MEMORANDUM
PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
April 11, 2022
TO: Ian Blackwood, Partner, Banking & Finance, Calderwood & Harkness LLP
FROM: Sophie Tremblay, Lead Associate, Banking & Finance Daniel Obi, Associate, Banking & Finance
RE: Verimark Hospitality Group Inc. — Preliminary Assessment of Proposed $700,000,000 Term Loan B Refinancing
Engagement No.: 1016-00009
Client: Verimark Hospitality Group Inc.
This memorandum is protected by the attorney-client privilege and constitutes attorney work product prepared in anticipation of litigation or in connection with the provision of legal advice. It is intended solely for the use of Calderwood & Harkness LLP attorneys and staff working on Engagement No. 1016-00009. Distribution to any person not authorized to receive privileged communications is strictly prohibited.
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I. Executive Summary
Calderwood & Harkness LLP ("C&H") has been engaged to represent Verimark Hospitality Group Inc. ("VHG" or the "Company") as borrower in a proposed $700,000,000 senior secured Term Loan B refinancing (the "Proposed Refinancing" or the "Transaction"). The engagement letter was executed on April 8, 2022, and the matter was formally opened on April 4, 2022, under Engagement No. 1016-00009. VHG is a Delaware corporation publicly traded on the New York Stock Exchange under the ticker symbol "VMRK," with its principal executive offices located at 8200 West Palmetto Park Road, Suite 1500, Boca Raton, Florida 33433.
The Proposed Refinancing contemplates a $700,000,000 senior secured Term Loan B facility (the "New TLB"), with Crescent Harbor Bank, N.A. ("Crescent Harbor") acting as Administrative Agent, Collateral Agent, Lead Arranger, and Bookrunner. Whitfield Gage & Partridge LLP ("WGP") has been engaged as counsel to the Administrative Agent and the Lenders.
The Transaction will refinance in full VHG's existing $625,000,000 Term Loan B facility (the "Existing TLB" or the "Greystone Facility"), which was originated on February 14, 2020, with Greystone Federal Credit Corp. ("Greystone") serving as administrative agent. The Proposed Refinancing is designed to accomplish three principal objectives: (i) reduce the applicable margin on VHG's term loan indebtedness by approximately 50 basis points, transitioning from LIBOR plus 425 basis points to Adjusted Term SOFR plus 375 basis points; (ii) effectuate an orderly transition of VHG's benchmark interest rate from the London Interbank Offered Rate ("LIBOR") to the Secured Overnight Financing Rate ("SOFR"), in advance of the scheduled cessation of most U.S. dollar LIBOR tenors on June 30, 2023; and (iii) generate approximately $75,000,000 in incremental proceeds ($700,000,000 minus the approximately $625,000,000 existing facility balance and related payoff costs) to be used for permitted acquisitions and general corporate purposes.
Meridian Strauss Advisory LLC ("Meridian Strauss") has been engaged by VHG as financial advisor for the Proposed Refinancing. The principal contact at Meridian Strauss is Elise Cavanaugh, Managing Director.
This memorandum provides a preliminary assessment of the Transaction structure, including an overview of VHG's business and current financial condition, a detailed analysis of VHG's existing capital structure and the proposed pro forma capital structure, a summary of the key economic and structural terms of the New TLB, an analysis of the LIBOR-to-SOFR transition mechanics, and an identification of the principal negotiation issues that will require attention during the course of the engagement. This memorandum is intended to serve as a foundational resource for the engagement team and to guide our approach to the term sheet negotiations that will follow receipt of Crescent Harbor's initial term sheet proposal.
The target timeline for the Transaction is as follows: VHG Board of Directors authorization is anticipated for mid-May 2022; the commitment letter and fee letter are targeted for execution by late May 2022; syndication is expected to commence in early June 2022 and conclude by late June 2022; and a simultaneous sign-and-close of the definitive Credit Agreement and related documentation is targeted for mid-to-late July 2022.
II. Overview of Verimark Hospitality Group Inc.
A. Business Description
VHG is one of the larger publicly traded owner-operators of hotels in the United States. As of the date of this memorandum, VHG owns and operates a portfolio of 74 full-service and select-service hotels located across 18 states, encompassing a diverse geographic footprint that includes major metropolitan markets, resort destinations, and convention-proximate locations. The Company's hotel portfolio has been appraised at approximately $3.1 billion in aggregate, based on the most recent independent appraisals obtained in connection with VHG's annual valuation cycle. VHG's properties are primarily flagged under nationally recognized brand families, with a select number of independent boutique properties in high-value resort markets.
VHG's senior management team consists of the following key executives:
• Chief Executive Officer: Marcus Delvecchio
• Chief Financial Officer: Renata Haines
• General Counsel and Corporate Secretary: Priya Narayanan
• Treasurer: Glenn Fischbach
Priya Narayanan (General Counsel) and Glenn Fischbach (Treasurer) are expected to serve as VHG's principal points of contact for the engagement team throughout the Transaction, with Renata Haines (CFO) providing oversight and approval on financial and economic terms. We anticipate regular interaction with all three officers as the documentation process progresses.
VHG's business model is characterized by its vertically integrated approach to hotel ownership and management. Through its subsidiary VHG Management Services Inc., the Company provides management services to substantially all of its owned properties, generating both hotel operating revenue and management fee income. This integrated structure is important to the collateral analysis, as it means that the management agreements, associated revenue streams, and related intellectual property (including trademarks, loyalty program assets, and proprietary reservation systems) constitute significant components of the collateral package.
B. Key Financial Metrics (FY2021)
Based on VHG's publicly filed financial statements for the fiscal year ended December 31, 2021, and supplementary financial information provided by Renata Haines (CFO) and Glenn Fischbach (Treasurer), VHG's key financial metrics are as follows:
• FY2021 Total Revenue: $1,420,000,000 ($1.42 billion)
• FY2021 EBITDA (as reported): $318,000,000
• FY2021 Adjusted EBITDA: $341,000,000
The difference between reported EBITDA and Adjusted EBITDA — approximately $23,000,000 — reflects addbacks for items that VHG management characterizes as non-recurring in nature. Based on preliminary discussions with VHG's treasury team, these addbacks include costs associated with property disposition activities, aborted acquisition expenses, pre-opening costs for newly renovated properties, severance and restructuring charges related to corporate headcount rationalization, and certain litigation settlement costs.
It is important to note that the Credit Agreement definition of "Adjusted EBITDA" (or the comparable defined term, such as "Consolidated EBITDA" or "Consolidated Adjusted EBITDA") and the scope of permitted addbacks will be a critical negotiation point in the Transaction. The Adjusted EBITDA definition directly affects the calculation of VHG's leverage ratio for purposes of the financial covenant, the incremental facility capacity (to the extent ratio-based), the excess cash flow sweep mechanics, and the various permissions and baskets throughout the Credit Agreement that are tied to leverage-based thresholds. We discuss this issue in greater detail in Section VI.D below.
C. Credit Ratings
VHG's corporate credit ratings and the expected ratings for the New TLB, as assigned by the two principal rating agencies covering VHG, are as follows:
These ratings position VHG squarely within the leveraged loan market and are consistent with a Term Loan B structure. The split between the corporate family rating and the expected facility rating reflects the structural subordination inherent in the TLB relative to VHG's overall enterprise credit, as well as standard rating agency methodology for secured term loan facilities within leveraged capital structures. Both rating agencies are expected to issue their definitive ratings for the New TLB prior to the launch of syndication in June 2022. Any unexpected deterioration in these ratings — particularly a downgrade below the B+/B1 threshold — could adversely impact syndication execution and may trigger pricing flex provisions in the commitment letter. We address this risk further in Section X below.
III. VHG's Existing Capital Structure
A thorough understanding of VHG's existing capital structure is essential for structuring the Proposed Refinancing, analyzing the payoff mechanics for the Existing TLB, and ensuring that the documentation for the New TLB properly accommodates VHG's outstanding indebtedness. This section provides a detailed summary of each component of VHG's existing debt facilities, followed by a total debt summary and a pro forma analysis of the post-refinancing capital structure.
A. Existing Term Loan B (Greystone Facility)
The key terms of the Existing TLB — which will be refinanced in full and terminated upon closing of the Proposed Refinancing — are summarized below:
Since origination in February 2020, VHG has made scheduled quarterly amortization payments that have reduced the outstanding principal balance of the Existing TLB. Based on our calculations, the aggregate amortization payments made through the anticipated closing date of the Proposed Refinancing have reduced the outstanding principal by approximately $3,125,000, resulting in a current outstanding principal balance of approximately $621,875,000. This figure will be confirmed in the payoff letter to be obtained from Greystone in connection with closing.
The Existing TLB includes a prepayment premium provision that will be triggered upon the full repayment and discharge of the facility. Based on our preliminary review of the Greystone credit agreement, the prepayment premium is calculated at 0.50% of the original principal amount, resulting in a premium of:
$625,000,000 × 0.50% = $3,125,000
In addition, accrued and unpaid interest from the last interest payment date through the anticipated payoff date is estimated at approximately $2,916,667, based on the current applicable LIBOR rate and the 425 basis point margin. The total estimated payoff amount for the Existing TLB is therefore approximately:
Outstanding principal: $621,875,000 Prepayment premium: $3,125,000 Estimated accrued interest: $2,916,667 Total estimated payoff: ~$627,916,667
We note that this estimate is subject to adjustment based on the actual payoff date, the LIBOR rate in effect at the time of payoff, and any additional administrative costs or breakage fees specified in the payoff letter. A detailed analysis of the existing prepayment provisions, assignment restrictions, repricing protections, and other relevant terms of the Greystone credit agreement is currently being prepared by Sophie Tremblay and will be circulated in a separate memorandum targeted for April 14, 2022.
B. Senior Secured Revolving Credit Facility
VHG maintains a $400,000,000 senior secured revolving credit facility (the "RCF") under a separate credit agreement. The key terms of the RCF are as follows:
Crescent Harbor's role as administrative agent for the RCF is noteworthy because Crescent Harbor is also the proposed Administrative Agent and Collateral Agent for the New TLB. This dual-agency role is common in leveraged finance transactions but introduces certain complexities with respect to the intercreditor arrangements, as discussed further below. The RCF is expected to remain undrawn at the closing of the Proposed Refinancing.
The RCF currently shares a first-priority lien on substantially all assets of VHG and its subsidiary guarantors with the Existing TLB, pursuant to an existing intercreditor agreement. Upon closing of the Proposed Refinancing, the existing intercreditor agreement will need to be amended and restated (or replaced in its entirety) to reflect the termination of the Existing TLB and the addition of the New TLB as a pari passu first-lien facility alongside the RCF. The preparation and negotiation of the Amended and Restated Intercreditor Agreement will be a significant workstream and is discussed further in Sections IV.J and VI.E below.
C. Senior Unsecured Notes
VHG has $245,000,000 in aggregate principal amount of senior unsecured notes outstanding (the "Notes"), with the following key terms:
The Notes are unsecured and are effectively subordinated to all of VHG's senior secured indebtedness (including the New TLB and the RCF) to the extent of the value of the collateral securing such senior indebtedness. The indenture governing the Notes will need to be reviewed carefully to ensure that the Proposed Refinancing does not trigger any restrictive covenants, change of control provisions, or event of default provisions contained therein. In particular, we will need to confirm that the incurrence of the New TLB is permitted under the indenture's debt incurrence covenant and that the grant of liens to secure the New TLB is permitted under the indenture's negative pledge covenant. We will also need to analyze the change of control definition in the indenture for consistency with the change of control provisions in the New TLB Credit Agreement, as discussed in Section VI.I below.
D. Total Debt Summary (Pre-Refinancing)
The following table summarizes VHG's total indebtedness as of the date of this memorandum, prior to giving effect to the Proposed Refinancing:
Total funded debt of approximately $866,875,000 is comprised of the approximately $621,875,000 outstanding under the Existing TLB and the $245,000,000 in Senior Unsecured Notes. The RCF is excluded from funded debt as it is currently undrawn.
E. Pro Forma Capital Structure (Post-Refinancing)
Upon closing of the Proposed Refinancing, VHG's capital structure will be as follows:
Key pro forma metrics at closing are as follows:
• Total funded debt at closing: $945,000,000 (comprised of $700,000,000 New TLB plus $245,000,000 Senior Unsecured Notes; the RCF is excluded as undrawn)
• Unrestricted cash on hand (estimated): $87,000,000
• Pro forma net debt: $945,000,000 − $87,000,000 = $858,000,000
• Pro forma Total Net Leverage Ratio: $858,000,000 ÷ $341,000,000 (LTM Adjusted EBITDA) = approximately 2.52x
The pro forma Total Net Leverage Ratio of 2.52x is well within the expected 4.5x maximum Total Net Leverage Ratio covenant under the New TLB, providing VHG with approximately 2.0x of covenant headroom. This substantial headroom is favorable from both a compliance perspective and a strategic perspective, as it preserves significant capacity for VHG to incur additional indebtedness, make acquisitions, and undertake other transactions that may require pro forma compliance with the leverage covenant. The headroom calculation will need to be pressure-tested under various stress scenarios, including a downside operating case and a case in which the RCF is substantially drawn, but the initial pro forma metrics are strong.
IV. Proposed Transaction Structure
A. Facility Terms
The principal terms of the New TLB, as currently proposed, are summarized below. These terms are based on preliminary discussions between VHG, Meridian Strauss Advisory LLC, and Crescent Harbor, and are subject to the receipt and review of Crescent Harbor's formal term sheet, which is expected to be delivered on or about April 22, 2022.
The principal contacts at Crescent Harbor Bank for the Transaction are Ted Marchetti, Managing Director, Leveraged Finance, and Anika Holm, Director, Loan Syndications. Crescent Harbor's headquarters are located at 600 Lexington Avenue, 34th Floor, New York, New York 10022. All correspondence and documentation related to the New TLB should be directed to both Mr. Marchetti and Ms. Holm, with copies to WGP (Harrison Whitfield III and Megan Yeung).
B. Purpose of Proceeds
The proceeds of the New TLB will be applied as follows:
(a) Refinancing of Existing TLB. The primary use of proceeds will be to refinance in full the Existing $625,000,000 Greystone Term Loan B facility. As noted in Section III.A above, the total estimated payoff amount for the Existing TLB is approximately $627,916,667, inclusive of outstanding principal, the 0.50% prepayment premium, and estimated accrued and unpaid interest.
(b) Incremental Proceeds. After satisfaction of the Existing TLB payoff and payment of transaction costs (OID, arrangement fees, advisory fees, and legal/closing costs), the Proposed Refinancing will generate approximately $60,483,333 in net proceeds available to VHG for permitted acquisitions and general corporate purposes. These incremental proceeds will support VHG's active acquisition pipeline, which management has indicated includes several near-term opportunities in the Southeast and Pacific Northwest markets.
C. Pricing
The proposed pricing terms for the New TLB represent a meaningful improvement over VHG's existing borrowing cost under the Greystone Facility. The key pricing parameters are as follows:
Applicable Margin. The applicable margin for the New TLB is proposed at 375 basis points (3.75%) over Adjusted Term SOFR. This represents a 50 basis point reduction from the 425 basis point margin under the Existing TLB. On a $700,000,000 facility, this margin reduction translates to estimated annual interest savings of approximately:
$700,000,000 × 0.50% = $3,500,000 per annum
However, we note that the incremental $75,000,000 in principal (above the approximately $621,875,000 outstanding under the Existing TLB) will partially offset these savings on a total interest cost basis, as VHG will be paying interest on a larger outstanding balance. The net economic benefit of the repricing, taking into account the increased principal amount, the transaction costs, and the OID, should be quantified by Meridian Strauss Advisory LLC in its financial advisory analysis.
SOFR Floor. A SOFR floor of 50 basis points (0.50%) will apply to the Adjusted Term SOFR rate. The floor establishes a minimum base rate for the facility, ensuring that lenders receive a minimum all-in yield even if SOFR rates decline to historically low levels. As of the date of this memorandum, 1-month Term SOFR is trading significantly above the proposed floor, so the floor is not currently economically relevant. However, it provides downside protection for the lender syndicate and is standard in current leveraged loan market practice.
Benchmark. The New TLB will utilize Adjusted Term SOFR as its benchmark interest rate, defined as CME Term SOFR (the forward-looking term rate published by CME Group based on SOFR futures) plus a credit spread adjustment ("CSA") intended to approximate the historical difference between LIBOR and SOFR. The proposed credit spread adjustments are as follows:
These CSA levels are consistent with the fixed spread adjustments recommended by the Alternative Reference Rates Committee ("ARRC") and used in the vast majority of SOFR-based leveraged loan facilities closed in 2021 and early 2022. A more detailed discussion of the SOFR transition mechanics is provided in Section V below.
Illustrative All-In Rate. Based on current 1-month Term SOFR levels (which have been fluctuating in the range of approximately 0.50% to 1.00% as of early April 2022, with upward pressure from recent Federal Reserve rate actions), the estimated all-in interest rate on the New TLB would be in the range of approximately 5.50% to 6.50%. This range is illustrative only and is subject to change based on movements in Term SOFR and the final negotiated margin.
Default Rate. Upon the occurrence and during the continuance of an event of default, the applicable interest rate will automatically increase by 200 basis points (2.00%) above the otherwise-applicable rate. This default rate provision is standard in leveraged loan documentation and will apply to all outstanding principal, accrued interest, and other obligations under the Credit Agreement.
D. Original Issue discount (OID)
The New TLB will be issued at a price of 99.00% of par (i.e., at a 1.00% original issue discount). The dollar amount of the OID is calculated as follows:
$700,000,000 × 1.00% = $7,000,000
As a result, VHG will receive net funding of $693,000,000 from the facility (before deduction of other transaction costs), rather than the full $700,000,000 face amount. The OID effectively increases the yield to lenders above the stated coupon rate, as the lenders acquire the loan at a discount to par but receive interest payments and principal repayment based on the full $700,000,000 par amount.
The tax implications of the OID are being analyzed separately by Leonard Cross, Tax Specialist Partner, and will be addressed in a dedicated tax memorandum targeted for April 18, 2022. Preliminary areas of tax analysis with respect to the OID include the amortization of the OID over the 7-year term of the facility under Internal Revenue Code Sections 1271 through 1275, and whether the facility could be characterized as an applicable high yield discount obligation ("AHYDO") under IRC Section 163(i). We discuss these tax considerations further in Section VII below.
E. Fees
The following fees are payable in connection with the Proposed Refinancing:
The arrangement fee of $3,500,000 is payable to Crescent Harbor in its capacity as Lead Arranger and will be earned and payable upon closing. The upfront fee payable to syndicate lenders (0.25% of each participating lender's committed amount) is structured to be embedded in the OID rather than paid as a separate cash fee; this is a common approach in leveraged loan syndication that simplifies settlement mechanics. The annual administrative agent fee of $150,000 is payable to Crescent Harbor on each anniversary of the closing date for so long as the facility remains outstanding.
The estimated legal and closing costs of approximately $3,200,000 encompass C&H's fees (as borrower's counsel), WGP's fees (as agent's/lenders' counsel, to be paid by VHG as borrower), recording fees, title insurance premiums, survey costs, UCC filing fees, appraisal fees, and other customary closing costs. This estimate is preliminary and subject to revision as the scope of the mortgage and title workstream becomes more defined.
F. Net Proceeds Analysis
The following analysis summarizes the expected application of the New TLB proceeds and the estimated net proceeds available to VHG after satisfaction of all closing obligations:
The net proceeds of approximately $60,483,333 will be deposited into VHG's operating accounts and will be available for permitted acquisitions and general corporate purposes. We note that this figure does not include the arrangement fee payable to Crescent Harbor ($3,500,000), which may be structured as a separate payment obligation or may be netted against proceeds at closing depending on the terms of the fee letter. The final funds flow memorandum prepared in connection with closing will reconcile all sources and uses of proceeds to the penny.
G. Maturity and Amortization
Maturity. The New TLB will have a tenor of seven (7) years from the closing date, resulting in an anticipated maturity date in July 2029 (assuming a closing in mid-to-late July 2022). The seven-year tenor is standard for Term Loan B facilities in the current market and provides VHG with a long-dated maturity profile that extends well beyond the 2028 maturity of its Senior Unsecured Notes.
Amortization. The New TLB will amortize at a rate of 1.00% per annum of the original principal amount, payable in equal quarterly installments. The quarterly amortization payment is calculated as follows:
$700,000,000 × 1.00% ÷ 4 = $1,750,000 per quarter
The 1.00% per annum amortization rate is the market standard for Term Loan B facilities and represents a minimal mandatory repayment obligation. Assuming a seven-year maturity (28 quarterly periods), the total amortization payments over the life of the facility would aggregate to:
$1,750,000 × 28 quarters = $49,000,000
The balloon payment due at maturity would therefore be:
$700,000,000 − $49,000,000 = $651,000,000
This amortization schedule assumes no voluntary prepayments, mandatory prepayments (from excess cash flow sweeps, asset sale proceeds, or casualty event proceeds), or other principal reductions prior to maturity. In practice, VHG's actual outstanding balance at maturity is likely to be lower than $651,000,000 due to the application of mandatory prepayment provisions discussed in Section VI below.
H. Financial Covenants
The New TLB is proposed to include a single financial maintenance covenant, structured as a springing covenant that is tested only under specified circumstances:
Maximum Total Net Leverage Ratio. The Credit Agreement will include a maximum Total Net Leverage Ratio covenant of 4.5x (i.e., the ratio of consolidated net debt to consolidated Adjusted EBITDA for the trailing four fiscal quarter period may not exceed 4.50 to 1.00).
Springing Trigger. Critically, this financial covenant will be tested on a quarterly basis only when the aggregate revolving credit exposure under the RCF exceeds 35% of total revolving commitments. Based on the current $400,000,000 RCF commitment, the testing trigger is calculated as follows:
$400,000,000 × 35% = $140,000,000
Accordingly, the leverage covenant will only be tested in any fiscal quarter in which VHG has more than $140,000,000 in aggregate revolving credit exposure (including drawn amounts, swingline loans, and letters of credit) outstanding under the RCF. Given that the RCF is currently undrawn and is expected to remain undrawn at closing, the springing mechanism means that the financial covenant will not be tested at closing and may not be tested for an extended period absent a significant drawdown.
Pro Forma Compliance at Closing. VHG's pro forma Total Net Leverage Ratio at closing is estimated at 2.52x, as calculated in Section III.E above. This provides approximately 2.0x of headroom relative to the 4.5x covenant level — a significant cushion that should provide comfort to both VHG and the lender syndicate.
No Minimum Interest Coverage Ratio. No minimum interest coverage ratio covenant is contemplated for the New TLB. This is consistent with market practice for Term Loan B facilities, which typically feature either a single springing leverage covenant or no financial maintenance covenants at all ("covenant-lite"). The absence of an interest coverage ratio requirement is favorable for VHG and should be confirmed in the final documentation.
Recommendation. We strongly recommend that the engagement team devote particular attention to negotiating the definition of "Adjusted EBITDA" (or the comparable defined term) in the Credit Agreement. As discussed in Section VI.D below, the Adjusted EBITDA definition directly controls the leverage ratio calculation, and the scope of permitted addbacks will determine the degree of financial flexibility available to VHG under the covenant. Given the $23,000,000 gap between VHG's reported EBITDA and its Adjusted EBITDA, the addback provisions must be sufficiently broad to capture all legitimate non-recurring and pro forma adjustments that VHG may need to rely upon in future periods.
I. Guarantors
The obligations of VHG under the New TLB will be unconditionally guaranteed by each of VHG's material domestic subsidiaries. Based on our preliminary review of VHG's corporate structure, the following entities are expected to serve as Guarantors:
(a) Verimark Resort Properties LLC — a Delaware limited liability company that owns 42 of VHG's 74 hotel properties. As the primary property-owning subsidiary, VRP holds the fee simple and leasehold interests in the real property assets that constitute the core of the collateral package. VRP's guarantee is critical to the security structure, as it provides the lenders with direct recourse to the entity that holds the most valuable collateral.
(b) VHG Management Services Inc. — a Delaware corporation that serves as VHG's hotel management subsidiary. This entity operates substantially all of VHG's owned properties under management agreements and generates management fee revenue. Its assets include the management contracts, associated receivables, and operational intellectual property.
(c) Verimark Convention Holdings LLC — a Delaware limited liability company that owns and operates VHG's convention center and event space portfolio. This subsidiary operates the dedicated meeting, banquet, and convention facilities associated with certain of VHG's larger full-service hotel properties.
(d) Palmetto Beachfront Hotels LLC — a Florida limited liability company that owns VHG's Florida coastal resort portfolio, consisting of 12 hotel properties. Given the concentration of collateral in Florida (12 of the 42 owned properties), Palmetto Beachfront's guarantee is of particular significance.
(e) Cascadia Hospitality Corp. — a Delaware corporation that owns VHG's Pacific Northwest hotel portfolio, consisting of 8 hotel properties located in Washington and Oregon.
Additional subsidiaries may be identified as required Guarantors during the due diligence process, based on the application of the materiality thresholds specified in the Credit Agreement (typically, any domestic subsidiary representing more than a specified percentage of consolidated total assets or consolidated revenue). We will coordinate with VHG's General Counsel, Priya Narayanan, to obtain a complete organizational chart and identify all entities that will be required to provide guarantees.
J. Collateral
The New TLB will be secured by a first-priority lien on substantially all assets of VHG and the Guarantors, sharing pari passu with the $400,000,000 RCF under an Amended and Restated Intercreditor Agreement. The collateral package is summarized below:
Real Property. The collateral will include fee simple and leasehold interests in the 42 hotel properties owned by Verimark Resort Properties LLC (the primary property-owning subsidiary). These 42 properties have been appraised at approximately $2.18 billion in aggregate. Mortgage liens will be recorded against each of the 42 properties, requiring mortgage deliverables across 12 states:
Equity Interests. The collateral will include 100% of the equity interests in each direct domestic subsidiary of VHG and the Guarantors, and 65% of the equity interests in each first-tier foreign subsidiary (the 65% limitation is customary and is designed to avoid adverse tax consequences under IRC Section 956 relating to deemed repatriation of foreign earnings).
Personal Property. The collateral will include accounts, inventory, equipment, intellectual property (including trademarks, trade names, the VHG loyalty program, and proprietary reservation and property management systems), general intangibles, and other personal property assets of VHG and the Guarantors.
Intercreditor Agreement. As noted above, the first-lien collateral will be shared on a pari passu basis between the New TLB and the RCF. Because Crescent Harbor serves as both the Administrative Agent for the RCF and the proposed Administrative Agent and Collateral Agent for the New TLB, the intercreditor arrangements will need to be carefully structured. The existing intercreditor agreement will be amended and restated to add the New TLB as a pari passu first-lien facility and to remove references to the Existing TLB (which will be terminated at closing). The Amended and Restated Intercreditor Agreement will address the relative rights of the TLB lenders and the RCF lenders with respect to collateral enforcement, lien priority, turnover of proceeds, and related matters.
Title Insurance. Title insurance for all 42 mortgaged properties will be obtained from Continental Fidelity Title Company, located at 1221 Brickell Avenue, Suite 900, Miami, Florida 33131. Title insurance commitments, surveys, and related deliverables will be required for each property.
Significant Workstream — Mortgage Deliverables. The mortgage and title workstream is expected to be one of the most labor-intensive and time-sensitive components of the closing process. Coordinating mortgage recordings, title insurance commitments and endorsements, surveys, environmental reports, and flood certifications across 42 properties in 12 separate jurisdictions presents significant logistical challenges. Each state has its own requirements regarding mortgage form, recording procedures, mortgage recording taxes, and title insurance standards. Given the complexity and scope of this workstream, we anticipate that it may be necessary to negotiate a post-closing period for the delivery of certain mortgage deliverables (typically 60 to 90 days following closing) to avoid delaying the closing itself. Daniel Obi will prepare a comprehensive mortgage checklist identifying the specific requirements for each property and jurisdiction.
V. LIBOR-to-SOFR Transition
A. Background
The Existing TLB under the Greystone Facility utilizes LIBOR as its benchmark interest rate, with an applicable margin of 425 basis points. As a consequence of the well-documented cessation of LIBOR, the regulatory directive from the Financial Stability Oversight Council, and the guidance issued by the Federal Reserve Board, the Commodity Futures Trading Commission, and other financial regulatory bodies, the publication of the most widely used U.S. dollar LIBOR tenors (overnight, 1-month, 3-month, 6-month, and 12-month) by the ICE Benchmark Administration is scheduled to cease permanently on June 30, 2023.
In light of this scheduled cessation, regulators and market participants have strongly discouraged new originations of LIBOR-based loans, and the Proposed Refinancing presents a natural and efficient opportunity for VHG to transition from LIBOR to SOFR as its primary interest rate benchmark. Rather than undertaking a standalone amendment of the Existing TLB to incorporate SOFR fallback provisions — which would require the consent of the Required Lenders under the Greystone credit agreement and would not achieve the other commercial objectives of the Transaction — the Proposed Refinancing allows VHG to simultaneously reduce its borrowing cost, extend its maturity, generate incremental proceeds, and complete the LIBOR-to-SOFR transition in a single integrated transaction.
B. Proposed SOFR Mechanics
The New TLB will utilize Adjusted Term SOFR as its primary interest rate benchmark. The specific mechanics are as follows:
Primary Benchmark — Adjusted Term SOFR. The base rate for the New TLB will be CME Term SOFR, the forward-looking term rate published by CME Group Benchmark Administration Limited based on overnight SOFR futures contracts. CME Term SOFR is published daily for 1-month, 3-month, and 6-month tenors, providing a term structure analogous to the LIBOR term rates that borrowers and lenders are accustomed to using.
Adjusted Term SOFR is defined as CME Term SOFR plus a credit spread adjustment ("CSA") intended to account for the historical basis differential between LIBOR and SOFR. LIBOR inherently incorporates a credit risk premium (reflecting the unsecured interbank lending market), whereas SOFR is a nearly risk-free rate (based on overnight Treasury repurchase transactions). The CSA is designed to bridge this gap and ensure that the transition from LIBOR to SOFR is economically neutral for both borrowers and lenders. The proposed CSA levels are:
These CSA levels are consistent with the fixed spread adjustments recommended by the Alternative Reference Rates Committee ("ARRC") and reflect the median historical five-year difference between each LIBOR tenor and its corresponding SOFR-based rate. They have been widely adopted in the leveraged loan market and are considered market standard as of the date of this memorandum.
SOFR Floor. A SOFR floor of 0.50% (50 basis points) will apply to the Adjusted Term SOFR rate. The floor establishes a minimum base rate for the facility, below which the benchmark rate will not fall regardless of the actual published Term SOFR rate. As discussed in Section V.C below, it will be important to confirm that the floor is applied to the base Term SOFR rate (before the addition of the CSA) rather than to the Adjusted Term SOFR rate (after the addition of the CSA), in order to avoid an unintended compounding effect.
Fallback Provisions. The Credit Agreement will include hardwired benchmark replacement language consistent with ARRC recommendations, providing for an automatic transition to a successor benchmark rate in the event that Term SOFR becomes permanently unavailable or is determined to be non-representative. The proposed fallback waterfall is:
(i) Primary Fallback: Term SOFR (if a different administrator publishes an equivalent forward-looking SOFR term rate);
(ii) Secondary Fallback: Daily Simple SOFR (compounded in arrears), plus an appropriate spread adjustment determined by the Administrative Agent in consultation with the Borrower.
The hardwired approach is preferred because it avoids the need for lender consent to effect a benchmark transition in the future, reducing the administrative burden and execution risk associated with a fallback event.
C. Key Considerations
Several aspects of the SOFR mechanics will require careful attention during the documentation process:
Credit Spread Adjustment Validation. We should confirm that the proposed CSA levels (+0.10% for 1-month, +0.15% for 3-month, and +0.25% for 6-month) remain consistent with market standard practice at the time of execution. While these levels are well-established, there has been some market discussion regarding whether fixed CSAs will remain appropriate as the SOFR market matures and the historical LIBOR/SOFR basis differential becomes less relevant. For present purposes, the proposed CSA levels are appropriate and consistent with virtually all recently closed leveraged loan transactions.
Interest Period Mechanics. VHG should have the flexibility to select interest periods of 1-month, 3-month, or 6-month duration, and to change its interest period election on each rollover date. This flexibility is important for VHG's treasury management, as it allows the Company to optimize its interest cost profile based on the prevailing shape of the SOFR term structure. We should confirm that no minimum notice period or administrative constraints unduly restrict VHG's ability to select its preferred interest period.
Floor Application. It is important to ensure that the 0.50% SOFR floor is applied to the base Term SOFR rate (before the addition of the CSA and the applicable margin), consistent with market convention. Specifically, the all-in interest rate should be calculated as:
Interest Rate = max(Term SOFR, 0.50%) + CSA + Applicable Margin (3.75%)
If the floor were inadvertently applied to the Adjusted Term SOFR rate (i.e., Term SOFR + CSA), the effect would be to increase the effective floor by the amount of the CSA, resulting in a marginally higher minimum rate. While the difference is modest (10 to 25 basis points depending on the tenor), it is a point that should be clarified in the documentation.
Administrative Readiness. We should confirm that Crescent Harbor Bank, as Administrative Agent, has full operational readiness for SOFR-based lending, including the ability to publish SOFR-based interest rate notices, calculate interest payments on an Adjusted Term SOFR basis, administer the conforming changes provisions, and handle the benchmark replacement mechanics if a fallback event occurs. Given that Crescent Harbor is a major financial institution with an active leveraged lending platform, we do not anticipate material administrative concerns, but this should be confirmed during the term sheet negotiation process.
D. Separate Memorandum
Given the technical complexity of the SOFR transition mechanics and their importance to the overall economic terms of the Transaction, a detailed SOFR transition mechanics memorandum will be prepared by Daniel Obi, in consultation with Sophie Tremblay, and is targeted for circulation in late May 2022. That memorandum will address the specific documentation language for the benchmark provisions, the conforming changes mechanism, the fallback waterfall, and any open questions regarding the interaction between the SOFR mechanics and other provisions of the Credit Agreement (including the interest period, default rate, and breakage provisions).
VI. Key Negotiation Points
This section identifies and analyzes the principal negotiation issues that we anticipate will arise during the documentation process for the Proposed Refinancing. For each issue, we summarize the relevant background, describe the expected position of Crescent Harbor and the lender syndicate, articulate VHG's negotiation objectives, and provide our preliminary recommendations. These recommendations are subject to discussion with Ian Blackwood and refinement as the negotiation progresses.
A. Most Favored Nation (MFN) Provision
Issue. Crescent Harbor, on behalf of the initial lender syndicate, will almost certainly require the inclusion of a Most Favored Nation ("MFN") clause in the Credit Agreement. The MFN provision is designed to protect the initial TLB lenders' economic bargain by providing that, if VHG subsequently incurs incremental term loans at a higher effective yield than the initial TLB, the margin on the initial TLB will be automatically adjusted upward to ensure that the initial lenders' yield remains within a specified tolerance (the "MFN Threshold") of the higher-yielding incremental term loans. The MFN provision is a standard feature of leveraged loan credit agreements and is a key focus area for both borrowers and lenders.
Proposed Structure. The expected MFN structure is as follows: if VHG incurs incremental term loans with an effective yield that exceeds the effective yield of the initial TLB by more than the MFN Threshold, the applicable margin on the initial TLB will be automatically increased by the amount necessary to reduce the yield differential to the MFN Threshold. For example, if the MFN Threshold is 50 basis points and VHG incurs an incremental term loan with an effective yield that is 75 basis points higher than the initial TLB, the initial TLB margin would be increased by 25 basis points (75 bps − 50 bps = 25 bps) to bring the differential within the 50 bps threshold.
Client Objectives. VHG's negotiation objectives with respect to the MFN provision are as follows:
(a) Maximize the MFN Threshold. The market range for MFN thresholds in current leveraged loan transactions is 50 to 75 basis points. A higher threshold provides VHG with greater flexibility to incur incremental term loans at competitive market rates without triggering an upward adjustment to the initial TLB margin. We recommend targeting an MFN Threshold of 50 basis points, which is at the borrower-favorable end of the market range but well within the range of negotiated outcomes for credits of VHG's quality.
(b) Secure a Finite MFN Sunset Period. VHG should negotiate for the MFN provision to expire after a defined period following the closing date (the "MFN Sunset Period"). After the MFN Sunset Period, VHG would be free to incur incremental term loans at any yield without triggering an adjustment to the initial TLB margin. Market precedents in the hospitality and broader leveraged loan space suggest MFN Sunset Periods in the range of 12 to 24 months from closing. We recommend targeting an 18-month MFN Sunset Period, which balances the lenders' legitimate interest in protecting their initial investment with VHG's need for long-term flexibility.
(c) Clear Yield Calculation Methodology. The definition of "effective yield" for purposes of the MFN calculation must be precisely defined. Key questions include whether the yield calculation includes or excludes OID, upfront fees, SOFR floors, and credit spread adjustments. VHG should seek to exclude OID and upfront fees from the yield calculation (or, if they are included, to include only the portion of OID amortized over the first 12 months), as the inclusion of these components can distort the yield comparison and make it more difficult for VHG to incur incremental term loans without triggering the MFN.
Interaction with Incremental Facility Basket. The MFN provision should apply only to incremental term loans that are fungible with, or have substantially similar terms to, the initial TLB (e.g., same maturity, same collateral priority, same currency). Incremental term loans that are structured as "sidecar" facilities — with different maturities, different collateral priorities, or other structurally distinct features — should be carved out from the MFN provision. This carve-out provides VHG with the flexibility to access different tranches of the debt capital markets without triggering the MFN protection.
Recommendation. We recommend preparing a detailed strategy memorandum on MFN negotiation, including a survey of recent market data on MFN thresholds, sunset periods, and yield calculation methodologies in comparable hospitality and leveraged loan transactions. This memorandum will be used to support VHG's negotiating positions with concrete market precedents.
B. Repricing Protection (Soft Call)
Issue. Crescent Harbor and the syndicate lenders will seek protection against early repricing of the New TLB — that is, a transaction in which VHG refinances or amends the TLB to achieve a lower effective yield within a short period after closing. From the lenders' perspective, they have underwritten the facility at a yield calibrated to compensate them for the credit risk, and a rapid repricing would diminish the expected economic return on their investment. The standard market mechanism for this protection is a "soft call" premium.
Proposed Structure. A prepayment premium of 1.00% of the principal amount prepaid will apply if VHG reprices or refinances the New TLB at a lower effective yield within a specified period following closing (the "Soft Call Period"). At the maximum exposure level (full prepayment of the entire $700,000,000 facility within the Soft Call Period), the dollar cost of the soft call premium would be:
1.00% × $700,000,000 = $7,000,000
Client Objectives. VHG's negotiation objectives with respect to the repricing protection are as follows:
(a) Limit the Soft Call Period to 6 Months. The market range for Soft Call Periods is 6 to 12 months from closing. A shorter Soft Call Period provides VHG with earlier optionality to reprice the facility if market conditions improve. We recommend targeting a 6-month Soft Call Period, which is at the more borrower-favorable end of the range and is achievable for credits of VHG's quality.
(b) Ensure Narrow Application. The soft call premium should apply only to repricing transactions — that is, prepayments or amendments that are undertaken for the primary purpose of reducing the effective yield on the TLB. The soft call premium should not apply to: (i) voluntary prepayments from asset sale proceeds, casualty event proceeds, or excess cash flow sweeps (which are already mandatory under the Credit Agreement); (ii) prepayments made in connection with a change of control or other transformative corporate event; or (iii) regularly scheduled amortization payments. Negotiating clear carve-outs for these categories of prepayments is essential to prevent the soft call premium from operating as a general prepayment penalty, which would be inconsistent with market practice for leveraged Term Loan B facilities.
Recommendation. We recommend negotiating express carve-outs from the repricing premium for all categories of mandatory prepayments and for voluntary prepayments that are not undertaken for repricing purposes. The Credit Agreement language should clearly delineate between "Repricing Transactions" (which trigger the premium) and other prepayment events (which do not).
C. Incremental Facility Provisions
VHG will want to preserve the flexibility to incur additional indebtedness in the future through the incremental facility provisions of the Credit Agreement, without the need to negotiate a new credit facility or obtain the consent of the existing lender syndicate. The incremental facility provisions allow VHG to incur additional term loan tranches and/or increase the revolving credit commitments under specified conditions. Key sub-issues include:
(a) Size of Incremental Basket. The Credit Agreement should provide for an incremental basket consisting of both a fixed dollar amount (e.g., $150,000,000 to $200,000,000) and a ratio-based "grower" basket that permits additional incremental indebtedness up to a specified pro forma leverage level (e.g., incurrence of incremental term loans permitted so long as the pro forma First Lien Net Leverage Ratio does not exceed a specified threshold). The combination of fixed and ratio-based baskets provides maximum flexibility, as the fixed basket is available regardless of VHG's leverage level, while the ratio-based basket expands VHG's incremental capacity as its leverage declines over time.
(b) Conditions to Incurrence. The conditions to the incurrence of incremental term loans will typically include (i) the absence of any default or event of default, (ii) pro forma compliance with the applicable leverage test (if ratio-based), (iii) certain documentation requirements (including delivery of a compliance certificate and evidence of board authorization), and (iv) compliance with the MFN provision (as discussed in Section VI.A above). VHG should ensure that the conditions are not overly burdensome and do not create practical impediments to accessing the incremental basket on a timely basis.
(c) MFN Interaction. As discussed above, the MFN provision will apply to incremental term loans incurred during the MFN Sunset Period. VHG should negotiate the broadest possible carve-outs and the most favorable MFN Threshold to minimize the constraints imposed by the MFN on incremental borrowing.
(d) Most Favored Borrower Provisions. Certain incremental term loan structures include "most favored borrower" provisions that require the incremental lenders to extend terms to VHG that are at least as favorable as the terms extended to other similarly situated borrowers. These provisions are relatively unusual in the leveraged loan market and may or may not be relevant to the Proposed Refinancing.
Recommendation. We recommend negotiating a ratio-based incremental basket in addition to a meaningful fixed dollar basket, and ensuring that the conditions to incurrence are reasonable and market-standard. The interplay between the incremental facility provisions and the MFN provision should be carefully structured to preserve VHG's future flexibility.
D. EBITDA Definition and Addbacks
The definition of Adjusted EBITDA (or the comparable defined term used in the Credit Agreement, such as "Consolidated EBITDA" or "Consolidated Adjusted EBITDA") is one of the most consequential provisions in the entire Credit Agreement. It directly affects:
(i) The calculation of the Total Net Leverage Ratio for purposes of the springing financial covenant; (ii) The size of the ratio-based incremental facility basket; (iii) The calculation of Excess Cash Flow for purposes of the mandatory prepayment sweep; (iv) The availability of various permissions, baskets, and exceptions throughout the Credit Agreement that are conditioned on compliance with specified leverage levels; and (v) The grower baskets for restricted payments, investments, and other builder provisions.
As noted in Section II.B above, VHG's FY2021 EBITDA was $318,000,000, while its Adjusted EBITDA (as calculated by VHG management) was $341,000,000 — a difference of approximately $23,000,000. The $23,000,000 gap between reported EBITDA and Adjusted EBITDA is attributable to addbacks for items that VHG management characterizes as non-recurring in nature, including property disposition costs, aborted acquisition expenses, pre-opening costs, severance and restructuring charges, and litigation settlement costs.
It is critical that the addback provisions in the Credit Agreement's Adjusted EBITDA definition be sufficiently broad to capture all of these items and to provide adequate flexibility for similar non-recurring adjustments in future periods. Typical addback categories in leveraged loan credit agreements include:
• Non-recurring charges, expenses, and losses (often subject to a cap, such as a percentage of Adjusted EBITDA or a fixed dollar amount)
• Restructuring costs and severance payments
• Pro forma cost savings and synergies from acquisitions, dispositions, and restructuring actions (often subject to a "run rate" requirement and a time-horizon limitation)
• Management fees and monitoring fees paid to sponsors or affiliates (less relevant for VHG as a publicly traded company, but may apply to certain inter-company management arrangements)
• Stock-based compensation expense (non-cash)
• Transaction costs, fees, and expenses incurred in connection with financings, acquisitions, and other permitted transactions
Recommendation. We recommend conducting a detailed review of the audit workpapers of Clearmont & Wharton LLP, VHG's independent registered public accounting firm (Ronald Ashby, engagement partner), regarding VHG's non-recurring adjustments. This review will enable us to fully understand the nature of the $23,000,000 in addbacks, assess whether each item is likely to be accepted by the lender syndicate as a permissible addback, and negotiate the Credit Agreement definitions accordingly. We should also analyze the Adjusted EBITDA definitions in comparable recent hospitality credit agreements to establish market benchmarks for the scope of permitted addbacks.
E. Permitted Indebtedness and Lien Baskets
The Credit Agreement's negative covenants restricting indebtedness and liens must be structured to accommodate VHG's existing and anticipated debt obligations, including:
(a) The existing $245,000,000 Senior Unsecured Notes (due 2028, with Atlantic Standard Trust Company as indenture trustee); (b) The $400,000,000 Senior Secured Revolving Credit Facility; (c) Customary general baskets for ordinary course indebtedness (including intercompany loans, capitalized leases, purchase money indebtedness, and letters of credit); (d) An acquisition basket for indebtedness incurred or assumed in connection with permitted acquisitions; and (e) Other customary carve-outs appropriate for a company of VHG's size, complexity, and business requirements.
The permitted lien baskets must be coordinated with the Amended and Restated Intercreditor Agreement to ensure consistency between the lien priority framework established by the intercreditor agreement and the permissions granted under the Credit Agreement. Specifically, the permitted lien provisions should clearly authorize the first-priority liens securing the RCF (on a pari passu basis with the New TLB) and the absence of liens on the assets securing the Senior Unsecured Notes (which are unsecured by their terms).
F. Asset Sale / Casualty Mandatory Prepayment
The Credit Agreement will include mandatory prepayment provisions requiring VHG to apply the net proceeds of certain asset sales and casualty events to prepay the New TLB. These provisions are standard in leveraged Term Loan B facilities and serve as a credit protection mechanism for the lender syndicate. Key negotiation points include:
(a) Reinvestment Rights. VHG should negotiate the right to reinvest asset sale and casualty proceeds in replacement assets or capital expenditures within a specified reinvestment period (typically 12 to 18 months, with an additional 6-month extension if VHG has committed to reinvest within the initial period). Qualifying reinvestments should include the acquisition of hotel properties, renovation expenditures, and other investments in similar lines of business.
(b) Leverage-Based Step-Downs. The percentage of net proceeds required to be applied to mandatory prepayment should step down as VHG's leverage decreases, incentivizing deleveraging. A typical structure would require prepayment of 100% of net proceeds at leverage levels above a specified threshold (e.g., 3.5x), stepping down to 50% at intermediate leverage levels, and potentially stepping down further to 0% at low leverage levels.
(c) De Minimis Exception. Asset sales and casualty events with net proceeds below a specified de minimis threshold (e.g., $5,000,000 individually or $15,000,000 in the aggregate per fiscal year) should be excluded from the mandatory prepayment obligation.