Understanding Debt Agreements and Managing Their Default Risks March 20, 2019

Understand Integrate Collaborate Mitigate Manage

Jeff Wallace Jim Simpson Managing Director Managing Director

Presentation Outline

. Minimizing default risk . How debt agreements are structured . Events of Default . Managing covenants by lender objective . Evaluating covenant risk . Q&A . About Debt Compliance Services

1 Minimizing Default Risk

You must first understand your debt agreements to successfully manage their default risks, which achieves these objectives: . Maintains lender confidence and access to the capital markets at the lowest possible cost . Satisfies the quarterly Officer’s Certificate: – The Company is in compliance with all covenants and – No Event of Default under all debt and ancillary agreements . Justifies classifying the debt as long‐term – ASC 470‐10 requires long‐term debt to be classified as short‐ term if there is any covenant violation that allows the debt to become payable on demand by the lender . And keeps your job

Three Different Default Risks

. Cash flow and adverse event risks can only be mitigated by having processes in place anticipating them and seeking consents before the fact Cash Flow Defaults Event Defaults – Broken ratios – Material Adverse Events – Missed payments – Failure to report an event . Technical default are all other covenants. Technical default risk is 100% controllable: there’s no excuse for a technical default Technical Defaults Technical Defaults (cont’d) – Permitted baskets – Invalidity of collateral, liens and – Cross default on the related other security documents ancillary documents – Affirmative covenants – Continuing reps and – Negative covenants warranties – Compliance reporting

3 16% of BB‐Rated Companies Default within 5 Years

. Source: S&P’s 2018 Transition Analysis . (Hard) Default = missed payment, distressed debt exchange, or bankruptcy filing . 35% of BBs become non‐ rated for many reasons, mostly bad

. 4x as many companies declined (55%) versus improved (14%) . After 5 years, if 8% of BB’s had a hard default, then at least another 8% must have had some kind of technical default, 16% in total

38% of B‐Rated Companies Default within 5 Years

. Source: S&P’s 2018 Transition Analysis . (Hard) Default = missed payment, distressed debt exchange, or a bankruptcy filing . Companies become non‐rated for many reasons, mostly bad . 5x as many companies declined (63%) versus improved (12%) . After 5 years, if 19% of the Bs had a hard default, then it is likely that additional 19% must have had some kind of technical default, 38% in total

5 Default is a Near‐Death Experience for Treasury

Presentation Outline

. Minimizing default risk . How debt agreements are structured . Events of Default . Managing covenants by lender objective . Evaluating covenant risk . Q&A . About Debt Compliance Services

7 How Debt Agreements are Structured

How to Read a Debt Agreement

9 Covenant Elements

A covenant 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:

Interpreting Covenants

11 You Must Know these 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

Presentation Outline

. Minimizing default risk . How debt agreements are structured . Events of Default . Managing covenants by lender objective . Evaluating covenant risk . Q&A . About Debt Compliance Services

13 Covenants are Assigned to Specific EoDs

These specific defaults are listed in the first four to six Events of Default clauses and refer to specific covenants in the agreement . Cure periods reflect the importance the lenders attach to each category . If a cure period is not given, then it is zero days Event of Default Category Cure Period 1. Reps & Warranties and incorrect reports, certificates, financial 0 ‐ 30 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

EoDs Connect All Ancillary Agreements

15 EoDs Connect All Agreements

The Remaining EoDs are Stand‐Alone Covenants

Other Events of Defaults Typically deal with other areas of the Borrower and do not appear elsewhere in the agreement so they must be included in the comprehensive covenant list Other Events of Default are: Other Events of Defaults include: . Cross default as discussed . Judgments . Cross acceleration . Loss of Material Contracts . Guarantors’ default . ERISA Events . Bankruptcy/insolvency . Governmental Actions . Change of Control . Revocation of Licenses

Cure Periods – Varies by specific default event, typically 0‐5 or 10 days

17 Presentation Outline

. Minimizing default risk . How debt agreements are structured . Events of Default . Managing covenants by lender objective . Evaluating covenant risk . Q&A . About Debt Compliance Services

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

19 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

Classifying Covenants by Lender Objectives

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

21 Maintain Status Quo

. Continuing Reps & Warranties – Required to be reaffirmed each time the borrower borrows – Continuing Reps & Warranties can include:

• Material Adverse Change • No Default • Lawsuits • Governmental Action • Strikes • Margin Regulations • Environmental • Intellectual Property • Solvency • Full Disclosure . Changes in business activities . Maintenance of existence . Maintenance of business Cure Periods . Usually 0 ‐ 30 days

Preserve Assets

Prohibited or Required Actions . Restricted payments . Sales of receivables (dividends, advances to third . Sales of assets parties, equity buybacks, debt repurchases, etc.) . Insurance coverage . Required interest rate hedging . Use of proceeds . Restrictive agreements . No derivative speculation . Restricted investments . Restrictive affiliate transactions, . Changes in business activities especially with unrestricted upstream holdcos and restricted downstream opcos Cure Periods . 0‐60 days

23 Minimize Claims

Prohibited Actions Compliance with laws . New Indebtedness . Patriot Act/FCPA/FATCA/OFAC . New Liens (negative pledge) . Environmental . Anti‐layering (current debt is . ERISA compliance subordinated to new debt) . Foreign pensions comply with . Sale and leasebacks applicable local laws . Lease obligations . Taxes paid . Parent and sub guarantees Cure Periods . 0‐5 days

Permit Some Claims

. Often, prohibitions against third party claims will have exceptions for – Foreign debt – Other debt – Sale and leasebacks – Other liens – Acquisitions – Sale of assets – Restricted payments . These exceptions can be found in a schedule listing allowed, routine or regularly occurring transactions or allowed up to a specific dollar limit ( “permitted basket”) Cure Periods . 0‐5 days

25 Managing Permitted Baskets

. Like financial ratios, their management is a function of the risk that the limits can be exceeded . Good practices are: – Ensure you have a good process for accurately reporting basket items • Especially those that are not in the G/L (e.g., Liens and L/Cs) – Baskets can have complex interrelationships, so make sure you understand how they work – Calculate the basket amounts monthly and quarterly – Perhaps do intra‐quarter quarter‐end forecasting . If basket limits are very tight, institute a Treasury Approval process for all actions that can impact a basket

Make Payments – Principal & Interest

Principal Payments Interest, Fees, and Other Payments . Required Amortization . Interest . Final payment – Additional Interest . Mandatory Prepayments – Change in circumstances (new – Excess Cash Flow taxes, changes in lender costs, – Net Proceeds from asset etc.) sales, insurance proceeds . Commitment and Usage Fees from casualty events, new . LC Fees debt, new equity . Agent/Trustee Fees . Make‐Whole Payments . Lender expense reimbursement . Voluntary Prepayments . Promptly pay taxes Cure Periods Cure Periods . 0‐1 Business Days, very . 0‐3 Business Days, sometimes up rarely longer to 5

27 Meet Benchmarks – Maintenance Covenants

Maintenance Covenants To the extent that the debt Financial ratios tested as of agreement has maintenance quarterly B/S dates and for last 12 financial ratios and there is risk in breaking their limits, these actions months are commonly taken: . Leverage ratios . Quarterly actions: . Fixed charge coverage ratio – Calculating . Interest coverage ratio – Stress‐testing . Working capital – Forecasting beyond quarter‐ . Net worth end (often 12 months out) . Cash flow . Non‐Quarter‐End Monthly . Capital expenditures actions can include: Cure Periods – Calculating . 0‐5 days – Stressing actions – Quarter‐end forecasting

Meet Benchmarks – Incurrence Covenants

. These are financial ratio tests that performed on a pro forma basis prior to a specified contemplated event such as – Incurring additional debt (e.g., due to an acquisition) – Paying dividends – Cash dominion event, etc. . The ratios are typically: – Leverage Ratios – Fixed Charge Coverage Ratio – Net Worth . If any of the specified events are likely to happen, it is always good practice to calculate them quarterly using current financial information to see how much leeway exists . Be aware of these required notice requirements to your lenders!

29 Report Material Events

Notifications Other Notifications . Events of Default . Prospective or actual Material . ERISA and foreign pension Adverse Events events . Asset Sales . Environmental claims, actions, . Casualty Events incidents, real or pending . Change in Collateral Location . Litigation . New subsidiaries . Strikes . Acquisitions • For weak credits, many of these items could be listed as Events of Default rather than as notification requirements • Failed notifications are a common technical default because no one is watching for them Cure Periods . 0‐5 days

Presentation Outline

. Minimizing default risk . How debt agreements are structured . Understanding Events of Default . Managing covenants by lender objective . Evaluating covenant risk . Q&A . About Debt Compliance Services

31 Evaluating Covenant Risk by Cure Periods

Categorizing Covenant Types by Risk Drives the Frequency of Compliance Review

33 Q&A

Understand Integrate Collaborate Mitigate Manage

Presentation Outline

35 DCS’ Value Proposition

. Managing default risk requires in a rigorous compliance process because 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 10th 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

DCS Clients

Founded in 2009, we have over 30 clients, ranging from large public to private middle market companies, including: • A power generator with • A NY Power Authority with its $10B in debt and 7 projects power and servicing authorities • Over 55 project financings of • RES Americas, a renewable a PE firm’s renewable energy energy company with 3 project portfolio financings • A utility with $35B in debt • A California O&G company with with 8 project financings $2.5B in debt • A midWest utility with $8.5B • A $6B pharmaceutical with in debt with three separate $10B in debt holding companies • Henry Schein, an $8B global • Municipal Authority of multinational Georgia, with $6B in debt • PolyOne, a $4B industrial manufacturer

37 The DCS Covenant Manager℠ Web Solution

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.

39 DCS Publications

1. “Up for Discussion: Negotiating Credit Agreements that Stand the test of time”, AFP Exchange, Fall 2017 2. “Cutting the Clutter: Developing a risk‐based covenant checklist”, AFP Exchange, August/September 2015 3. “No Doubt, FASB’s new rules forces firms to disclose going concern doubts”, AFP Exchange, October 2014 4. “Coming Due, Treasurers must be wary of today’s easy covenants”, AFP Exchange, September 2014 5. “Truth or Consequences: Understanding Default Risk and its Ramifications”, AFP Exchange, September 2013 6. “Pure Speculation: Treasurers of Non‐Investment Grade Companies Must Reduce Covenant Risk”, AFP Exchange, June 2013 7. In collaboration with the AFP, the AFP Debt Compliance Survey, January 2013

About Debt Compliance Services

. DCS is a joint venture between Greenwich Treasury Advisors and Corporate Finance Solutions . Jim Simpson founded Corporate Finance Solutions 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 founded Greenwich Treasury Advisors 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

41 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