Some covenants will allow a bond issuer to calculate capacity under the covenants as of the date of entry into a definitive agreement relating to a transaction, and do not require capacity to be retested at closing of the transaction. In this ELFA Covenant Tip, we explain how “Limited Condition Acquisition” flexibility works
When the transaction could be credit positive (e.g., if the issuer is buying a valuable asset), this “Limited Condition Acquisition” flexibility could be seen as favourable to both the issuer and bond investors as it reduces transaction risk.
But some provisions allow sponsors to benefit from this flexibility by permitting the portability ratio to be calculated on the date the sponsor enters into an agreement to sell the issuer, shifting the transaction risk to investors.
If there is a significant time lag between entry into the acquisition agreement and closing of the transaction, investors may find that the issuer’s leverage has increased, either because EBITDA has decreased or more debt has been incurred.
To determine if this flexibility is present for the sponsor, look for the “Financial Calculations” covenant or ctrl-F for “Limited Condition Acquisition”, and check for references to Change of Control.