The “auto covenant reset” (“ACR”) concept is increasingly being pushed by sponsors and borrowers as a necessary corollary to debt incurrence permissions that allow re-leveraging to closing leverage (or in some instances above). An ACR is intended to ensure that a Group’s ability to make acquisitions and incur debt is not unduly restricted by a leverage covenant that requires de-leveraging over the life of a facility by ensuring a similar level of headroom is maintained in the leverage covenant profile if a re-leveraging event occurs.
There are various factors for Lenders to consider if agreeing the inclusion of an ACR in their leveraged loan agreements. These include:
- Trigger for exercising the ACR: Lenders will typically require this to be an EBITDA-positive acquisition that has been funded by way of a term facility established under the loan agreement.
- Reset Covenant Levels and Profile: Lenders will expect the reset covenant levels to be determined by reference to revised levels of indebtedness and consolidated EBITDA (both pro forma for the relevant acquisition), after applying the same headroom used to calculate the leverage covenant at closing.
- Other controls: Lenders may wish to include additional parameters around the ACR including, eg: (a) a minimum increase in consolidated EBITDA for triggering the ACR; (b) a hard cap on the maximum covenant level for each quarter over the life of the loan particularly in instances where re-leveraging above closing leverage can occur; (c) a cap on the number of times the ACR can be exercised; (d) the time period following closing during which the ACR may be exercised and following the relevant trigger event giving rise to the right; (e) information to be provided to Lenders in support of the calculation of reset covenant levels including requirements for any replacement base case model; (f) time period and scale of de-leveraging post a re-leveraging event.
