Benchmark prior transactions, bonds, loans or company profiles using over 300 credit metrics.

Comparables

AI transcripts & instant analysis, making earnings season easier than ever.

Earnings

A full suite of ESG data and analysis. Built for your workflow

Spot undervalued credits and potential future restructurings with our purpose-built tools.

Distressed and Restructuring

We use AI to aggregate newsflow from 2,000 sources, and deliver it to your inbox quicker than anyone else.

News

Full Financial profiles with 3 statements, KPIs, segment splits & credit metrics. All traced to source documents.

Financials

New deal analysis and covenant comparison tools, understand key risks in seconds not days.

Covenants

We've successfully predicted more than 65 price sensitive events - before they happened.

Deal predictions

Say goodbye to CTRL + F with our powerful search. Thousands of documents text searchable for any keyword or phrase.

Search

Track high yield deals from issuance through to maturity, with integrated legal, credit and ESG analysis.

High Yield Bonds

Shine a light on private markets with 9fin's news and legal analysis of syndicated loans

Leveraged Loans

21st century tech and expert analysis to help CLO teams make informed decisions faster.

Structured Credit 

Find information others can't see in one of the fastest growing corners of finance

Private Credit 

Alice Holian

Brian Dearing

In this edition of 9fin Educational, we take a look at the Restricted Payments covenant, exploring how it works and the key things to focus on when reviewing it. Previously, in another 9fin Educational, we discussed J.Crew and unexpected value leakage, but here, we are exploring expected value leakage.

This is the first of a two part series on the Restricted Payments covenant. Part 1 focuses on the structure of the RP covenant, and then does a deep dive on the Builder Basket. Click here to read Part 2 will look at the Permitted Payment baskets. 

The purpose of the Restricted Payments (RP) covenant, at the most basic level, is to prevent value (in the form of cash and/or assets) from being transferred outside the Restricted Group (also referred to as “leakage”). The covenant is drafted following the customary approach in negative covenants. First providing for a general prohibition on the making of any RPs by the Restricted Group, and then setting out a significant number of exceptions to that general prohibition.

The RP Covenant specifically prohibits the following forms of leakage: (a) making dividends; (b) share buybacks; (c) repaying subordinated debt; (d) repaying shareholder loans; and (e) making restricted investments. The exceptions to these prohibitions can be broadly split into two categories: (i) the Builder Basket and (ii) Permitted Payment baskets (the subject of Part 2 of this series).

The first, and certainly the most complex, exception to the general prohibition on RPs is the Builder Basket. Fundamentally it exists to allow successful companies to “build-up” dividend capacity. If a company is generating profit, the argument goes, it should be allowed to distribute some of that to its shareholders. While this sounds logical, there are a number of ways this concept has slowly changed over the years that have started to undermine this logic, and make it work much more favourably for the issuer.

Conditions to Availability - a very basic “health check”

In order to have access to the Builder Basket, certain conditions must be satisfied - this is to ensure the company is healthy at the time it distributes any value. These conditions principally consist of:

A requirement that there is no Default or Event of Default at the time, and that none would result from the RP itself (more on this later); and


The issuer must have capacity to incur at least €1.0 of ratio debt — typically pursuant to the Fixed Charge Coverage Ratio. This is included to ensure that when the issuer gets to the higher end of leverage, they retain value to protect the investment made by bondholders / lenders.


If the two basic “health checks” are met, then the Builder Basket may be accessed, the only question is how much is available (if any). It is important to note that this is a very complex calculation - with the potential to be heavily adjusted from figures set out in the financial statements, and it’s widely understood that most issuers have no idea what their Builder Basket availability is at any given moment.

Broadly speaking, the amount that is available (or “built”) is calculated based on the following criteria:

50% of Consolidated Net Income (CNI), minus 100% of any deficit; plus


100% net cash proceeds received after the issue date from:

undefinedundefinedundefinedundefinedundefinedundefined

100% of the FMV of Restricted Investments in Unrestricted Subsidiaries that are brought into the Restricted Group later; plus

Starter Basket - typically a fixed amount that provides capacity day one.

Note that the use of most other RP capacity (i.e., fixed baskets that are discussed in Part 2 of this series) does not reduce the amount available under the Builder Basket.

Builder Basket: Key Considerations and Developments

The Builder Basket generally relies on the performance of the Restricted Group to build, even further, access to the basket is limited to when the company is “healthy”. The theory goes that if the company is doing well, we loosen the belt and let them make distributions, when they aren’t doing well, we tighten the belt and conserve cash. However, such as it is in covenant-land, the underlying theory of the builder basket has, potentially, been undermined a bit. Below we discuss a few key areas where the Builder Basket is changing.

There has been a some weakening in the Default / Event of Default conditions applicable for the Builder Basket to be available. Instead of being subject to no Default and no Event of Default, sometimes the Builder Basket is either subject to just no Event of Default or just a no payment / insolvency event. Furthermore, in some cases, the ability to make Restricted Investments under the Builder Basket is neither subject to a Default / Event of Default blocker nor the €1.0 ratio debt test.

Typically CNI is counted starting around when the bond was issued, but it is not unusual to see the CNI Builder component build from a date prior to the issue/closing date. This happens when an issuer has outstanding bonds and they want their capacity to sync up, or the company has been quite successful (or a certain event occurred) and it wants the benefit. In the past, when a company refinance their bonds they reset the Builder Basket, but it is increasingly common to continue to set the start date as of the companies first issuance, even when the prior debt is no longer outstanding.

It has become increasingly common to include a “zero-floor” component in the 50% CNI Builder such that the CNI component of the Builder Basket cannot be negative, in other words, issuers only count the upside and exclude the downside of their performance. There are two permutations of this, the first (and more issuer friendly) treats a period with negative CNI as zero (see Modulaire Group and McAfee). This means that the specific quarter doesn’t build the basket, because its zero, but equally it doesn’t reduce any amounts previously built-up. The second looks at the full build-up period as whole and reduces the total built-up amount by any negative CNI that occurs. This means means that the total amount of Builder Basket capacity within the CNI prong cannot dip below zero. Note that in both permutations, given there is a zero floor, even if the overall CNI of the company is negative, this prong won’t reduce the other components of the builder basket. As an example, if a company had negative £10m CNI, but had a £15m starter basket, with this language, they would not need to reduce the amount in their starter basket.

One other Builder Basket innovation that we have seen crop up in a few loans and bonds (US deals such as Ancestry, Paysafe, Medline Industries, Athenahealth and Scientific Games Lottery) is the ability for the Builder Basket to build from the “greater” or “greatest” of several growth metrics. 



Clients can click through on the link to see the results of this search within the description of notes. If you would like to know more about how 9fin's powerful search works to enable you to target your search and save time, please click here. 

For instance, in Medline Industries, the Builder Basket builds from the greatest of (1) 50% CNI, (2) cumulative retained excess cash flow and (3) cumulative EBITDA less 1.5x cumulative fixed charges. Given the tendency of US innovations to float across the pond, we think it’s only a matter of time before we begin seeing this type of construct in more European bonds.

Equity contributions or subordinated shareholder debt as part of M&A sometimes come after the issue date, but given these are part of the overall financing of the transaction, they should not help build-up capacity in the Builder Basket. This is protected against by specifically defining and carving out the equity contribution that is expected to come. Clients can see example language here.

If you need to quickly review the Builder Basket on a particular transaction, what should you look out for? The following is intended to be a short list to help you focus your review on the key points.

When does the CNI build-up component start from? Is it backdated?


Is there a “zero floor” concept? Is it on a quarterly basis, or is it on the total CNI component?


Is the Builder Basket subject to a Default and/or Event of Default blocker and a €1.0 ratio debt test (or another ratio?)?
undefinedundefined

Are any equity contributions (or similar) expected as part of the transaction that aren’t excluded?

🍪 Our Cookies

(Un)Restricted Payments - Part 1 - the Builder Basket (9fin Educational)

Read all our public content for free

Recently Published

VistaJet works up new pref deal to smooth financing runway

Taking the Credit — A warmer end to the year, you can account on it

Excess Spread — Relax, playing the blues, synthetic solution

ATD’s DIP approved after revising the rollup feature

What are you waiting for?