Traditional Margin MFN

In the context of leveraged loans, the traditional margin MFN provision is designed to protect the interests of current TLB lenders by preventing the borrower offering materially more attractive pricing to new lenders when it raises additional debt. For European leveraged loans, the all-in-yield differential (margin, fees, OID and interest rate floor) offered to new incremental facility lenders can usually be no more than 100bps above TLB pricing. In the US, where the market is generally tighter than in Europe, you typically see between 50bps-100bps MFN protection offered to TLB lenders. MFN protection usually lasts for 6 -12 months from the date of the loan agreement, otherwise known as the ‘sunset’, and should provide comfort to existing TLB lenders that for a period of time, the borrower will not offer substantially better pricing to lenders of new debt. The MFN provision has weakened over time due to extensive carve-outs from the protection, so the comfort it was intended to provide may now be illusory.

Syndication MFN

The syndication MFN provision that we are seeing increasingly in the current market is being agreed between the mandated lead arrangers and the TLB lenders (rather than the borrower and TLB lenders) as part of the syndication process where underwriting banks are unable to sell down a portion of TLB in primary syndication.

A recap on OID

A typical syndication process for an underwritten deal on a firm commitment basis (rather than on a ‘best efforts’ basis) starts with the underwriting banks agreeing to provide debt to the borrower at a certain price. If, following a syndication process, the banks are unable to find lenders who are willing to purchase this debt at the price the banks have agreed with the borrower, the banks (rather than the borrower) will have to take the loss. The loss is referred to as the original issue discount, being the difference between the original face value of the debt and the price paid for the debt.

For example, the underwriting banks provide a €100m loan to the borrower and then sell that debt to the syndicate banks, ideally at face value. However if the syndicate banks are unwilling to buy the debt at this price, the underwriters will offer a discount. If the loan is bought by the syndicate banks at €90m, the difference between the face value and the price paid, being €10m, is the original issue discount. This OID is a loss borne by the underwriting banks, which they can offset against their deal fees.

In the current market, underwriting banks are finding it difficult to syndicate debt, particularly at the larger end of the market. In this case, knowing that they will struggle to syndicate the full amount of debt that the borrower requires and which has been underwritten, the banks may hold part of the debt on their balance sheets and syndicate a smaller amount. The debt which remains on balance sheet uses up capital and impacts the banks’ capital ratios, and therefore the banks will look to sell this debt in the secondary market as soon as possible. The debt is kept on balance sheet as a TLB and/or TLA; compared to TLB, traditional TLA has a shorter maturity and greater amortisation, typically at a fixed % per year, and therefore has temporal seniority. Assuming the final margin on any TLA tranche is no worse than TLB, it may be preferable for the banks to hold any debt on balance sheet as TLA.

The underwriting banks will look to syndicate the debt they have kept on their balance sheet as soon as possible in the secondary market. The existing TLB lenders are naturally concerned that new lenders who purchase this debt will do so at better pricing, i.e. at a steeper discount. In addition to the new lenders getting a greater discount on the debt, the secondary sale to the new lenders will clearly have an impact on the debt’s pricing in the secondary market. Using the example above, the underwriters could sell the remaining debt at a further discount of €85m (versus the €90m they sold it to the syndicate banks) meaning the OID is now €15m and the syndicate lender’s debt starts trading lower than the €90m it was purchased for.

Syndication MFN

To avoid the scenario of new lenders being offered more attractive pricing, the underwriters on a number of recent deals which have not syndicated in full have agreed to a different style of MFN provision. This syndication MFN provision differs from the margin MFN which is typical in leveraged loan deals and provided by the borrower in relation to incremental facilities. The syndication MFN is designed to offer the syndicate lenders any additional discount offered to the new lenders, so the pricing the syndicate lenders receive is the same as the new lenders. This MFN protection is agreed between the underwriters (not the borrower) and the TLB lenders and is therefore typically documented outside of the loan agreement in a side letter.

The syndication MFN protection which is by reference to OID usually applies for a certain period after the allocation date, such as 6 - 12 months. Taking the scenario above, the original OID is €10m, being the discount the debt was sold by the banks to the syndicate. As the new lenders purchase the debt in the secondary market at the lower price of €85m, the syndicate lenders invoke the MFN. Assuming the MFN protection comes with no headroom, the syndicate lenders receive additional OID equal to the entire difference between the price at which they bought the debt and the price the remaining debt was sold in the secondary market, being €5m.

This MFN protection is rare, and we have only heard of it being provided on a couple of occasions in the past, for example, on Advent’s acquisition of Evonik’s methacrylates plastics unit, Madrid, where the financing comprised a large TLB tranche in excess of €1 billion that struggled in syndication. More recently, syndication MFN protection was provided on the KronosNet deal (ICG acquisition of Comdata and Konecta) in relation to both TLA and TLB; banks agreed to compensate syndicate lenders if the remaining debt is sold in the secondary market at less than 92 OID.

Lock it up

Another protection for the syndicate TLB lenders that may go hand-in-hand with the syndication MFN is a straightforward ‘lock-up’ period, whereby the banks holding the TLA or TLB piece agree not to sell it down for a specified period. This lock-up period was a feature of the debt financing for Vista EquityPartners and Evergreen Coast Capital Corp’s buyout of Citrix where the underwriting banks agreed not to sell the TLA debt before the end of the year. It was also seen on Bain’s acquisition of Inetum where banks agreed not to sell their TLA positions before January 2023.

In reality, if both a syndication MFN provision and a lock-up period are agreed to by the underwriting banks on the same deal, it will likely be in relation to different tranches of debt. For example, the lock-up period may apply to TLA, preventing its sale for a number of months after the allocation date, and the syndication MFN provision may apply to TLB to compensate syndicate lenders if any unallocated portion of TLB is sold at a discount in the secondary market. If a syndication MFN provision and lock-up period apply to the same tranche of debt, the lock-up period would need to be shorter than the sunset period for the syndication MFN assuming both periods run concurrently from the allocation date. For example, if the banks were to agree to a lock up period of 3 months and a syndication MFN of 12 months in relation to TLB, the MFN would only be relevant for the 9 months after the lock up period ends.

With increased market disruption, we anticipate seeing greater use of syndication MFN provisions and lock-up periods on debt held by underwriting banks following primary syndication.