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Fall 2024

The “Magnificent Seven” Lender Protections

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Summary

Recent examples of “lender-on-lender violence” have created both issues and opportunities for credit investors as credit documentation is increasingly in focus
OHA negotiates key lender protections in its credit agreements to enhance protection for investors. We refer to the protections colloquially as the “Magnificent Seven”
OHA has specialized in credit for 30+ years and has deep experience evaluating and negotiating key credit terms to seek downside protection for our investors

As certain companies face pressures in the current environment with elevated base rates and/or leverage, they may attempt to employ tactics to optimize value for equity holders by inducing lenders to work against each other or otherwise force their hands. These transactions are known broadly as liability management exercises or “LMEs,” which in turn can induce “lender-on-lender violence” as creditors are often pitted against one another or else fall victim to a prisoner’s dilemma created by the borrower. LMEs typically are new financings that involve collateral stripping maneuvers such as dropping valuable assets out of the credit group so they may be financed by other creditors, and sometimes preferential treatment to larger, favored members of the lender group while forcing other lenders to accept lower paydowns or other impairment of their lien or payment priority.

While recently structured leverage finance transactions often include documentation that limits some or most LME transactions, the syndicated loan and high yield markets are populated by many borrower capital structures that have “loose” documentation and contain many risks for existing lenders / investors. As the prevalence of LMEs has increased, being aware of these covenant and documentation loopholes is essential to understanding downside risk in these investments and managers that are focused and knowledgeable of the risks may have an advantage versus other investors.

Fortunately, the private credit market has seen very few LMEs. Further, private credit typically has financed simpler capital structures without multiple classes of creditors and lender groups are much smaller. As a result, borrowers and their private equity sponsors are considerably more relationship-oriented with their key lenders. The partnership nature, rather than transactional nature of many of the relationships in broadly syndicated loans, make LMEs less common but not impossible. While we believe a judicious underwriting process and careful credit selection will be paramount in protecting against losses, documentation and structuring are critical if and when a borrower becomes troubled. OHA views every commitment letter and credit agreement we negotiate through a lens of potential distress for this reason.

John Toronto Managing Director—Head of Private Credit Capital Markets

Learn more about the key lender protections OHA negotiates in its credit agreements to enhance protection for investors.

The “Magnificent Seven” Lender Protections

While there are dozens of terms that must be negotiated properly in commitment letters and credit agreements, the following seven protections are OHA’s thematic areas of focus for protecting investor capital. Several are commonly known by the names of the first highly visible credits in which the targeted threat was employed. Taken together, the “Magnificent Seven” intend to fortify OHA’s credit investments against priority impairment and value leakage—broadly speaking, they aim to keep our secured deals as secured as possible by seeking the following three benefits:

1. Protect the collateral and guarantees of our lender group

2. Maintain lender lien and payment priority

3. Limit value leakage from our credit group

The “Magnificent Seven” Lender Protections

Protection	Description	Benefit
“J. Crew”	J. Crew and the related Envision and Pluralsight protections guard against the transfer of material intellectual property and sometimes other valuable assets to parties not in our credit group	Protect the collateral and guarantees of our lender group
“Chewy”	Chewy blocks the stripping of subsidiary guarantees via bad faith partial stock sales or transfers	Protect the collateral and guarantees of our lender group
Non-Guarantor Investment Cap	Caps investments that may be made to entities affiliated with the borrower but which are not members of our credit group	Protect the collateral and guarantees of our lender group
“Serta”	Serta limits the ability of sponsors / borrowers to make sweetheart deals with majority lenders to the detriment or exclusion of minority lenders	Maintain lender lien and payment priority
Pro Rata Sharing	Requires a 100% vote for changes to the credit agreement to ensure fair treatment among lenders with respect to the payment of principal, interest and fees	Maintain lender lien and payment priority
Non-Guarantor Debt Cap	Preserves access to the value in certain third parties by limiting the amount of debt that can be placed ahead of our loan	Limit value leakage from our credit group
Definitions of EBITDA & Leverage¹	Imposes reasonable and objective limits on EBITDA addbacks and seeks to base the secured leverage definition on debt secured by any assets versus only those assets covered by a more limited definition of “Collateral”	Limit value leakage from our credit group

_{¹EBITDA is defined as earnings before interest, taxes, depreciation and amortization. EBITDA is a commonly used proxy for cash flow.}

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Key Risks and Disclosures

This document is for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any securities or partnership interests. Any investor who subscribes, or proposes to subscribe, for an investment in a fund or separately managed account must be able to bear the risks involved and must meet relevant suitability requirements. All investments are subject to market risk, including the possible loss of principal. Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. Investments in high-yield bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. Some or all alternative investments may not be suitable for certain investors. No assurance can be given that a fund or separately managed account’s investment objectives will be achieved. Alternative investments are speculative and involve a substantial degree of risk. Opportunities for withdrawal/redemption and transferability of interests are generally restricted, so investors may not have access to capital when it is needed. The use of leverage will magnify the potential for loss on amounts invested. The use of a single advisor applying generally similar trading programs could mean lack of diversification and, consequently, higher risk. The use of leverage and other speculative practices may increase the risk of investment loss or make investment performance volatile. In addition, the fees and expenses charged may be higher than the fees and expenses of other investment alternatives, which will reduce profits. There can be no assurance that an advisor will be able to implement its strategy or avoid incurring any losses.

Opinions and estimates offered herein constitute the judgment of OHA as of the date this document is provided to you (unless otherwise noted) and are subject to change, as are statements about market trends. All opinions and estimates are based on assumptions, all of which are difficult to predict and many of which are beyond the control of OHA in addition, any calculations used to generate the estimates were not prepared with a view towards public disclosure or compliance with any published guidelines. In preparing this document, OHA has relied upon and assumed, without independent verification, the accuracy and completeness of all information. OHA believes that the information provided herein is reliable; however, it does not warrant its accuracy or completeness.

This document may contain, or may be deemed to contain, forward-looking statements, which are statements other than statements of historical facts. By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. The future of investment results of the investments described herein may vary from the results expressed in, or implied by, any forward-looking statements included in this document, possibly to a material degree.

This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision

The recipient may contact OHA at (212) 326-1500 to obtain additional information or ask questions about any information, including the methodology used for any calculations and details concerning any of the summary charts or information provided herein.

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