votes, and once the deadline has passed, the administrative agent will advise the lending group whether the amendment or waiver was successful and when the fee will be paid to those that voted in favor.

  • Occasionally, a borrower will fail to obtain the requisite number of votes to pass the amendment or waiver. In such a case, the administrative agent and the borrower will reconvene to discuss changing the terms of the amendment or waiver and/or increasing the fee to obtain lenders' approval. In some circumstances, an amendment or waiver will fail to pass because lenders demand a fee that the borrower is not willing to pay.

• The most common structure for an amendment fee is a single upfront payment calculated as a percentage of principal or commitment amount, paid to consenting lenders if the amendment or waiver passes.

• • Since only lenders who vote for the proposed amendment or waiver receive the fee, a large majority of lenders tend to vote for an amendment or waiver if it is expected to pass.

  • Typically, about 85 percent of lenders consent and receive the fee.

• One variation on the basic structure offers higher fees to lenders who consent early.

• In some cases, an amendment or waiver proposal may include an increase to the rate of interest payable on the loan in addition to (or in lieu of) an amendment fee for consenting lenders. In such a case, the increase to the interest rate would benefit all lenders under the loan, not just consenting lenders.

• An amendment or waiver of a significant covenant under a syndicated loan is ultimately a surrender by the lenders of certain of their existing rights in exchange for cash compensation from the borrower.

• Although there is no fixed formula for the calculation of amendment fees, the amount may be influenced by any of the following factors:

• • the remaining term of the loan (with a longer remaining term suggesting a larger fee);

  • changes that have occurred since the origination of the loan in the borrower's credit quality or in prevailing interest rates and credit spreads (with net increases to the borrower's borrowing costs tending to suggest a larger fee, since those are the costs that the borrower would suffer if the loan were accelerated and it were forced to obtain a new loan);

  • the type and degree of the proposed change to the terms of the loan (with greater changes suggesting a larger fee);

  • the existence of a proposed commercial transaction for which the amendment or waiver is a requirement (which could affect the fee either way);

  • the number of lenders (which could affect the fee either way); and

  • the identity of the lenders (i.e., whether they are banks or institutional investors, with institutional investors tending to require larger fees).²

• Amendment fees are generally viewed by the market as additional yield.

• If a loan is trading below par, lenders may seek to obtain an amendment fee that makes up a portion of the discount.

• Even if the commercial effect of an amendment or waiver is small and the lenders are relatively indifferent to the actual change to the loan agreement, an amendment fee may be necessary simply to induce the lenders to take the effort to vote their approval, or to make up, in part, for a loan's reduced trading value.

• The following examples are based on actual amendment fees:

• • Company W violates a covenant by failing to comply with SEC filing obligations. In order to secure a temporary waiver to provide enough time to correct the problem, it pays a one-time amendment fee of 25 basis points to consenting lenders.

  • Company X wishes to modify a covenant that imposes certain restrictions on the composition of its assets. To do so, it pays a one-time amendment fee of 25 basis points to consenting lenders.

  • Company Y wishes to modify a covenant to allow it to incur additional new debt. To do so, it pays a one-time amendment fee of 50 basis points to consenting lenders and also agrees to increase the interest rate paid to all lenders under the loan by 25 basis points.

  • Company Z is in danger of breaching a covenant that requires its costs not to exceed a certain percentage of its income, because of unavoidable increases in the price of certain materials used in its business. The loan in question is trading 10 percent below par. In order to secure a temporary waiver of the covenant, Company Z pays consenting lenders a one-time amendment fee of 200 basis points.

² One reason that institutional lenders sometimes require higher fees is that they typically invest in the non-amortizing tranches of a credit facility. As such, they are more exposed to the potential credit effects of an amendment.