Best Practices in Debt Compliance Texpo 2019

Cutting the Clutter: Best Practices in Debt Compliance Texpo 2019

Understand Integrate Collaborate Mitigate Manage

Jeff Wallace Managing Director

Best Practices in Debt Compliance

. Executive summary . How debt agreements are structured . Identify and categorize the covenant requirements . Evaluate covenant requirement risk . Develop an effective, efficient review process . Automate using web tools . Q&A . About Debt Compliance Services

1 Best Practices in Debt Compliance

Developing a best practices debt compliance process requires understanding the true risks and costs of a default, which then justifies a CFO‐approved policy with objectives and corporate‐wide responsibilities that requires: . Effectively categorizing covenants by risk . Developing a covenant requirement review that minimizes the legalese by focusing only on the covenant’s required or prohibited action . Further making the review effective and efficient by only asking about covenants that need to be managed quarterly, annually, or when triggered by events, excluding the minimal risk covenants . Asking respondents to also identify possible future events that may have covenant consequences . Requiring the Compliance Team to be responsible for ensuring the accuracy and completeness of the responses and then evaluating the responses against the Team’s interpretation of the full covenant text . Automate the process using web tools

Most Companies Decline & Die Over Time

Rating Transitions after 5 Years 5 Year Ratio of Declining/Improving Credit 100% Ratings 90% 80% 6.0 70% 5.2 60% 5.0 50% 40% 4.0 30% 4.0 20% 3.4 10% 0% 3.0 BBB BB B Upgraded 11% 14% 12% 2.0 Unchanged 52% 31% 25% Non‐Rated 25% 35% 41% 1.0 Downgraded 10% 12% 3% 0.0 Defaulted 2% 8% 19% BBB BB B Defaulted Downgraded Non‐Rated Unchanged Upgraded

Source: S&P’s 2018 Transition Analysis . Default = missed payment, distressed debt exchange, bankruptcy . If not acquired, non‐rated occurs for mostly bad reasons

3 A Default Would be the Worst 6‐8 Weeks of Your Treasury Career

Where does Your Debt Compliance Need to Improve?

Little Component to None Somewhat Adequate Better Best‐in‐Class Corporate No debt compliance Written procedures. Treasury policy; some Corporate policy with Controls policy, no written SOX requirements, SOX objectives and assigned procedures. rep letter tested responsibilities Responsibility 100% Treasury. 90% Treasury, some 80% Treasury, 20% 100% Corporate: Treasury, Legal. others. Legal, Accounting, SMEs. Managing Quarterly calculations. Quarterly calcs with Monthly/quarterly calcs Monthly/quarterly calcs, Financial Ratios stressing/forecasting. with stress testing. stressing and forecasting.

Managing No review. Basket list reviewed. Calculated quarterly. Monthly/quarterly calcs, Permitted with controls on adding new Baskets basket items. Identifying the No covenant checklist. Checklist of the senior Checklist of the major Risk‐based covenant Non‐Financial debt's major covenants of the major checklist of all unique debt Covenants covenants. agreements. agreements, with (NFCs) controlling covenants. Quarterly Undocumented Undocumented Excel or Word Risk‐based, web question‐ NFC Review agreement review. review of checklist questionnaires. naires and reporting.

Required No list of due dates. Personal Excel or Department calendar of Web calendar process with Deliverables Outlook calendars. all deliverables. tasks assigned to owners and managers.

5 Debt Compliance Policy Objectives & Means

Best Practices in Debt Compliance

7 How Debt Agreements are Structured

How to Read a Debt Agreement

9 The Critical Defined Terms

. Permitted definitions: These definitions (Permitted Indebtedness, Liens, Investments, etc.) provide a list of exceptions to prohibited activities . Various Accounting Terms: EBITDA, Indebtedness, Net Income, etc. often include negotiated carve‐outs that may differ across agreements . Restricted Payments: This definition usually covers dividends, interco advances, fees and payments to subordinated indebtedness . Key Date Definitions: anticipated key event dates over the course of the agreement (e.g., end of construction), quarterly dates, payment dates, and business day definition

The Agreement Covenants have Specific EoDs

The agreement’s covenants are referenced in first four to six Events of Default:

Event of Default Category Cure Period 1. Reps & Warranties and incorrect reports, certificates, financial 0 Days statements and other documents furnished 2. Validity, enforceability, etc. of Loan Documents 0 Days 3. Principal payments, including Mandatory Prepayments 0‐1 Days 4. Interest, fee and other required payments 0‐3 Days 5. Specifically identified covenants, such as maintenance, 0‐5 Days negative, reporting and notifications 6. All other covenants in a catch‐all phrasing 30 – 60 Days . Cure periods reflect the importance the lenders attach to each category – If a cure period is not given, then it is zero days

11 Cross‐Default Clauses Connect All Agreements

Breaches of Ancillary Documents are EoDs

13 The Remaining EoDs are Stand‐Alone Covenants

Other Events of Defaults The other EoDs are requirements not appearing elsewhere in the agreement that must be included in the covenant listing: . Cross acceleration . Judgments . Guarantors’ default . Cancellation of Material Contracts . Voluntary/involuntary . ERISA Events bankruptcy/insolvency . Governmental Actions . Change of Control . Revocation of Licenses

Cure Periods – Varies by specific default event, typically 0‐5/10, sometimes 30 days

Best Practices in Debt Compliance

15 Covenants vs. Covenant Requirements

. Covenants are identified by a specific section or sub‐section, such as – 15 subsections in Article VII, Negative Covenants or – Section 6.07 Existence; Conduct of Business . Covenants will have multiple covenant requirements, which are individually a distinct promise to do or not do some specific action . For example, Section 6.07 has two individual requirements – The Borrower must cause each of its respective Subsidiaries to do all things necessary to preserve, renew and keep in full force and effect its legal existence. – The Borrower must cause each of its respective Subsidiaries to keep in effect the rights, licenses, permits, privileges, franchises, patents, copyrights, trademarks and trade names material to the conduct of its business. . The only way to ensure that the covenant is fully complied with is to deal with each covenant requirement separately . In our experience, each covenant will average 1.8 covenant requirements – That Negative Covenants Article probably has 25‐30 requirements

Covenant Requirement Elements

A covenant requirement is any specified action whose failure to do or not to do is an event of default (EoD) and will have many, if sometimes not all, of these elements:

17 Many, Many Covenants Everywhere

. Many companies assume that the affirmative and negative covenant sections contain all of the covenants that need to be followed . However, 35‐50% of all covenants are found in virtually every other agreement section: Revolving Credit Senior Notes Covenant Type Covenants Requirements Covenants Requirements

Affirmative 25 45 20 36

Negative 15 27 10 18

Reps & Warranties 15 27 0 0

Other 25 45 15 27

Total Covenants 80 144 45 81

. For managing covenants, this legal categorization is not very useful . Two better categorizations are by the lenders’ objectives and by cure periods

Classify Covenants by Lender Objective

This classification makes covenant management more understandable and facilitates accurately identifying like covenants across multiple agreements

19 Controlling & Subordinated Covenants

. Companies with many debt agreements will usually have their tightest covenants and permitted baskets limits in the senior credit facility – This is true if all the other financing agreements, such as senior notes, term loans or ABLs were written simultaneously with – or after – the senior credit . However, if the sub debt was written under earlier tighter credit conditions, was badly negotiated, or there are dollar limits on very old debt that are now too small, the risk is high that there are sub debt covenants running the senior debt – Just because the senior debt has priority in bankruptcy doesn’t mean that the junior debt can’t put you there . Minimize clutter by only asking about the tightest covenant, knowing that negative responses will trigger review the subordinated covenants

Independent & Dependent Covenants

. Independent covenants are triggered by specific events or actions outside the agreement while dependent covenants are triggered by an independent covenant . For example, asset sale covenants often have dependent covenants: a submission of a reinvestment plan, plan completion notice, and/or the mandatory prepayment, etc. . While independent covenants represent the initial risk, dependent covenants also pose a significant risk because they are often forgotten . Minimize clutter by only asking about dependent covenants when triggered by independent covenant responses

21 Best Practices in Debt Compliance

Factors to Consider in Evaluating Covenant Risk

1. Short Cure Periods: covenants with 0‐3 day cure periods need controls to maintain compliance 2. Covenant Type: specific types of covenants do not need quarterly or even annual review 3. Operational Risk: what is the probability that a covenant breach will occur given the company’s current performance, existing controls, and existing SME awareness of covenants in their areas of responsibility? 4. SME Training: Asking low risk questions quarterly is a good way to train and remind SMEs on the actions and events in their areas that have covenant consequences If a company’s conditions adversely change, the quarterly review will need to include previous low risk and possibly even minimal risk covenants

23 Evaluate Covenant Risk by Cure Periods

Covenant Types Drives the Frequency of the Compliance Review

25 Best Practices in Debt Compliance

Develop an Effective, Efficient Review Process

. Don’t waste respondent time by asking about covenants that will never happen or haven’t been triggered . Don’t require respondents to interpret the covenant legalese – You cannot expect them to do this accurately or consistently . Do ask simple yes/no questions about the covenant’s required or prohibited action – What are the facts of what happened or didn’t happened? . Be prospective: ask would the facts change in the foreseeable future? . Do require the Compliance Team’s to validate the responses for accuracy . Do require the Compliance Team to evaluate the response against their interpretation of the covenant text to determine how the responses should be managed, monitored or mitigated

27 Covenant Clutter

Article 6 Each Loan Party covenants and agrees that, until termination of all of the Commitments and payment in full of the Obligations, the Loan Parties will not and will not permit any of their Restricted Subsidiaries to do any of the following: Section 6.1 … Section 6.7 Enter into or permit to exist any encumbrance or restriction that (a) limits the ability (i) of any Subsidiary to make Restricted Payments to any Loan Party or to otherwise transfer property to or invest in any Loan Party, (ii) of any Subsidiary to guarantee the Indebtedness of any Loan Party or (iii) of Parent or any Subsidiary to create, incur, assume or suffer to exist Liens on property of such Person; provided, that, this clause (iii) shall not prohibit any negative pledge incurred or provided in favor of any holder of Permitted Purchase Money Indebtedness solely to the extent requires the grant of a Lien to secure an obligation of such Person if a Lien is granted to secure another obligation of such Person;any such negative pledge relates to the property financed by or the subject of such Indebtedness; or (b) provided, that, this Section 6.7 shall not prohibit (i) restrictions contained in any agreement in effect (A) (1) on the date hereof and set forth on Schedule 6.7 and (2) to the extent the restrictions permitted by clause (1) are set forth in an agreement evidencing Indebtedness, are set forth in any agreement evidencing any Refinancing Indebtedness in respect of such Indebtedness so long as such renewal, extension or refinancing does not expand the scope of the restrictions described in clause (a) or (b) that are contained in such agreement or (B) at the time any Subsidiary becomes a Subsidiary of Parent, so long as such agreement was not entered into solely in contemplation of such Person becoming a Subsidiary of Parent, (ii) restrictions that are binding on a Restricted Subsidiary at the time such Restricted Subsidiary first becomes a Restricted Subsidiary, so long as such restriction was not entered into in contemplation of such Person becoming a Restricted Subsidiary, (iii) restrictions that arise in connection with any Permitted Disposition, (iv) are customary provisions in joint venture agreements and other similar agreements applicable to joint ventures constituting Permitted Investments, (v) any restrictions imposed by any agreement related to Indebtedness constituting Permitted Indebtedness under clause (r) of the definition of such term or Refinancing Indebtedness with respect thereto, to the extent such restrictions are not more restrictive, taken as a whole, than the restrictions contained in this Agreement and in any event permit Liens on the Collateral to secure the Obligations, (vi) are customary restrictions on leases, subleases, licenses or asset sale agreements otherwise permitted hereby so long as such restrictions may relate to the assets subject thereto, (vii) comprise restrictions or Liens imposed by any agreement relating to Permitted Purchase Money Indebtedness to the extent that such restrictions apply only to the property or assets securing such Indebtedness or (viii) are customary provisions restricting subletting or assignment of any lease governing a leasehold interest.

Cutting Covenant Clutter

1. Identify the party or parties governed by the covenant Article 6 Each Loan Party covenants and agrees that … the Loan Parties will not and will not permit any of their Restricted Subsidiaries to do any of the following: …. 2. Identify only the restrictions (and ignore the exceptions) Section 6.7 Enter into or permit to exist any encumbrance or restriction that… (a) limits the ability (i) of any Subsidiary to make Restricted Payments to any Loan Party …… (ii) of any Subsidiary to guarantee the Indebtedness of any Loan Party or (iii) of Parent or any Subsidiary to create, incur, assume or suffer to exist Liens on property of such Person; provided, that, this clause shall not prohibit …. (b) requires the grant of a Lien to secure an obligation of such Person … provided, that, this Section 6.7 shall not prohibit …. 3. Write broad questions asking whether the parties violated the restrictions Question #1: Have any of the Loan Parties or any of their Restricted Subsidiaries entered into or permitted to exist any encumbrance or restriction that limits the ability of any Subsidiary to make Restricted Payments to any Loan Party or to otherwise transfer property to or invest in any Loan Party? Question #2: Have any of the Loan Parties or any of their Restricted Subsidiaries entered into or permitted to exist any encumbrance or restriction that limits the ability of any Subsidiary to guarantee the Indebtedness of any Loan Party? 4. If the restrictions have been violated, then evaluate whether the actions fall under the exceptions.

29 Best Practices in Debt Compliance

Automate Using Web Tools

. Excel does great managing and creating numbers, but it doesn’t do text well and is a poor database. In Excel, – Covenant checklist becomes cumbersome, then unmanageable, and always subject to errors – Questionnaires are difficult to aggregate and then evaluate answers from multiple respondents – Debt calendar risks corruption when rolled over to next year and is a poor workflow process . A web database tool can provide: – Web questionnaires that require full and complete answers – Web reporting to evaluate responses that are linked to the covenant text generating the questions – A web calendar work‐flow process with assigned tasks for ensuring that all debt deliverables and payments are done on the exact business day

31 Q&A

Understand Integrate Collaborate Mitigate Manage

Jeff Wallace Jim Simpson Managing Director Managing Director Debt Compliance Services Debt Compliance Services www.debtcompliance.com 32 © 2019 Debt Compliance Services LLC© 2018 Debt Compliance Services LLC

Best Practices in Debt Compliance

33 DCS’ Value Proposition

. A default damages a company’s reputation, hits its stock price, increases interest, incurs legal and audit fees, and has GAAP and SOX consequences . In our 11th year, we provide an automated, risk‐based debt compliance process in the cloud that minimizes default risk by: – Identifying the covenants that must be managed quarterly or annually or when triggered by events or not at all – Documenting compliance by SMEs with our concise web questionnaires, training them on their covenant risks – Researching covenant issues quickly with our multi‐agreement contextual search engine on hyperlinked debt agreement webpages – Ensuring all scheduled requirements are delivered on time with our web calendar process . ASC 350‐40 requires capitalizing our implementation fees

About Debt Compliance Services

. DCS is a joint venture between Greenwich Treasury Advisors (GTA) and Corporate Finance Solutions (CFS) . Jim Simpson, Managing Director, founded CFS in 2002 – A 35‐year career leading over $4 bn in convertibles, high yield bonds, revolvers, term loans, and ABLs – CFO of Moore Medical (public, $300M sales) and CS Brooks (private, $200M sales), and Treasurer of Sandoz USA (now Novartis) . Jeff Wallace, Managing Director, founded GTA in 1992 – Recognized expert in risk management and international treasury – VP‐International Treasury at American Express, AT at both Seagram and D&B, and a CPA at Price Waterhouse . Cindy Fryer, Senior Director, joined DCS earlier this year – Recently Senior Director – Treasury at Endo Pharmaceuticals – Progressively responsible finance & accounting positions at South Jersey Industries, JP Morgan, and Campbell Soup, and started as a CPA at PwC

35 The DCS Covenant Manager℠ Web Solution

DCS Clients

Our clients range from large public investment grade issuers to speculative grade companies: • A power generator with • Two water company utilities $25B in debt and over 40 with holding company and sub project financings company debt • A utility with $21B in debt • A $6B pharmaceutical with with 8 project financings $10B in debt • RES Americas, a renewable • Henry Schein, an $8B global energy company with 3 multinational project financings • PolyOne, a $4B industrial • A midWest utility with $8.5B manufacturer in debt with three separate • Church & Dwight, a $3.3 holding companies debt billion consumer products • Municipal Authority of company Georgia, with $6B in debt • Hyster‐Yale, a $2B industrial • A Big 4 audit firm

37 Client Testimonials

“You have a best‐in‐class debt compliance process,” reported the lead manager of a Big 4 audit of the company’s debt compliance to the treasurer of a client that is one of the five largest US utilities.

“Actavis is one of the world’s leading generic pharmaceutical companies, operating in 50 countries across the globe. We chose Debt Compliance Services to assist us in designing a comprehensive debt compliance process to meet the reporting requirements of our complex external financing arrangements. We are impressed with the sophistication of their debt compliance services and the professionalism and responsiveness of their ongoing support. DCS’ unique global web questionnaire system has enabled our key business stakeholders to better understand our ongoing obligations and resulted in an efficient way to manage the substantial information flow generated by our large and complex business. We now have a clear overview of what is going on in the Group without having to spend too much time and resources in the attempt. We highly recommend DCS’ professionalism and services.” —Gudjon Gustafsson, Group Treasurer, Actavis Group

“Debt Compliance Services’ tools reduce my risk, save me and my team time and effort, and have made our compliance reporting easy. Gone are the days when we would have to pull out our old, worn loan documents to review all of the various covenants and restrictions before making critical strategic business decisions. With DCS, reviewing our agreements is literally done with a few clicks of the mouse.” —Christine Sacco, Chief Financial Officer & Treasurer, Smart Balance, Inc.

Contact Information

. For more information, please contact:

Jim Simpson (203) 329‐7491 [email protected] Jeff Wallace (303) 442‐4433 [email protected]

. Visit our website at www.debtcompliance.com