The US Private Placement (USPP) market is an important source of long-term debt funding for Australian companies and often fosters a close relationship between investors and corporate issuers.

But the USPP market also has its own unique features that might be less familiar to new borrowers and top of the list would be covenants and the corresponding amendment process, which is not an uncommon event in the long life of a USPP.

The term “amendment” in the US Private Placement market can range from something as benign as a technical change to an otherwise effective note agreement to something more difficult such as building headroom in the financial covenants for a company that is struggling to stay compliant with the terms and conditions of its note agreement.

Our US Private Placement team, in conjunction with Bruce Dailey at Sidley Austin, and Michael Harrison at Chapman and Cutler LLP, recently produced a report “Navigating the US Private Placement Market Amendment Process,” on which this article is based.

Why amend a USPP transaction?

A common theme is the long-dated tenor of a USPP note agreement. Whereas a company with bank debt of the usual three to five years is unlikely to go through major changes during the life of the loan, the average term for a USPP transaction is 10 to 15 years — with some tranches issued for as long as 20 to 30 years as in the case of Sydney Airport or NSW Ports.

Over that period of time, the issuer’s industry conditions, strategy or corporate structure may well undergo changes that require the company to revisit and amend a USPP arrangement.

Mergers and acquisitions

“We see a lot of amendment requests and often the reason is that there is M&A activity that requires temporary rather than permanent relief as a company integrates a transaction,” said Michael Harrison, Partner at Chapman and Cutler LLP, a law firm that represents USPP investors.

After a merger, the acquired debt from the takeover target may go onto the buyer’s balance sheet as soon as the transaction closes, but new earnings will only begin to flow through over time. So an issuer may ask for temporary covenant relief of 12 months or so until the benefits of the merger flow through to the balance sheet.

“It’s important to remember that US Private Placement investors have both similarities and differences from the banks. They have much closer relationships than normal bondholders, but at the same time they don’t have the same frequency of contact that banks do,” said Geoffrey Schmidt, General Manager, Corporate Finance North America at National Australia Bank.

Aiming for consistency

He said that issuers sometimes request an amendment to their USPP debt because they wish to harmonise the terms and conditions across all of their financing arrangements.

It can be an administrative burden to calculate covenants across different debt platforms, so by making all covenants consistent, that burden (and the corresponding reporting risk) disappears. “We have this dialogue frequently with issuers from this market. It is usually part of a broader discussion about strategy and market heuristics,” said Schmidt.

Performance issues

The third key reason for seeking an amendment, though also less common than the first two, is that an issuer may look for covenant relief when the company’s performance or outlook deteriorates.

“This happens in business and the private placement market is a long-term bond market, so cycles can be witnessed,” said Bruce Dailey, Partner at Sidley Austin, a law firm representing issuers.

Some issuers may come to face significant performance challenges due to changes in their sector, a poor strategic decision or, in extreme cases, a failure to adapt to a fundamental shift in the industry (the classic example being Kodak and the advent of the digital camera and smart phones).  At the extreme, an issuer may slip to non-investment grade.

“When this happens the investors naturally become concerned.  As a non-investment grade holding, the investors face a higher cost to capital to hold the investment and the asset simply may become uneconomic at the stated coupon,” Dailey said.

These experts agreed that investors in the private placement market will respond to genuine issues and challenges, but will resist conforming exercises simply for the sake of conforming if an issuer wishes to update its financial agreements. A properly drafted private placement will have significantly less covenants than a bank package and investors will focus on including only material covenants.  Those covenants are generally considered to be “set and forget”.

For the full report on “Navigating the US Private Placement Market Amendment Process,” please contact your NAB banker.