PRIVILEGED AND CONFIDENTIAL ATTORNEY WORK PRODUCT
INTERNAL MEMORANDUM
CALDERWOOD & HARKNESS LLP One Liberty Plaza, 52nd Floor New York, New York 10006
May 30, 2022
This memorandum is a privileged and confidential attorney work product prepared by Calderwood & Harkness LLP for internal use in connection with the representation of Crescent Harbor Bank, N.A. This memorandum is protected by the attorney-client privilege and the work product doctrine. It should not be disclosed to any person outside of Calderwood & Harkness LLP without the express written consent of Ian Blackwood. Distribution within the firm should be limited to those attorneys and staff directly involved in the Verimark Hospitality Group Inc. engagement.
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I. Executive Summary
The purpose of this memorandum is to analyze the confidential syndication flex provisions contained in the Letter Agreement — Syndication Flex Provisions dated May 27, 2022 (the "Flex Letter") between Verimark Hospitality Group Inc. ("VHG" or the "Borrower") and Crescent Harbor Bank, N.A. ("Crescent Harbor," "CHB," or the "Lead Arranger"), which was executed contemporaneously with the Commitment Letter dated May 27, 2022 (the "Commitment Letter"). The Flex Letter grants Crescent Harbor, in its capacity as Lead Arranger and Bookrunner for the proposed $700,000,000 Term Loan B facility (the "Term Loan B" or the "Facility"), the right to adjust certain pricing and structural terms of the Facility if market conditions necessitate such adjustments to achieve successful syndication.
This memorandum provides a comprehensive analysis of each flex provision contained in the Flex Letter, models five pricing scenarios ranging from the base case (no flex exercise) through the worst-case scenario (full exercise of all available flex provisions), and quantifies the impact of each scenario on VHG's all-in borrowing cost, net funding proceeds, and pro forma leverage. Additionally, this memorandum confirms that VHG would remain in compliance with the springing maximum total net leverage ratio covenant of 4.50x under each modeled scenario.
Key Conclusion. Even under the worst-case scenario involving full adverse exercise of all flex provisions — including a 50 basis point margin increase, an OID increase to 2.00% of par, a 25 basis point increase to the SOFR floor, a tightening of the MFN threshold by 25 basis points, and an extension of the repricing protection period to 12 months — VHG's pro forma net leverage ratio remains at approximately 2.52x, well within the 4.50x maximum covenant level, providing approximately 1.98 turns of headroom. The incremental annual interest cost under full margin flex is approximately $3,500,000, which, while meaningful in absolute terms, is manageable relative to VHG's last-twelve-months ("LTM") Adjusted EBITDA of $341,000,000 (representing approximately 1.0% of Adjusted EBITDA). The worst-case scenario would, however, substantially diminish the primary commercial rationale for the refinancing — namely, the achievement of spread savings relative to the existing Greystone facility — and would reduce net proceeds available to VHG by approximately $7,000,000 due to the increased OID. These impacts warrant clear communication to VHG management so that internal walk-away thresholds can be established in advance of the anticipated syndication launch.
Related Documents. This memorandum should be read in conjunction with the following documents:
(a) the Commitment Letter dated May 27, 2022 between VHG and Crescent Harbor;
(b) the Fee Letter dated May 27, 2022 between VHG and Crescent Harbor;
(c) the Flex Letter dated May 27, 2022 between VHG and Crescent Harbor; and
(d) the Internal Memorandum — MFN Sunset and Repricing Protection Negotiation Strategy dated May 10, 2022 prepared by S. Tremblay.
II. Background and Deal Terms Recap
A. Transaction Overview
VHG is undertaking a refinancing of its existing $625,000,000 Term Loan B credit facility (the "Existing TLB"), which was originated on February 14, 2020 with Greystone Federal Credit Corp. ("Greystone") serving as administrative agent. The Existing TLB bears interest at LIBOR plus 425 basis points with a LIBOR floor of 75 basis points, and was issued at an original issue discount of 0.50%. As of the anticipated payoff date, the outstanding principal balance of the Existing TLB will be approximately $621,875,000, reflecting $3,125,000 of scheduled amortization payments since origination.
Under the proposed transaction, VHG will enter into a new $700,000,000 Term Loan B credit facility, with Crescent Harbor serving in the capacities of Administrative Agent, Collateral Agent, Lead Arranger, and Bookrunner. The $75,000,000 incremental borrowing over the Existing TLB provides VHG with additional liquidity for general corporate purposes, including potential acquisitions in the hospitality sector consistent with VHG's stated growth strategy.
The parties are targeting a simultaneous sign-and-close execution in late July 2022, with the anticipated closing date of July 21, 2022. The transaction timeline contemplates a syndication launch on or about June 6, 2022, followed by lender presentations during the week of June 13–17, 2022, with a target final allocation date of June 30, 2022. This timeline is aggressive but reflects Crescent Harbor's confidence in the marketability of the credit and the desire to close before the late-summer market slowdown.
B. Base Case Pricing Terms (Per Commitment Letter / Term Sheet)
The following summarizes the pricing terms set forth in the Commitment Letter and the Term Sheet attached thereto as Exhibit A, which represent the "base case" pricing prior to any exercise of flex provisions:
Applicable Margin: 375 basis points (3.75%) over Adjusted Term SOFR (as defined in the Term Sheet, which incorporates the CME Term SOFR Reference Rate plus the applicable SOFR credit spread adjustment of 10 basis points for the one-month tenor).
SOFR Floor: 50 basis points (0.50%). The Adjusted Term SOFR rate used for interest calculations shall not be less than 0.50% per annum.
Original Issue discount: 1.00% of par, representing $7,000,000 on the $700,000,000 commitment. Net funding to VHG at closing will be $693,000,000 prior to application of other fees and expenses.
Arrangement Fee: 0.50% of the aggregate commitment, totaling $3,500,000, payable to Crescent Harbor at closing for its services as Lead Arranger and Bookrunner.
Upfront Fee to Syndicate Lenders: 0.25% of each syndicate lender's allocated commitment, embedded within the 1.00% OID (i.e., 75 basis points of the OID is retained by CHB, and 25 basis points is passed through to syndicate lenders as an upfront participation incentive).
Administrative Agent Fee: $150,000 per annum, payable quarterly in arrears to Crescent Harbor in its capacity as Administrative Agent.
Advisory Fee: 0.20% of the aggregate commitment, totaling $1,400,000, payable at closing to Meridian Strauss Advisory LLC ("Meridian Strauss"), VHG's financial advisor, for advisory services rendered in connection with the refinancing.
Maturity: Seven (7) years from the closing date, maturing on July 21, 2029.
Amortization: 1.00% per annum of the original principal amount, payable in equal quarterly installments of $1,750,000 each, with the balance due at maturity.
Repricing Protection: A 1.00% soft call premium applies for a period of six (6) months following the closing date (through January 21, 2023), applicable in the event of any repricing transaction that reduces the effective yield of the Term Loan B.
MFN Threshold: 50 basis points. Any incremental term loan facility incurred within the MFN sunset period that bears an effective yield exceeding the initial Term Loan B yield by more than 50 basis points will trigger an upward adjustment to the initial Term Loan B margin to eliminate the differential in excess of the threshold.
MFN Sunset: 18 months from the closing date (through January 21, 2024). Following the sunset date, incremental term loan facilities may be incurred without regard to the MFN provision.
At the base case pricing, and using a one-month Term SOFR rate of approximately 2.29% as of late May 2022, the illustrative all-in coupon rate is calculated as follows:
1-month Term SOFR (~2.29%) + SOFR credit spread adjustment (10 bps) + Applicable Margin (375 bps) = approximately 6.14% per annum.
C. VHG Capital Structure Context
To provide context for the covenant compliance analysis and the relative significance of the flex provisions, the following sets forth VHG's pro forma capital structure at closing on a base case basis:
Funded Debt at Closing:
• New Term Loan B: $700,000,000
• Senior Unsecured Notes due 2028 (7.25% coupon; Atlantic Standard Trust Company as indenture trustee; CUSIP 92347KAC5): $245,000,000
• Total Pro Forma Funded Debt: $945,000,000
Revolving Credit Facility: $400,000,000 (undrawn at closing; provided under the same Credit Agreement as the Term Loan B, with Crescent Harbor as Administrative Agent).
Unrestricted Cash: $87,000,000 (based on VHG management's projections for the anticipated closing date, net of transaction costs).
Pro Forma Net Debt: $945,000,000 − $87,000,000 = $858,000,000
LTM Adjusted EBITDA (FY2021): $341,000,000, as reported in VHG's audited financial statements for the fiscal year ended December 31, 2021, prepared by Clearmont & Wharton LLP (Ronald Ashby, engagement partner), and as adjusted in accordance with the Adjusted EBITDA definition in the Term Sheet.
Pro Forma Net Leverage Ratio at Closing (Base Case): $858,000,000 ÷ $341,000,000 = 2.52x
This provides substantial headroom relative to the 4.50x maximum total net leverage ratio covenant, as discussed in greater detail in Section V below.
Credit Ratings:
• Kellaway Ratings Group: BB- (corporate family rating)
• Pinnacle Credit Services: Ba3 (corporate family rating)
VHG's credit profile reflects its position as a mid-market hospitality operator with a diversified portfolio of branded hotel properties, stable cash flow generation, and moderate leverage. The credit ratings place VHG solidly in the upper tier of the broadly syndicated loan market, which supports Crescent Harbor's expectation of robust syndication demand at the base case pricing levels.
III. Summary of Flex Provisions
The Flex Letter sets forth four categories of flex provisions available to Crescent Harbor as Lead Arranger: (A) margin flex (spread flex), (B) OID flex (Discount flex), (C) SOFR floor flex, and (D) structural flex (encompassing adjustments to amortization, the MFN threshold, and the repricing protection period). Each category is discussed below, together with an analysis of its economic impact and relevant negotiation context.
A. Margin Flex (Spread Flex)
Crescent Harbor has the right to increase the applicable margin on the Term Loan B by up to 50 basis points, from 375 basis points to a maximum of 425 basis points over Adjusted Term SOFR. The margin flex may be exercised in increments at Crescent Harbor's discretion (i.e., CHB is not required to exercise the full 50 basis points and may exercise a partial flex of, for example, 25 basis points if that is sufficient to achieve successful syndication).
The economic significance of the margin flex provision is considerable. A full 50 basis point increase to the applicable margin would return VHG's borrowing spread to 425 basis points — the identical spread applicable under the Existing TLB with Greystone. This would effectively eliminate the 50 basis point spread savings that constitutes one of the core commercial rationales for the refinancing transaction. At a margin of 425 basis points on $700,000,000 of funded debt, the incremental annual interest cost relative to the base case would be approximately $3,500,000.
It is worth noting the negotiation context of this provision. During the initial Commitment Letter negotiations, VHG, through its outside counsel and Meridian Strauss, sought to cap the margin flex at 25 basis points, arguing that a 50 basis point flex would negate the spread savings objective of the refinancing. Crescent Harbor's syndication desk, led by Ted Marchetti (Managing Director, Loan Syndication) and Anika Holm (Director, Loan Syndication), insisted on the 50 basis point cap, citing elevated credit market volatility in the spring of 2022 attributable to rising interest rates, geopolitical uncertainty related to the Russia-Ukraine conflict, and a broader repricing in the leveraged loan market. After several rounds of negotiation, the 50 basis point cap was ultimately agreed by VHG, with the understanding that Crescent Harbor would exercise commercially reasonable efforts to minimize any exercise of the margin flex.
B. OID Flex (Discount Flex)
Crescent Harbor has the right to increase the original issue discount from 1.00% to a maximum of 2.00% of par. At the base case OID of 1.00%, the discount represents $7,000,000, resulting in net funding of $693,000,000. At the maximum OID of 2.00%, the discount would increase to $14,000,000, reducing net funding to $686,000,000.
The primary effect of an OID increase is twofold. First, it increases the effective yield to syndicate lenders by providing a greater day-one discount on the par amount of the loan, which is amortized as additional yield over the expected life of the facility. Second, it reduces the net cash proceeds available to VHG at closing, which directly impacts the funds flow and the quantum of excess proceeds available after payoff of the Existing TLB and payment of transaction fees and expenses.
Unlike margin flex, OID flex does not increase VHG's ongoing periodic interest expense — the coupon rate remains unchanged. The cost to VHG is realized in the form of reduced upfront proceeds. From a lender syndication perspective, OID flex is sometimes viewed as a less visible form of yield enhancement than a margin increase, as it does not appear in the stated coupon rate and is therefore less likely to generate negative market signaling.
C. SOFR Floor Flex
Crescent Harbor has the right to increase the SOFR floor from 50 basis points to a maximum of 75 basis points. The SOFR floor establishes a minimum Adjusted Term SOFR rate for purposes of calculating interest, such that VHG's effective borrowing rate cannot fall below the floor rate plus the applicable margin, regardless of how low the actual Term SOFR rate may decline.
The current economic impact of the SOFR floor flex is nil. As of late May 2022, the one-month Term SOFR rate stands at approximately 2.29%, which significantly exceeds both the 50 basis point base case floor and the 75 basis point maximum flex floor. The floor is therefore not currently binding and has no effect on VHG's interest expense under present market conditions.
However, the SOFR floor flex carries meaningful significance in a declining rate environment. If Term SOFR were to fall below 75 basis points in the future (a scenario that, while not anticipated in the near term given current Federal Reserve tightening, cannot be ruled out over the seven-year tenor of the facility), the higher floor would result in VHG paying a higher effective rate than it would under the base case 50 basis point floor. In a scenario where Term SOFR declines to zero, for example, the 25 basis point difference in floors would translate to an additional $1,750,000 in annual interest expense ($700,000,000 × 25 bps). This is an asymmetric risk that primarily affects VHG in stressed economic conditions where central bank policy drives rates to near-zero levels.
D. Structural Flex
The structural flex provisions in the Flex Letter address non-pricing terms that may be adjusted to enhance the marketability of the Term Loan B to potential syndicate lenders. The structural flex provisions are as follows:
Amortization: Crescent Harbor may restructure the amortization schedule; however, the amortization rate is locked at 1.00% per annum. No upward flex on amortization was agreed during negotiations. VHG successfully resisted any increase to the annual amortization rate, which remains at $7,000,000 per annum payable in equal quarterly installments of $1,750,000.
Maturity, Covenant Levels, and Collateral/Guarantor Package: The Flex Letter expressly provides that Crescent Harbor may not alter the maturity date of the Term Loan B, the financial covenant levels (including the 4.50x springing maximum total net leverage ratio), or the collateral and guarantor package without VHG's prior written consent. These are non-flexable terms that provide important protections for VHG.
MFN Threshold Adjustment: Crescent Harbor may adjust the MFN threshold downward by up to 25 basis points, from 50 basis points to a minimum of 25 basis points. This means that, in the worst case, any incremental term loan facility incurred during the 18-month MFN sunset period (through January 21, 2024) that bears an effective yield exceeding the initial Term Loan B yield by more than 25 basis points (rather than 50 basis points) would trigger an upward adjustment to the initial Term Loan B margin. A tighter MFN threshold effectively constrains VHG's flexibility to incur incremental term loan debt at higher yields without triggering a ratchet adjustment to the existing facility.
Repricing Protection Period Extension: Crescent Harbor may extend the repricing protection period from 6 months to up to 12 months following the closing date. Under the base case, the soft call period expires on January 21, 2023 (six months post-closing). If the repricing protection is extended to 12 months, the soft call period would not expire until July 21, 2023. During the soft call period, any repricing transaction that reduces the effective yield of the Term Loan B would require VHG to pay a 1.00% prepayment premium, equal to $7,000,000 on the initial $700,000,000 commitment.
E. Limitations on Flex Exercise
The Flex Letter contains several important limitations on Crescent Harbor's ability to exercise the flex provisions, which provide procedural and substantive protections for VHG:
(a) Consultation Requirement. Crescent Harbor must consult with VHG prior to exercising any flex provision. The consultation must be directed to Renata Haines (Chief Financial Officer) and Glenn Fischbach (Treasurer) as VHG's designated contacts for flex-related communications. While the Flex Letter requires consultation, it does not require VHG's consent to the exercise of flex (other than for changes to the non-flexable terms identified above).
(b) Reasonable Necessity Standard. Flex may only be exercised if reasonably necessary to achieve successful syndication, defined as obtaining commitments from syndicate lenders totaling the full $700,000,000 facility amount. Crescent Harbor may not exercise flex provisions merely to increase lender participation beyond the required amount or to improve its own economic position as an arranger.
(c) Commercially Reasonable Efforts. Crescent Harbor must use commercially reasonable efforts to minimize the exercise of flex provisions. This standard requires Crescent Harbor to explore alternatives to flex exercise (such as adjusting lender allocation, increasing its own hold position, or modifying syndication strategy) before resorting to pricing adjustments.
(d) Expiration Upon Syndication Completion. The flex provisions automatically expire upon completion of the syndication process, defined as the date of final allocation of commitments among syndicate lenders. Based on the current timeline, the flex provisions are expected to expire on or about June 30, 2022.
IV. Downside Scenario Analysis
This section presents five pricing scenarios, ranging from the base case (no flex exercise) through the worst case (full exercise of all available flex provisions). Each scenario is modeled using a one-month Term SOFR rate assumption of approximately 2.29% as of late May 2022, plus the 10 basis point SOFR credit spread adjustment applicable to the one-month tenor. It should be noted that Term SOFR is a floating rate and will fluctuate over the life of the facility; the scenarios below are illustrative based on current rates and are intended to isolate the incremental impact of flex exercise.
A. Scenario 1: Base Case (No Flex Exercised)
Under the base case, no flex provisions are exercised and the Term Loan B is syndicated at the pricing terms set forth in the Commitment Letter and Term Sheet:
Applicable Margin: 375 basis points
OID: 1.00% ($7,000,000)
SOFR Floor: 50 basis points
Net Funding: $693,000,000
Illustrative All-In Coupon Rate: 1-month Term SOFR (~2.29%) + SOFR credit spread adjustment (10 bps) + Applicable Margin (375 bps) = approximately 6.14% per annum
Estimated Annual Interest Expense on $700M: approximately $42,980,000
Annual Interest Savings vs. Existing Greystone TLB: approximately $3,500,000 (reflecting the 50 basis point reduction in applicable margin from 425 bps to 375 bps, applied to the $700,000,000 principal amount)
Net Proceeds to VHG After Payoff and Transaction Costs: The funds flow under the base case is as follows: $693,000,000 net funding minus $627,916,667 payoff of the Existing Greystone TLB (consisting of $621,875,000 principal, approximately $2,916,667 accrued interest, and $3,125,000 prepayment premium), minus $1,400,000 Meridian Strauss advisory fee, minus approximately $3,200,000 in estimated legal and closing costs = approximately $60,483,333 in net excess proceeds available to VHG for general corporate purposes.
Pro Forma Net Leverage: $858,000,000 ÷ $341,000,000 = 2.52x (headroom of 1.98x to the 4.50x covenant)
The base case represents the optimal outcome for VHG and delivers meaningful spread savings relative to the Existing TLB while providing $75,000,000 in incremental borrowing capacity and transitioning VHG's reference rate from LIBOR to SOFR in advance of the anticipated LIBOR cessation.
B. Scenario 2: Margin Flex Only (+25 bps)
Under this scenario, Crescent Harbor exercises a partial margin flex of 25 basis points, increasing the applicable margin from 375 basis points to 400 basis points. No other flex provisions are exercised.
Applicable Margin: 400 basis points (375 + 25)
OID: 1.00% ($7,000,000)
SOFR Floor: 50 basis points
Net Funding: $693,000,000
Illustrative All-In Coupon Rate: 1-month Term SOFR (~2.29%) + SOFR credit spread adjustment (10 bps) + Applicable Margin (400 bps) = approximately 6.39% per annum
Estimated Annual Interest Expense on $700M: approximately $44,730,000
Incremental Annual Interest Cost vs. Base Case: approximately $1,750,000 ($700,000,000 × 25 bps)
Annual Interest Savings vs. Existing Greystone TLB: reduced to approximately $1,750,000 (25 basis points on $700,000,000), reflecting the partial erosion of spread savings from the refinancing.
Net Proceeds to VHG: approximately $60,483,333 (unchanged from base case, as margin flex does not affect OID or net funding)
Pro Forma Net Leverage: 2.52x (unchanged; the leverage ratio calculation is based on the principal amount of funded debt, not the interest rate)
This scenario represents a moderate downside outcome. VHG retains 25 basis points of spread savings relative to the Existing TLB, and the incremental annual interest cost of $1,750,000 is modest in the context of VHG's $341,000,000 Adjusted EBITDA. Interest coverage remains robust, with Adjusted EBITDA providing approximately 7.6x coverage of annual interest expense.
C. Scenario 3: Full Margin Flex (+50 bps)
Under this scenario, Crescent Harbor exercises the full 50 basis point margin flex, increasing the applicable margin from 375 basis points to 425 basis points. No other flex provisions are exercised.
Applicable Margin: 425 basis points (375 + 50)
OID: 1.00% ($7,000,000)
SOFR Floor: 50 basis points
Net Funding: $693,000,000
Illustrative All-In Coupon Rate: 1-month Term SOFR (~2.29%) + SOFR credit spread adjustment (10 bps) + Applicable Margin (425 bps) = approximately 6.64% per annum
Estimated Annual Interest Expense on $700M: approximately $46,480,000
Incremental Annual Interest Cost vs. Base Case: approximately $3,500,000 ($700,000,000 × 50 bps)
Annual Interest Savings vs. Existing Greystone TLB: effectively zero on a spread basis. Both the Existing TLB and the new Term Loan B (under full margin flex) would carry an applicable margin of 425 basis points. VHG would no longer realize any spread savings from the refinancing.
Net Proceeds to VHG: approximately $60,483,333 (unchanged from base case)
Pro Forma Net Leverage: 2.52x (unchanged)
This scenario is significant from a commercial perspective because it effectively eliminates one of the primary justifications for the refinancing — the 50 basis point spread reduction. However, it is important to note that VHG would still derive tangible benefits from the transaction even under full margin flex, including: (i) $75,000,000 in incremental borrowing capacity; (ii) the transition from LIBOR to SOFR, which provides certainty in advance of LIBOR cessation and avoids the potential disruption and basis risk associated with fallback provisions in the Existing TLB; (iii) a refreshed covenant package with more favorable baskets and permissions than the 2020-vintage Greystone documentation; and (iv) the SOFR credit spread adjustment mechanics, which may result in a marginally lower effective rate compared to the LIBOR-based Existing TLB over time. Nevertheless, the loss of spread savings should be clearly communicated to VHG management as it may affect the overall cost-benefit analysis of proceeding with the refinancing.
D. Scenario 4: OID Flex Only (OID to 2.00%)
Under this scenario, Crescent Harbor exercises the full OID flex, increasing the original issue discount from 1.00% to 2.00% of par. No margin, floor, or structural flex is exercised.
Applicable Margin: 375 basis points
OID: 2.00% ($14,000,000)
SOFR Floor: 50 basis points
Net Funding: $686,000,000 (compared to $693,000,000 under the base case)
Reduction in Net Proceeds to VHG: The additional $7,000,000 of OID directly reduces VHG's net proceeds from approximately $60,483,333 to approximately $53,483,333 — a $7,000,000 reduction that constrains VHG's available cash for its acquisition pipeline and other general corporate purposes.
Illustrative All-In Coupon Rate: approximately 6.14% per annum (unchanged from base case, as the coupon rate is determined by the applicable margin and SOFR, not the OID)
Estimated Annual Interest Expense on $700M: approximately $42,980,000 (unchanged from base case; VHG's periodic interest obligation is calculated on the full $700,000,000 principal amount regardless of the OID)
Effective Yield to Lenders: Higher than the base case due to the larger OID. The additional $7,000,000 discount is amortized over the expected life of the facility using the constant yield method, resulting in an effective yield spread above the stated coupon. Assuming a 7-year life to maturity and no prepayments, the additional OID of $7,000,000 contributes approximately 14–15 additional basis points of effective yield to lenders.
Pro Forma Net Leverage: 2.52x (unchanged; the leverage ratio is calculated based on the $700,000,000 commitment amount, not the net funded amount after OID)
AHYDO Considerations. The increase in OID from 1.00% to 2.00% warrants analysis under the applicable high yield discount obligation ("AHYDO") rules set forth in Section 163(i) of the Internal Revenue Code. Under the AHYDO rules, if a debt instrument has significant OID (defined as OID exceeding the instrument's stated redemption price at maturity multiplied by the product of its yield-to-maturity and the number of accrual periods), a portion of the interest deduction may be deferred and the issuer may be required to make annual payments of accrued OID. Based on the preliminary analysis set forth in Leonard Cross's Internal Memorandum — Tax Considerations for TLB Refinancing dated April 18, 2022, even at the maximum OID of 2.00%, the yield-to-maturity of the Term Loan B does not approach the applicable federal rate plus 500 basis points, which is the AHYDO threshold. Accordingly, no AHYDO issue is anticipated. However, we recommend that Leonard Cross confirm this analysis if the OID flex is actually exercised, as the applicable federal rate may change between the date of his memorandum and the closing date.
Impact on Funds Flow. The larger OID means that VHG will receive $686,000,000 in net funding rather than $693,000,000. After application of the payoff amount for the Existing TLB (approximately $627,916,667), the advisory fee ($1,400,000), and estimated legal and closing costs (approximately $3,200,000), VHG's remaining excess proceeds would be approximately $53,483,333. This is a $7,000,000 reduction from the base case, which may affect VHG's near-term capital allocation plans and available liquidity for acquisitions.
E. Scenario 5: Worst Case — Full Margin Flex, Full OID Flex, Floor Flex, MFN Tightened, Repricing Extended
Under this scenario, Crescent Harbor exercises all available flex provisions to their maximum extent. This represents the most adverse pricing outcome for VHG under the Flex Letter and reflects the theoretical ceiling of flex exercise.
Applicable Margin: 425 basis points (full 50 bps margin flex)
OID: 2.00% ($14,000,000) (full OID flex)
SOFR Floor: 75 basis points (full 25 bps floor flex)
MFN Threshold: 25 basis points (tightened from 50 bps)
Repricing Protection Period: 12 months (extended from 6 months; soft call period now runs through July 21, 2023)
Net Funding: $686,000,000
Illustrative All-In Coupon Rate (at Current Rates): 1-month Term SOFR (~2.29%) + SOFR credit spread adjustment (10 bps) + Applicable Margin (425 bps) = approximately 6.64% per annum. The 75 bps SOFR floor is not binding at current rates because Term SOFR (approximately 2.29%) exceeds the floor. In a declining rate environment where Term SOFR falls below 75 basis points, the effective rate would be: SOFR Floor (75 bps) + SOFR credit spread adjustment (10 bps) + Applicable Margin (425 bps) = 5.10% per annum.
Estimated Annual Interest Expense on $700M at Current Rates: approximately $46,480,000
Incremental Annual Interest Cost vs. Base Case: approximately $3,500,000 (reflecting the full margin flex; the OID and floor flex do not affect periodic interest expense at current rates)
Net Proceeds to VHG After Payoff and Transaction Costs: approximately $53,483,333 (reflecting the reduced net funding of $686,000,000 due to the increased OID)
Pro Forma Net Leverage: 2.52x (unchanged; debt principal remains $700,000,000)
Annual Interest Savings vs. Existing Greystone TLB: negligible on a spread basis, as the applicable margin under full flex (425 bps) is identical to the spread on the Existing TLB. The primary refinancing benefits are reduced to the SOFR transition, the $75,000,000 incremental borrowing capacity, and the refreshed covenant package.
Impact of Tightened MFN Threshold (25 bps). The tightening of the MFN threshold from 50 basis points to 25 basis points significantly constrains VHG's ability to incur incremental term loan debt at yields above the initial Term Loan B yield during the 18-month MFN sunset period (through January 21, 2024). Under the base case, VHG could incur incremental term loans at effective yields up to 50 basis points above the initial Term Loan B yield without triggering an MFN ratchet. Under the worst case, this headroom is reduced to 25 basis points. In a rising rate environment where incremental term loan pricing is trending wider, this reduced headroom could either (a) prevent VHG from accessing the incremental term loan basket on economically attractive terms or (b) trigger an MFN adjustment that increases the margin on the entire initial Term Loan B, compounding the cost of the incremental borrowing.
Impact of Extended Repricing Protection (12 Months). The extension of the repricing protection period from 6 months to 12 months means that VHG would be locked into the fully flexed pricing (425 basis points margin) for a full year following closing, with no ability to reprice the facility at a lower yield without paying the 1.00% soft call premium of $7,000,000. This is a meaningful constraint if market conditions improve and credit spreads tighten during the 12-month period. Under the base case, VHG would have been able to reprice as early as January 21, 2023 (six months post-closing) without incurring the premium. The combination of full margin flex and extended repricing protection represents the most commercially adverse pairing of flex provisions from VHG's perspective.
Management Communication. While the simultaneous full exercise of all flex provisions is considered unlikely based on current market conditions and Crescent Harbor's initial syndication feedback, this scenario represents the maximum adverse outcome under the Flex Letter and should be communicated clearly to VHG's management team — specifically, Renata Haines (CFO) and Glenn Fischbach (Treasurer) — so that they can evaluate walk-away thresholds and make informed decisions about whether to proceed with the refinancing in the event that flex exercise approaches the worst-case parameters.
F. Summary Table of Scenarios
The following table summarizes the key financial metrics under each of the five scenarios:
As the table demonstrates, pro forma net leverage is constant across all scenarios at 2.52x, reflecting the fact that flex exercise affects pricing and net proceeds but does not alter the principal amount of funded debt. The maximum incremental annual interest cost under full margin flex is $3,500,000, and the maximum reduction in net proceeds under full OID flex is $7,000,000.
V. Covenant Compliance Analysis Under Flex Scenarios
A. Maximum Total Net Leverage Ratio (4.50x Springing)
The Term Loan B facility contains a single financial maintenance covenant: a springing maximum total net leverage ratio of 4.50x, tested quarterly on a trailing four-quarter basis. Critically, this covenant is a "springing" covenant that is only tested when aggregate revolving credit exposure under the $400,000,000 revolving credit facility exceeds 35% of total revolving commitments — i.e., when more than $140,000,000 of the revolving facility is drawn (including outstanding letters of credit).
At the anticipated closing date, the revolving credit facility will be fully undrawn. Accordingly, the springing test will not be triggered at closing, and VHG will not be required to demonstrate compliance with the 4.50x maximum total net leverage ratio as a condition to closing or the initial funding of the Term Loan B.
Even if the springing test were triggered — for example, if VHG subsequently drew more than $140,000,000 under the revolving facility — VHG's pro forma net leverage of 2.52x provides 1.98 turns of headroom to the 4.50x maximum covenant level. To breach the covenant, VHG's net debt would need to increase to $1,534,500,000 (4.50x × $341,000,000 Adjusted EBITDA), representing an additional $676,500,000 of net debt above the pro forma closing level.
The exercise of flex provisions does not affect the leverage ratio calculation for the following reasons:
(i) Margin flex changes VHG's periodic interest cost but does not alter the principal amount of funded debt, which is the numerator of the leverage ratio. The Term Loan B will be funded at $700,000,000 regardless of whether the margin is 375 basis points or 425 basis points.
(ii) OID flex changes the net cash proceeds received by VHG at closing but does not change the commitment amount or the outstanding principal balance for purposes of the leverage calculation. Under standard leveraged loan conventions (and as reflected in the draft Credit Agreement), the Term Loan B is recorded as a $700,000,000 funded debt obligation, with the OID treated as a deferred financing cost that is amortized over the life of the facility. The leverage ratio numerator is based on the face amount of outstanding debt, not the net funded amount.
(iii) SOFR floor flex and structural flex provisions (MFN threshold tightening and repricing protection extension) similarly do not alter the principal amount of debt or the Adjusted EBITDA denominator.
Conclusion: Covenant compliance is unaffected by any flex scenario. VHG's pro forma net leverage of 2.52x remains constant across all five modeled scenarios, with 1.98 turns of headroom to the 4.50x covenant threshold.
B. Impact on Interest Coverage (Informational)
The Term Loan B facility does not include a minimum interest coverage ratio as a financial maintenance covenant. This is consistent with current market practice for broadly syndicated Term Loan B facilities for borrowers at VHG's credit profile, where the trend has been toward single-covenant (leverage only) credit agreements.
However, for informational purposes and as a reference point for discussions with VHG management and the lender syndicate, the following interest coverage metrics are noteworthy:
Base Case Interest Coverage: $341,000,000 Adjusted EBITDA ÷ $42,980,000 estimated annual interest expense = approximately 7.9x
Worst Case Interest Coverage: $341,000,000 Adjusted EBITDA ÷ $46,480,000 estimated annual interest expense = approximately 7.3x
Both levels provide substantial coverage comfort. A decline from 7.9x to 7.3x represents a modest erosion that is well within the range that lenders in the broadly syndicated loan market would consider acceptable for a BB-/Ba3 rated hospitality credit. This coverage analysis further supports the conclusion that VHG's credit profile can absorb the incremental cost of full flex exercise without material deterioration.
It should be noted that the interest coverage calculations above reflect only the Term Loan B interest expense and do not include interest on the $245,000,000 senior unsecured notes (7.25% coupon, or approximately $17,762,500 per annum). On a total debt basis, estimated total annual interest expense ranges from approximately $60,742,500 (base case) to approximately $64,242,500 (worst case), yielding total interest coverage of approximately 5.6x to 5.3x, respectively. These remain comfortable levels.
C. Impact on Permitted Indebtedness Baskets
Certain permitted indebtedness baskets in the draft Credit Agreement are sized as a ratio or fixed dollar amount relative to Adjusted EBITDA, total assets, or other financial metrics. For example, the general debt basket permits VHG to incur additional indebtedness in an aggregate principal amount not to exceed the greater of $150,000,000 and 0.44x LTM Adjusted EBITDA, and the incremental term loan basket permits incremental borrowings in an aggregate amount not to exceed $250,000,000 plus unlimited amounts subject to a pro forma total net leverage ratio not exceeding 3.50x (the "ratio-based incremental basket").
The exercise of flex provisions does not alter any of these calculations. The flex provisions affect pricing terms (margin, OID, floor) and certain structural terms (MFN threshold, repricing protection period) but do not change the aggregate principal amount of debt, the Adjusted EBITDA figure, or the total assets figure used in these basket calculations.
However, the tightened MFN threshold (reduced to 25 basis points in the worst case) could affect VHG's practical ability to incur incremental term loan debt at attractive pricing within the 18-month MFN sunset period, even though it does not affect the permitted quantum of such debt. This distinction is important: the MFN provision does not restrict the amount of incremental debt VHG can incur, but it does restrict the yield at which VHG can incur such debt without triggering a ratchet adjustment to the initial Term Loan B margin. The practical effect is that VHG may need to limit the yield on incremental term loans to avoid an economically undesirable MFN ratchet.
VI. Interaction of Flex Provisions with MFN and Repricing Protection
A. MFN Interaction
The interaction between the margin flex and the MFN provision creates a dynamic that warrants careful analysis. The MFN clause provides that if VHG incurs incremental term loans during the 18-month sunset period at an effective yield exceeding the initial Term Loan B yield by more than the applicable MFN threshold, the initial Term Loan B margin must be adjusted upward to eliminate the excess differential.
The key insight is that margin flex, by increasing the initial Term Loan B yield, actually creates more absolute headroom under the MFN clause for future incremental term loans. Conversely, if the MFN threshold is tightened from 50 basis points to 25 basis points via structural flex, this additional headroom may be partially or fully offset. The net effect depends on the specific combination of flex provisions exercised.
Worked Example:
Base Case (375 bps margin, 50 bps MFN threshold): Incremental term loans may be incurred at effective yields up to 375 bps + 50 bps = 425 bps without triggering an MFN adjustment to the initial Term Loan B.
Full Margin Flex Only (425 bps margin, 50 bps MFN threshold): Incremental term loans may be incurred at effective yields up to 425 bps + 50 bps = 475 bps without triggering an MFN adjustment. The 50 bps margin increase has created 50 bps of additional absolute headroom.
Worst Case (425 bps margin, 25 bps MFN threshold): Incremental term loans may be incurred at effective yields up to 425 bps + 25 bps = 450 bps without triggering an MFN adjustment. This is modestly wider in absolute terms than the base case (450 bps vs. 425 bps), but the relative headroom has tightened from 50 bps to 25 bps.
The practical significance of this analysis is that while the worst-case MFN threshold of 25 basis points appears to provide a similar absolute ceiling on incremental term loan yields (450 bps vs. 425 bps base case), the relative flexibility is materially reduced. In a widening spread environment where lenders demand higher yields on incremental term loans, VHG's 25 basis points of MFN headroom could be consumed quickly, triggering a ratchet adjustment that would increase the coupon on the entire $700,000,000 initial Term Loan B.
VHG should be advised that the MFN flex provision is a meaningful negotiating loss if exercised. It reduces VHG's flexibility for the full 18-month sunset period through January 21, 2024, and its impact is amplified if VHG pursues an acquisition strategy that requires incremental term loan financing during that period.
B. Repricing Protection Interaction
The extension of the repricing protection period from 6 months to 12 months, if exercised, has the effect of preventing VHG from repricing the Term Loan B at a lower yield until July 21, 2023, unless VHG is willing to pay the 1.00% soft call premium of $7,000,000. Under the base case, VHG would have been able to reprice freely (without the premium) beginning January 21, 2023.
The combination of full margin flex (425 bps) and extended repricing protection (12 months) represents the most commercially adverse pairing of flex provisions from VHG's perspective. Under this combination, VHG would be locked into a 425 basis point margin — identical to the spread on the Existing TLB that VHG sought to refinance at a lower rate — for a full year with no economically viable option to reprice. If market conditions improve during the first 12 months post-closing and comparable credits are pricing at tighter spreads, VHG would face the unenviable choice of either (a) paying the $7,000,000 soft call premium to reprice (which, depending on the magnitude of the spread reduction, may or may not be economically justified) or (b) waiting until the soft call period expires on July 21, 2023.
The $7,000,000 soft call premium equates to approximately 1.00% of the facility size. In order for a repricing to be economically justified (i.e., for the NPV of future interest savings to exceed the $7,000,000 premium), VHG would need to achieve a spread reduction of at least approximately 17 basis points over the remaining roughly six-year life of the facility (calculated as: $7,000,000 ÷ $700,000,000 ÷ approximately 5.75 remaining years ≈ 17 bps). If the available spread reduction exceeds this threshold, the repricing would generate positive NPV even with the premium; if it falls short, VHG would be better served waiting for the soft call period to expire.
VII. Tax Considerations Under Flex Scenarios
This section provides a summary of the key tax considerations relevant to the exercise of flex provisions, drawing on the more detailed analysis set forth in the Internal Memorandum — Tax Considerations for TLB Refinancing prepared by Leonard Cross (Tax Partner) dated April 18, 2022. The discussion below is not intended to be a comprehensive tax analysis and should be read in conjunction with Leonard Cross's memorandum and the forthcoming Tax Opinion.
AHYDO Analysis. As discussed in Section IV.D above, the potential increase in OID from 1.00% to 2.00% warrants analysis under the AHYDO rules of IRC Section 163(i). Based on Leonard Cross's preliminary analysis, even at the maximum OID of 2.00%, the yield-to-maturity of the Term Loan B (incorporating the OID amortization over the 7-year tenor) does not approach the applicable federal rate plus 500 basis points, which is the threshold for AHYDO classification. The applicable federal rate for long-term obligations as of April 2022 was approximately 2.55%, establishing an AHYDO threshold of approximately 7.55%. Even under the worst-case scenario (425 bps margin + 2.00% OID + current SOFR rates), the effective yield-to-maturity of the Term Loan B is estimated at approximately 6.85–6.95%, well below the 7.55% AHYDO threshold. However, given that the AHYDO calculation is sensitive to the applicable federal rate at the time of issuance (which will be measured at closing in July 2022), we recommend that Leonard Cross refresh this analysis prior to closing to confirm that no AHYDO concern has emerged due to interim changes in the applicable federal rate.
OID Amortization. The OID on the Term Loan B — whether $7,000,000 (base case) or $14,000,000 (maximum flex) — will be amortized for tax purposes over the 7-year term of the facility under the constant yield method prescribed by IRC Section 1272. The resulting OID deductions will be available to VHG on an annual basis and will partially offset the economic cost of the OID to VHG over the life of the facility. At the maximum OID of $14,000,000, the annual OID deduction would be approximately $2,000,000 per year (subject to the constant yield methodology, which results in slightly lower deductions in the early years and slightly higher deductions in later years).
Deductibility of Existing TLB Prepayment Premium. The $3,125,000 prepayment premium payable to Greystone in connection with the payoff of the Existing TLB is expected to be deductible by VHG in the tax year of payment. This deduction is available regardless of whether flex provisions are exercised on the new Term Loan B, as it relates to the extinguishment of the prior facility and is independent of the terms of the replacement financing.
Unamortized Deferred Financing Costs. VHG incurred deferred financing costs in connection with the origination of the Existing TLB in February 2020, a portion of which remains unamortized as of the anticipated payoff date. Because the refinancing constitutes a "significant modification" of the debt instrument under Treasury Regulation Section 1.1001-3 — primarily due to the change in administrative agent (from Greystone to Crescent Harbor) and the change in pricing and structural terms — the refinancing will be treated as an extinguishment of the old debt and an issuance of new debt for federal income tax purposes. As a result, VHG will be entitled to deduct the remaining unamortized deferred financing costs from the 2020 Greystone origination in the year of extinguishment (i.e., the 2022 tax year). This accelerated deduction provides a modest tax benefit that is available regardless of flex exercise.
VIII. Recommendations and Next Steps
A. Client Communication
Based on the foregoing analysis, we recommend the following communications with VHG management:
1. Management Briefing. We recommend scheduling a briefing with Renata Haines (Chief Financial Officer) and Glenn Fischbach (Treasurer) to present the range of potential outcomes under the flex provisions. The briefing should focus on the two key variables that most directly affect VHG's economic outcome: (a) the potential increase in annual interest expense from approximately $43.0 million (base case) to approximately $46.5 million (worst case), representing an incremental cost of approximately $3.5 million per annum; and (b) the potential reduction in net proceeds from approximately $60.5 million (base case) to approximately $53.5 million (worst case), representing a $7.0 million reduction in available liquidity. Both impacts should be presented in the context of VHG's overall financial profile, including the $341 million LTM Adjusted EBITDA and the 2.52x pro forma leverage ratio.
2. Walk-Away Thresholds. We recommend that VHG establish internal walk-away thresholds — pricing levels beyond which VHG management would reassess whether the refinancing remains economically justified. Based on our analysis, we suggest that a full margin flex to 425 basis points combined with an OID increase beyond 1.50% (i.e., OID exceeding $10,500,000) should trigger a formal re-evaluation by VHG management. At that level, the spread savings from the refinancing would be entirely eliminated, the incremental annual interest cost would be approximately $3.5 million, and the net proceeds would be reduced by more than $3.5 million relative to the base case. While the refinancing would still provide benefits (incremental borrowing capacity, SOFR transition, refreshed covenants), the diminished economic rationale may not justify the transaction costs and management attention required to complete the refinancing.
3. General Counsel Notification. Priya Narayanan (General Counsel) should be kept apprised of any flex exercise communications from Crescent Harbor. Specifically, any communication from Ted Marchetti or Anika Holm at CHB's syndication desk indicating potential flex exercise should be promptly shared with Ms. Narayanan so that she can coordinate VHG's response and ensure that any flex exercise is consistent with the limitations and procedural requirements set forth in the Flex Letter.
B. Monitoring During Syndication
1. Syndication Timeline. The syndication launch is anticipated for June 6, 2022, with lender presentations scheduled for the week of June 13–17, 2022. Final allocation is targeted for June 30, 2022. Calderwood & Harkness should actively monitor the syndication process during this period, including tracking lender feedback, commitment levels, and any indications from Crescent Harbor's syndication team that flex exercise may be necessary.