PRIVILEGED & CONFIDENTIAL — ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP One Liberty Plaza, 52nd Floor New York, NY 10006
MEMORANDUM
TO: Ian Blackwood, Responsible Partner, Banking & Finance
CC: Stephanie Okafor, Billing Partner, Banking & Finance; Leonard Cross, Specialist Partner, Tax
FROM: Sophie Tremblay, Lead Associate, Banking & Finance; Daniel Obi, Working Associate, Banking & Finance
DATE: June 3, 2022
RE: Verimark Hospitality Group Inc. — $700,000,000 Senior Secured Term Loan B Refinancing: Analysis of Key Defined Terms and Covenant Build
CLIENT: Verimark Hospitality Group Inc.
MATTER/ENGAGEMENT NO.: 1016-00009
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I. PURPOSE AND EXECUTIVE SUMMARY
The purpose of this memorandum is to analyze and explain the key defined terms in the Credit Agreement (the "Credit Agreement") currently being negotiated among Verimark Hospitality Group Inc., a Delaware corporation ("VHG" or the "Borrower"), the Guarantors party thereto, Crescent Harbor Bank, N.A. ("Crescent Harbor"), in its capacity as Administrative Agent and Collateral Agent, and the Lenders from time to time party thereto, in connection with the proposed $700,000,000 senior secured Term Loan B refinancing (the "Refinancing" or the "Transaction"). This memorandum is intended to serve as a comprehensive reference for the deal team and to guide our negotiation strategy as we prepare the Second C&H Revised Draft for circulation.
Drafting History. Calderwood & Harkness LLP ("C&H") circulated the first draft of the Credit Agreement on May 16, 2022. On May 20, 2022, C&H prepared and distributed an Issues List identifying key negotiation points and areas requiring further discussion with the Lender group. On May 26, 2022, we received a revised draft from Whitfield Gage & Partridge LLP ("WGP"), counsel to Crescent Harbor and the Lender group, led by Harrison Whitfield III and Megan Yeung. This memorandum responds to the WGP revised draft and should be read in conjunction with the C&H Issues List dated May 20, 2022.
Objective. Our overarching objective is to ensure that the defined terms — particularly those feeding into the financial covenant and the various ratio-based baskets — are drafted to maximize flexibility for VHG while remaining commercially acceptable to Crescent Harbor and the broader lending syndicate. In particular, the definitions of "Adjusted EBITDA," "Consolidated Net Income," "Consolidated Net Debt," and "Total Net Leverage Ratio" are of central importance because they determine not only covenant compliance but also capacity under the incremental facility, restricted payment, and Permitted Indebtedness provisions.
Summary Conclusion. Based on our analysis, the pro forma Total Net Leverage Ratio at closing is approximately 2.52x, providing substantial headroom of approximately 1.98x against the 4.5x maximum covenant level. The springing nature of the financial covenant — triggered only when aggregate revolving credit exposure exceeds 35% of total revolving credit facility ("RCF") commitments (i.e., exceeds $140,000,000) — further protects VHG by ensuring that the leverage test is not even conducted at closing or in the ordinary course unless VHG has drawn significantly on the revolver. These structural features, together with the broad Adjusted EBITDA definition and generous Permitted Indebtedness baskets, should afford VHG significant operational and strategic flexibility.
Scope of Memorandum. This memorandum covers: (a) the "Adjusted EBITDA" definition, (b) the "Consolidated Net Income" definition, (c) the "Total Net Leverage Ratio" definition and mechanics, (d) the "Permitted Indebtedness" definition, (e) other key economic definitions, and (f) a full covenant build and pro forma compliance analysis, including sensitivity scenarios. The memorandum also includes appendices providing a condensed covenant build summary table, a comparison chart of key defined terms between the existing Greystone facility and the proposed Crescent Harbor facility, and a sources and uses of funds summary.
II. BACKGROUND: TRANSACTION OVERVIEW
A. The Borrower
Verimark Hospitality Group Inc. 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. VHG is a leading owner and operator of full-service and select-service hotels across the United States, currently operating a portfolio of 74 hotel properties spanning 18 states. The portfolio was most recently appraised at approximately $3.1 billion in the aggregate.
For the fiscal year ended December 31, 2021 ("FY2021"), VHG reported consolidated revenue of approximately $1.42 billion, GAAP EBITDA of approximately $318 million, and Adjusted EBITDA (as calculated in accordance with the methodology described below) of approximately $341 million. Audited financial statements for FY2021 were prepared by Clearmont & Wharton LLP, with Ronald Ashby, CPA serving as engagement partner.
VHG's senior management team includes:
• Marcus Delvecchio — Chief Executive Officer
• Renata Haines — Chief Financial Officer
• Priya Narayanan — General Counsel
• Glenn Fischbach — Treasurer
VHG's pre-refinancing credit ratings are BB- from Kellaway Ratings Group and Ba3 from Pinnacle Credit Services, placing the company squarely within the sub-investment grade, cross-over credit category typical of hospitality-sector Term Loan B borrowers.
B. The Refinancing Transaction
The Transaction involves the refinancing of VHG's existing $625,000,000 Term Loan B 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 + 425 basis points. As of the anticipated closing date, the outstanding principal balance of the Existing TLB, after scheduled amortization, is approximately $621,875,000.
VHG proposes to replace the Existing TLB with a new $700,000,000 Term Loan B facility (the "New TLB") under the Credit Agreement, with Crescent Harbor Bank, N.A. as administrative agent and collateral agent. The New TLB will bear interest at Adjusted Term SOFR + 375 basis points, with a SOFR floor of 0.50%. This represents a 50 basis point reduction in applicable margin relative to the Existing TLB, yielding estimated annual interest savings of approximately $3,500,000.
The incremental $75,000,000 in proceeds (above the approximately $621,875,000 needed to retire the Existing TLB, after accounting for transaction costs) will be available to fund VHG's acquisition pipeline and for general corporate purposes.
Key Terms of the New TLB:
C. Capital Structure
Pre-Refinancing Capital Structure:
Post-Refinancing Capital Structure:
As reflected in the table above, the post-refinancing capital structure features $945,000,000 in total funded debt (comprising $700,000,000 under the New TLB and $245,000,000 in senior unsecured notes), with the $400,000,000 RCF fully undrawn at closing. Unrestricted cash at closing is estimated at $87,000,000 (prior to the deposit of net refinancing proceeds), resulting in Consolidated Net Debt of approximately $858,000,000.
III. ANALYSIS OF KEY DEFINED TERMS
A. "Consolidated Net Income"
1. Definition as Drafted. As set forth in Section 1.01 of the Credit Agreement, "Consolidated Net Income" is defined as the net income (or net loss) of VHG and its Restricted Subsidiaries on a consolidated basis, determined in accordance with GAAP, for the applicable period. This definition serves as the starting point for the calculation of Adjusted EBITDA and, accordingly, is a foundational component of the financial covenant and all ratio-based tests in the Credit Agreement.
The definition is intended to reflect VHG's core economic performance by stripping out items that, while required to be reflected in GAAP net income, are not indicative of recurring operating results or do not generate or consume cash. Both C&H and WGP recognize the importance of reaching agreement on the scope of the permitted addbacks and exclusions, as these items flow directly through to the Adjusted EBITDA calculation and therefore affect covenant compliance, incremental facility capacity, restricted payment capacity, and other ratio-based baskets.
2. Key Addbacks and Exclusions Under Negotiation. The following categories of addbacks and exclusions are the subject of active negotiation between C&H and WGP:
(a) Extraordinary, Unusual, or Non-Recurring Gains and Losses. The definition excludes all gains and losses characterized as extraordinary, unusual, or non-recurring. This is a standard provision in leveraged credit agreements, but the scope of "non-recurring" is a frequent source of negotiation. C&H has proposed language that defines non-recurring items broadly to include charges associated with hotel property dispositions, litigation settlements, regulatory costs, and one-time restructuring charges. WGP has countered by seeking to include a cap on the aggregate amount of non-recurring exclusions, as well as a requirement that any item characterized as "non-recurring" must not have been incurred in more than two of the last four fiscal quarters. C&H's position is that a per-item characterization approach, without an aggregate cap, is more appropriate given the cyclical nature of the hospitality industry and the potential for periodic asset impairments and property-level adjustments.
(b) Gains and Losses from Asset Dispositions Outside the Ordinary Course. Net gains and losses arising from the sale, transfer, or other disposition of assets not in the ordinary course of business are excluded from Consolidated Net Income. This provision is particularly relevant for VHG, which may from time to time divest individual hotel properties or dispose of non-core assets as part of its portfolio optimization strategy.
(c) Non-Cash Stock-Based Compensation Expense. All non-cash stock-based compensation expense recognized under ASC 718 is excluded from Consolidated Net Income. This is a standard and generally non-controversial exclusion in sub-investment grade credit agreements.
(d) Effects of Purchase Accounting Adjustments. The exclusion covers the effects of adjustments arising from the application of purchase accounting (ASC 805), including inventory step-up adjustments, fair value adjustments to tangible and intangible assets, and the amortization of any resulting goodwill or intangible assets. Given VHG's active acquisition strategy, this exclusion is critical to ensuring that EBITDA is not artificially depressed by purchase accounting charges related to hotel portfolio acquisitions.
(e) Addback of Intercompany Management Fees. Management and franchise fees paid by VHG's operating subsidiaries to VHG Management Services Inc. are added back to the extent such fees are eliminated in consolidation. This ensures that the economic value of VHG's management fee income stream — a significant revenue source — is fully reflected in the Consolidated Net Income calculation. WGP has not objected to this addback in principle, but has sought to confirm that the management fees are at arm's length.
(f) Unrealized Gains and Losses from Mark-to-Market Hedging Instruments. Unrealized gains and losses arising from the mark-to-market valuation of hedging instruments (including interest rate swaps, caps, and collars) that do not qualify for hedge accounting under ASC 815 are excluded from Consolidated Net Income. This exclusion prevents volatility in reported net income driven by non-cash hedging adjustments from affecting the leverage calculation.
(g) Income Attributable to Minority/Non-Controlling Interests. Income attributable to non-controlling interests in subsidiaries of VHG is excluded from Consolidated Net Income except to the extent of cash actually distributed to VHG or a Restricted Subsidiary during such period. This is a protective provision for the Lender group, as it ensures that the Borrower does not receive credit for earnings that are not accessible for debt service.
3. WGP Position. WGP's revised draft dated May 26, 2022 proposes a narrower set of addbacks than the C&H first draft. In particular, WGP seeks to: (i) include a cap on the aggregate amount of restructuring charges that may be excluded from Consolidated Net Income, (ii) limit the scope of the "non-recurring" exclusion to items that are individually material (defined as exceeding $5,000,000), and (iii) require that any item characterized as non-recurring be supported by an officer's certificate delivered to the Administrative Agent.
4. C&H Recommendation. We recommend pushing for the broadest permissible set of exclusions, consistent with precedent for BB-rated hospitality-sector credit facilities. In particular, we believe VHG should insist on excluding non-cash impairments on hotel assets from Consolidated Net Income, given the nature of hospitality real estate and the potential for periodic write-downs related to property-level performance, market conditions, or brand transitions. We also recommend ensuring that franchise and management fee income from VHG Management Services Inc. is fully captured in the calculation, including intercompany fees that would otherwise be eliminated in consolidation.
B. "Adjusted EBITDA" (also referred to as "Consolidated Adjusted EBITDA")
1. Central Importance of the Definition. The definition of "Adjusted EBITDA" (alternatively referred to in the Credit Agreement as "Consolidated Adjusted EBITDA") is the single most important defined term in the Credit Agreement. Adjusted EBITDA serves as the denominator in the Total Net Leverage Ratio calculation and therefore functions as the key gating metric for: (i) covenant compliance under the springing financial covenant, (ii) incurrence-based capacity under the incremental facility provisions, (iii) capacity under restricted payment and investment baskets, (iv) Permitted Indebtedness basket sizing (for baskets expressed as a percentage of Adjusted EBITDA), and (v) determination of the Excess Cash Flow sweep percentage.
Every dollar of Adjusted EBITDA recognized under the definition directly reduces the computed leverage ratio and expands the operational and financial flexibility available to VHG. Accordingly, C&H has devoted substantial attention to ensuring that the definition captures the full economic earnings power of VHG's hotel operations, including appropriate adjustments for non-cash items, one-time charges, and synergies associated with acquisitions and renovations.
2. Base Calculation. Adjusted EBITDA is calculated on a trailing four-quarter (last twelve months, or "LTM") basis, beginning with Consolidated Net Income and adding back, to the extent deducted in calculating Consolidated Net Income:
(a) Consolidated interest expense;
(b) Provision for federal, state, local, and foreign income taxes;
(c) Depreciation and amortization expense; and
(d) Additional addbacks enumerated in the definition (described in detail below).
For FY2021, VHG's GAAP EBITDA (i.e., Consolidated Net Income plus interest, taxes, depreciation, and amortization, before any further adjustments) was approximately $318,000,000. After application of the permitted addbacks described below, Adjusted EBITDA for FY2021 was approximately $341,000,000. The $23,000,000 difference between EBITDA and Adjusted EBITDA reflects the aggregate amount of additional addbacks recognized during the period, as detailed in the covenant build analysis in Section IV below.
3. Key Addbacks Under Negotiation. The following categories of addbacks are the subject of active negotiation between C&H and WGP. We describe each addback category, the current positions of each party, and our recommendation.
(1) Non-Cash Charges, Losses, and Expenses. C&H's draft provides for the addback of all non-cash charges, losses, and expenses, including but not limited to: asset impairments, write-downs of hotel property carrying values, non-cash stock-based compensation expense (to the extent not already excluded from Consolidated Net Income), non-cash pension and post-retirement benefit expense, and any other non-cash items reducing Consolidated Net Income. This addback is subject to a standard "cash return" clawback provision, which provides that if any non-cash charge added back to Adjusted EBITDA in a prior period represents an accrual of, or reserve for, a cash expenditure that is expected to be made in a future period, such cash expenditure shall be deducted from Adjusted EBITDA in the period in which it is paid. The cash return clawback is a customary lender protection and is not a significant negotiation point.
WGP has not raised material objections to the scope of the non-cash addback, but has proposed language requiring that non-cash charges be itemized in the officer's compliance certificate delivered with each set of quarterly financial statements.
(2) Restructuring and Integration Costs. This addback covers costs related to hotel portfolio restructuring, property rebranding, workforce reductions, and the integration of assets and operations following permitted acquisitions. C&H has proposed that this addback be uncapped for costs incurred within 24 months of the consummation of a permitted acquisition, reflecting the reality that hospitality acquisitions frequently involve multi-year integration and renovation programs. WGP has countered with a proposed cap at the greater of $25,000,000 and 7.5% of LTM Adjusted EBITDA.
This is a significant negotiation point. VHG's acquisition pipeline includes several potential hotel portfolio transactions that may involve substantial integration costs, including property renovations, brand conversions, and systems integration. An overly restrictive cap on restructuring addbacks could constrain VHG's ability to execute acquisitions without jeopardizing covenant compliance.
C&H's recommendation is to seek a compromise at the greater of $35,000,000 and 10% of LTM Adjusted EBITDA, as discussed further in Section VI below.
(3) Transaction Expenses. Fees, costs, and expenses incurred in connection with the Refinancing itself are addable to Adjusted EBITDA to the extent deducted in calculating Consolidated Net Income. These costs include:
• Arrangement fee payable to Crescent Harbor Bank, N.A.: $3,500,000
• Advisory fee payable to Meridian Strauss Advisory LLC: $1,400,000
• Estimated legal and closing costs (including fees of C&H and WGP, recording and filing fees, title insurance, environmental assessments, and other customary closing expenses): approximately $3,200,000
This addback is standard and not a significant negotiation point.
(4) Projected Cost Savings and Synergies (Run-Rate Adjustments). This addback permits VHG to include in Adjusted EBITDA, on a pro forma basis, cost savings, operating improvements, and synergies that are (a) reasonably identifiable, (b) factually supportable, and (c) expected to be realized within 18 months following the action giving rise to such savings. This type of run-rate addback is common in hospitality-sector credit agreements, where acquisitions and property renovations frequently yield quantifiable improvements in revenue per available room (RevPAR), occupancy rates, and operating margins, but where the full economic benefit may not be reflected in historical financial statements for several quarters.
The magnitude of the cap on run-rate addbacks is a key negotiation point:
• C&H Position: Cap at 25% of Adjusted EBITDA (calculated before giving effect to the run-rate addbacks), consistent with the more borrower-friendly end of recent hospitality and real-estate Term Loan B transactions reviewed by C&H.
• WGP Position: Cap at 15% of Adjusted EBITDA, which WGP characterizes as "market" for sub-investment grade hospitality credits.
C&H's recommendation is to hold firm at 25%, as this level is well within the range observed in comparable transactions and is critical to VHG's ability to demonstrate the earnings impact of its acquisition and renovation activities.
(5) Hotel Pre-Opening Costs. This addback covers costs incurred in connection with the opening of new hotel properties or major renovations of existing properties, including pre-opening staffing, training, marketing, and other start-up costs that are expensed under GAAP but do not reflect the stabilized earning capacity of the property.
• C&H Position: Fully addable, without cap, as pre-opening costs are inherently temporary and self-limiting.
• WGP Position: Capped at $10,000,000 per fiscal year.
C&H recommends pushing for the uncapped treatment. Pre-opening costs are among the most widely recognized addbacks in hospitality-sector credit agreements, and imposing a cap could discourage VHG from pursuing growth opportunities.
(6) Losses from discontinued Operations. Losses from operations that have been classified as discontinued under GAAP are excluded from the Adjusted EBITDA calculation. This is a standard provision and is not a significant negotiation point.
(7) Management and Franchise Fees Paid to Affiliates. To the extent management fees or franchise fees paid by VHG's operating subsidiaries to VHG Management Services Inc. (or other affiliates) are eliminated in GAAP consolidation, such fees are added back to Adjusted EBITDA. This addback is necessary to ensure that the economic value of VHG's fee streams — a material component of consolidated cash flow — is reflected in the leverage calculation.
(8) Casualty and Insurance Proceeds. Adjusted EBITDA includes an addback for business interruption insurance proceeds that have not yet been received but are contractually owed to VHG under applicable insurance policies, provided that such proceeds are received within 365 days following the end of the applicable measurement period. If such proceeds are not received within the 365-day period, the addback is reversed in the next compliance certificate. This provision is particularly important for a hospitality company, as hotel properties may be subject to casualty events (hurricanes, floods, fires) that temporarily disrupt operations but are covered by insurance.
4. Deductions from Adjusted EBITDA. Consistent with market practice, the definition provides that non-cash gains and income are deducted from Adjusted EBITDA to the extent such gains or income increased Consolidated Net Income during the applicable period. This deduction serves as the mirror image of the non-cash charge addback and ensures symmetrical treatment of non-cash items.
5. Calculation Methodology. Adjusted EBITDA is calculated on a trailing four-quarter (LTM) basis. Pro forma adjustments are permitted for acquisitions and dispositions consummated during the measurement period, calculated as if such acquisition or disposition had occurred on the first day of the applicable four-quarter period. This "annualization" methodology is standard in leveraged credit agreements and ensures that the leverage ratio reflects the current run-rate of VHG's operations, rather than being distorted by mid-period transactions.
6. Summary Recommendation. C&H recommends pushing for: (i) the 25% cap on run-rate cost savings addbacks, (ii) uncapped restructuring and integration addbacks for costs incurred within 24 months of a permitted acquisition (or, if a cap is necessary, a cap at the greater of $35,000,000 and 10% of LTM Adjusted EBITDA), (iii) a broadly drafted non-cash addback with standard cash return clawback, and (iv) uncapped hotel pre-opening costs. These positions are consistent with recent hospitality and real-estate Term Loan B precedent transactions reviewed by C&H, including the Coastal Pacific Hotels refinancing (2021), the Meridian Lodging Partners recapitalization (2022), and the Harborview Resorts Term Loan B (2021).
C. "Consolidated Total Debt" and "Consolidated Net Debt"
1. Consolidated Total Debt. "Consolidated Total Debt" is defined as all indebtedness of VHG and its Restricted Subsidiaries on a consolidated basis, determined in accordance with GAAP, including:
(i) Drawn amounts under the New TLB ($700,000,000 at closing);
(ii) Drawn amounts under the $400,000,000 RCF ($0 at closing, as the RCF is fully undrawn);
(iii) Outstanding principal amount of the senior unsecured notes due 2028 ($245,000,000), issued under an indenture with Atlantic Standard Trust Company as indenture trustee;
(iv) Capital lease obligations;
(v) Purchase money indebtedness; and
(vi) Guarantees of indebtedness of third parties (to the extent constituting funded indebtedness).
The definition expressly excludes: (a) letters of credit (to the extent undrawn), (b) hedging obligations, and (c) intercompany indebtedness between VHG and its Restricted Subsidiaries.
2. Consolidated Net Debt. "Consolidated Net Debt" is defined as Consolidated Total Debt minus unrestricted cash and cash equivalents held by VHG and its Restricted Subsidiaries. The "netting" of cash against total debt is a borrower-favorable feature, as it recognizes that cash on hand is available to service or repay indebtedness and therefore reduces effective leverage.
3. Key Negotiation Points. Three issues relating to these definitions remain under active negotiation:
(a) Treatment of the Original Issue discount. The New TLB has a face amount of $700,000,000 and an OID of 1.00%, resulting in net funding proceeds of $693,000,000. VHG's position is that the TLB should be recorded at the net funded amount of $693,000,000 for purposes of the Consolidated Total Debt definition, consistent with GAAP treatment of original issue discount. WGP's position is that the full face amount of $700,000,000 should be included in Consolidated Total Debt. While the $7,000,000 difference is not material in the context of the overall leverage calculation, we recommend aligning with GAAP treatment for consistency and internal coherence of the financial definitions.
(b) Definition of "Unrestricted Cash." C&H has proposed that the definition of "unrestricted cash" include all domestic cash and cash equivalents held in deposit accounts maintained by VHG and its Restricted Subsidiaries, without limitation. VHG currently reports approximately $87,000,000 in unrestricted cash on its balance sheet. WGP has proposed either (i) capping the amount of cash that may be netted against total debt at $100,000,000, or (ii) excluding cash held in foreign jurisdictions. Given that VHG's operations are predominantly domestic, the exclusion of foreign cash is unlikely to be a material issue in the near term, but the proposed cap on cash netting is an unnecessary restriction that could become problematic if VHG's cash balances grow. C&H recommends resisting any cap on domestic cash netting.
(c) Treatment of Drawn Revolving Amounts. Drawn amounts under the RCF are included in Consolidated Total Debt; undrawn revolver commitments are excluded. This treatment is standard and is not a significant negotiation point.
4. Closing Date Calculations. At closing, the relevant calculations are as follows:
D. "Total Net Leverage Ratio"
1. Definition and Mechanics. The "Total Net Leverage Ratio" is defined as the ratio of Consolidated Net Debt to LTM Adjusted EBITDA, calculated on a trailing four-quarter basis with pro forma adjustments for acquisitions and dispositions consummated during the measurement period.
Formula:
Total Net Leverage Ratio = Consolidated Net Debt ÷ LTM Adjusted EBITDA
2. Covenant Level. The Credit Agreement imposes a Maximum Total Net Leverage Ratio of 4.5x. This is the sole financial maintenance covenant in the Credit Agreement, consistent with the "covenant-lite" structure typical of Term Loan B facilities in the current market.
3. Springing Mechanism. Importantly, the financial covenant is springing in nature. The 4.5x Maximum Total Net Leverage Ratio is tested quarterly on a trailing four-quarter basis, but only springs into effect when aggregate revolving credit exposure — defined as the sum of (i) drawn revolving loans and (ii) outstanding letters of credit — under the $400,000,000 RCF exceeds 35% of total revolving commitments. The 35% threshold translates to $140,000,000 in aggregate revolving credit exposure.
• If aggregate RCF exposure is at or below $140,000,000, the leverage covenant is not tested — providing significant protection for VHG and effectively eliminating the risk of a financial covenant default so long as RCF utilization remains modest.
• If aggregate RCF exposure exceeds $140,000,000, the leverage covenant becomes operative and VHG must demonstrate pro forma compliance with the 4.5x maximum at each quarterly testing date.
Negotiation History. WGP initially proposed a 30% springing trigger (i.e., $120,000,000 in aggregate RCF exposure). Through negotiation, C&H secured an increase to 35% ($140,000,000), providing an additional $20,000,000 of revolving capacity before the covenant springs. This point was agreed in principle during the call on May 23, 2022, and should be confirmed in the next draft of the Credit Agreement.
4. Other Uses of the Total Net Leverage Ratio. In addition to its role as the sole financial maintenance covenant, the Total Net Leverage Ratio is referenced throughout the Credit Agreement in connection with the following provisions:
(a) Incremental Facility Incurrence Test. The Credit Agreement permits VHG to incur additional term loans and/or revolving commitments under the incremental facility provisions, subject to (among other conditions) a pro forma incurrence-based leverage test. VHG may incur additional incremental indebtedness if the pro forma Total Net Leverage Ratio does not exceed the lesser of (x) the closing date leverage ratio plus 0.50x (i.e., 2.52x + 0.50x = 3.02x) and (y) 4.0x. This dual-test structure provides meaningful incremental capacity at closing.
(b) Restricted Payments and Investments Baskets. Certain ratio-based "grower" baskets for restricted payments (dividends, distributions, share repurchases) and investments are available to VHG when the pro forma Total Net Leverage Ratio does not exceed specified levels (typically 3.0x or 3.5x for restricted payments, and 4.0x for investments, depending on the basket).
(c) Prepayment of Junior Indebtedness. VHG's ability to prepay, redeem, or repurchase subordinated indebtedness is subject to pro forma compliance with the Total Net Leverage Ratio at levels specified in the applicable restricted payments provisions.
(d) Excess Cash Flow Sweep Step-Downs. As described in Section III.G below, the annual Excess Cash Flow sweep percentage steps down based on the Total Net Leverage Ratio, with a 0% sweep applicable at leverage of 2.75x or below.
(e) Applicable Margin Step-Downs. The current deal structure provides for a flat Applicable Margin of Adjusted Term SOFR + 375 bps with no step-down grid. Accordingly, the Total Net Leverage Ratio is not currently used for margin determination. However, if a step-down grid is introduced in subsequent negotiations, the Total Net Leverage Ratio would serve as the reference metric.
E. "Permitted Indebtedness"
The "Permitted Indebtedness" definition enumerates the categories of indebtedness that VHG and its Restricted Subsidiaries are permitted to incur, maintain, or guarantee without triggering an event of default under the Credit Agreement. The definition is structured as a series of enumerated baskets, each with its own cap or condition. C&H has sought to maximize the size and flexibility of these baskets, employing a "dual-prong" structure (the greater of a fixed dollar amount and a percentage of LTM Adjusted EBITDA) wherever possible, to ensure that the baskets grow with VHG's earnings.
The following baskets are included in the definition:
(1) Existing Facility Indebtedness. The $700,000,000 New TLB and the $400,000,000 RCF under the Credit Agreement are expressly permitted.
(2) Incremental Term Loans and Revolving Commitments. VHG may incur additional incremental term loans and/or revolving commitments in an aggregate principal amount not to exceed the greater of (x) $150,000,000 and (y) 100% of LTM Adjusted EBITDA (i.e., $341,000,000 based on FY2021 Adjusted EBITDA). In addition, VHG may incur unlimited incremental indebtedness subject to satisfaction of the incurrence-based leverage test described in Section III.D.4(a) above (pro forma Total Net Leverage Ratio ≤ 4.0x, or, with respect to pari passu secured debt, ≤ 3.5x).
MFN Interaction. Incremental term loans incurred during the 18-month MFN sunset period (through January 21, 2024) are subject to the 50 basis point MFN threshold. If the yield on any incremental term loan exceeds the initial TLB yield by more than 50 basis points, the Applicable Margin on the initial TLB is automatically adjusted upward to within 50 basis points of the incremental term loan yield. This provision protects existing Lenders from margin compression in the event VHG incurs higher-yielding incremental debt during the sunset period.
(3) Senior Unsecured Notes. The existing $245,000,000 senior unsecured notes due 2028 (Atlantic Standard Trust Company as indenture trustee) and any permitted refinancing thereof.
(4) Capital Lease Obligations. Capital lease obligations in an aggregate amount not to exceed the greater of $50,000,000 and 15% of LTM Adjusted EBITDA.
(5) Purchase Money Indebtedness. Purchase money indebtedness in an aggregate amount not to exceed $25,000,000.
(6) General Basket. Indebtedness in an aggregate amount not to exceed the greater of $75,000,000 and 22% of LTM Adjusted EBITDA. WGP has proposed a flat cap of $50,000,000 without the grower component. C&H recommends holding the dual-prong position.
(7) Intercompany Indebtedness. Intercompany indebtedness between VHG and its Restricted Subsidiaries is permitted without cap, provided that any such indebtedness is evidenced by an intercompany note that is subordinated in right of payment to the obligations under the Credit Agreement.
(8) Acquisition Indebtedness. Indebtedness incurred to finance permitted acquisitions, subject to pro forma compliance with the incurrence-based leverage test.
(9) Non-Recourse Indebtedness of Project Finance Subsidiaries. Non-recourse indebtedness incurred by project finance subsidiaries in an aggregate amount not to exceed $100,000,000. This basket is relevant for potential joint venture hotel development projects that VHG may pursue, where the indebtedness would be non-recourse to VHG and the Guarantors.
(10) Hedging Obligations. Hedging obligations incurred in the ordinary course of business and not for speculative purposes.
(11) Subordinated Indebtedness. Subordinated indebtedness, subject to pro forma compliance with a Total Net Leverage Ratio of 5.0x (measured on a net basis).
Key Negotiation Point. As noted above, C&H is pushing for the dual "fixed dollar / percentage of EBITDA" grower structure in each applicable basket. WGP initially proposed fixed dollar caps only, which would limit VHG's flexibility as the business grows. The grower structure is increasingly common in BB-rated credit facilities and reflects the principle that a company's debt capacity should expand proportionally with its earnings. We recommend holding our position on this point across all applicable baskets.
F. "Permitted Liens"
1. Overview. The "Permitted Liens" definition sets forth the categories of liens that VHG and its Restricted Subsidiaries may grant without triggering a default under the negative pledge covenant. This definition interacts directly with the collateral package securing the obligations under the Credit Agreement.
2. Collateral Package. The New TLB and the RCF are secured by a first-priority lien on substantially all assets of VHG and the Guarantors, which include the following entities:
• Verimark Resort Properties LLC
• VHG Management Services Inc.
• Verimark Convention Holdings LLC
• Palmetto Beachfront Hotels LLC
• Cascadia Hospitality Corp.
The liens securing the New TLB are pari passu with the liens securing the $400,000,000 RCF, as governed by the Amended and Restated Intercreditor Agreement to be entered into at closing.
The collateral package includes: (i) fee simple and leasehold interests in 42 hotel properties (appraised at approximately $2.18 billion in the aggregate), (ii) 100% of the equity interests in each domestic Restricted Subsidiary, (iii) 65% of the equity interests in each first-tier foreign Restricted Subsidiary, and (iv) substantially all personal property of VHG and the Guarantors (including accounts receivable, inventory, equipment, intellectual property, and deposit accounts).
3. Permitted Lien Baskets. The definition of "Permitted Liens" includes the following standard baskets and carve-outs:
• Existing liens (as identified on a schedule to the Credit Agreement)
• Purchase money liens securing purchase money indebtedness permitted under the Permitted Indebtedness definition
• Liens securing capital lease obligations permitted under the Permitted Indebtedness definition
• Liens on assets of non-Guarantor Restricted Subsidiaries (limited to the value of such assets)
• Judgment liens not exceeding an aggregate amount of $30,000,000 (provided that such liens are stayed or bonded within 60 days)
• Liens for taxes not yet due and payable or being contested in good faith
• Statutory liens (mechanics' liens, materialmen's liens, landlord liens)
• Easements, rights-of-way, restrictions, and other similar encumbrances that do not materially interfere with the use or value of the affected property
• Liens securing hedging obligations permitted under the Credit Agreement
G. Other Key Definitions
The following additional defined terms are relevant to the covenant structure and economic terms of the Credit Agreement:
"Applicable Margin." The Applicable Margin for the New TLB is 375 basis points (3.75%) over Adjusted Term SOFR. The current deal structure provides for a flat margin with no step-down grid. Accordingly, the Applicable Margin remains constant at 375 basis points regardless of VHG's leverage level or credit rating.
"Adjusted Term SOFR." Adjusted Term SOFR is defined as the forward-looking term rate published by CME Group Benchmark Administration Limited (or a successor administrator) for the applicable interest period, plus a credit spread adjustment of 0.10% for one-month interest periods, 0.15% for three-month interest periods, and 0.25% for six-month interest periods. The credit spread adjustment is intended to approximate the historical basis differential between LIBOR and SOFR. A comprehensive analysis of the SOFR transition mechanics applicable to this facility is set forth in the separate memorandum prepared by Daniel Obi dated May 24, 2022, which should be read in conjunction with this memorandum.
"SOFR Floor." Adjusted Term SOFR is deemed not to be less than 0.50% for purposes of calculating the interest rate on the New TLB. The floor provides a minimum return to Lenders in a low-rate environment and is standard for current-vintage Term Loan B facilities.
"Default Rate." Upon the occurrence and during the continuance of an event of default, the interest rate on all outstanding obligations increases by 200 basis points above the otherwise applicable rate.
"Material Adverse Effect." The definition of "Material Adverse Effect" follows the standard formulation for leveraged credit agreements, encompassing any event, circumstance, development, or condition that has had, or would reasonably be expected to have, a material adverse effect on (i) the business, financial condition, or results of operations of VHG and its Restricted Subsidiaries taken as a whole, (ii) the ability of the Loan Parties to perform their obligations under the Loan Documents, or (iii) the rights and remedies of the Administrative Agent and the Lenders under the Loan Documents. C&H is seeking broad carve-outs to the Material Adverse Effect definition for: (a) industry-wide hospitality downturns (including seasonal fluctuations), (b) pandemics or public health emergencies, (c) changes in law or regulation of general applicability, (d) changes in GAAP or accounting standards, and (e) conditions arising from acts of war, terrorism, or natural disasters to the extent not disproportionately affecting VHG relative to other participants in the hospitality industry.
"Change of Control." A Change of Control triggers a mandatory prepayment of the New TLB at par (100% of outstanding principal). Change of Control is defined to include: (i) the acquisition by any person or group of more than 35% of VHG's outstanding voting stock, or (ii) the replacement of a majority of the members of VHG's board of directors with individuals who are not "continuing directors" (i.e., individuals who were members of the board on the closing date, or whose election or nomination was approved by a majority of the then-continuing directors).
"Restricted Payment." The term "Restricted Payment" encompasses dividends, distributions, and share repurchases by VHG. Restricted Payments are subject to ratio-based baskets tied to the Total Net Leverage Ratio, as well as a "builder basket" that accumulates a percentage of Consolidated Net Income (typically 50%) over time and is available for Restricted Payments once accumulated to a specified threshold.
"Excess Cash Flow." The Credit Agreement requires an annual mandatory prepayment of a specified percentage of "Excess Cash Flow," defined generally as Adjusted EBITDA minus the sum of (i) cash interest expense, (ii) cash taxes paid, (iii) scheduled debt amortization, (iv) capital expenditures (to the extent financed with internally generated cash flow), and (v) increases in working capital (with a deduction for decreases in working capital). The prepayment percentage is subject to step-downs based on the Total Net Leverage Ratio:
Given VHG's pro forma closing leverage of 2.52x, VHG is currently in the 0% sweep tier, providing maximum cash flow flexibility. VHG is not required to prepay any portion of Excess Cash Flow so long as leverage remains at or below 2.75x. This is a significant benefit of the current leverage profile and the broad Adjusted EBITDA definition.
IV. COVENANT BUILD AND PRO FORMA COMPLIANCE ANALYSIS
A. Methodology. The covenant build and pro forma compliance analysis set forth below tests VHG's compliance with the 4.5x Maximum Total Net Leverage Ratio on a pro forma basis as of the anticipated closing date of July 21, 2022, giving effect to the consummation of the Refinancing and all related transactions, including:
(i) The incurrence of the $700,000,000 New TLB (with OID of $7,000,000, resulting in net funding proceeds of $693,000,000);
(ii) The repayment in full of the existing Greystone TLB (outstanding principal of $621,875,000, plus approximately $2,916,667 in accrued and unpaid interest, plus a prepayment premium of $3,125,000, for total payoff of approximately $627,916,667);
(iii) The payment of the arrangement fee to Crescent Harbor ($3,500,000), the advisory fee to Meridian Strauss Advisory LLC ($1,400,000), and estimated legal and closing costs (approximately $3,200,000); and
(iv) The application of the remaining net proceeds to VHG's general corporate accounts for use in funding permitted acquisitions and general corporate purposes.
LTM Adjusted EBITDA is based on the four fiscal quarters ended March 31, 2022, the most recent quarterly period for which financial data is available. For purposes of this analysis, we have used VHG's FY2021 Adjusted EBITDA of $341,000,000 as the reference point, subject to update once Q1 2022 financial results are delivered by VHG's finance team (Renata Haines and Glenn Fischbach). We note that FY2021 audited financial statements were prepared by Clearmont & Wharton LLP, engagement partner Ronald Ashby, CPA.
B. Detailed Covenant Build Table
The following table presents the full covenant build, with line-by-line detail reconciling from GAAP Consolidated Net Income to Adjusted EBITDA, and from Adjusted EBITDA to the pro forma Total Net Leverage Ratio.
Part 1: Adjusted EBITDA Reconciliation (FY2021)
Part 2: Pro Forma Leverage Calculation (Post-Refinancing)
Note 1: Unrestricted cash of $87,000,000 reflects VHG's balance sheet cash at closing prior to the deposit of net refinancing proceeds. The approximately $60,483,333 in net proceeds from the Refinancing (after payoff of the Greystone TLB, OID, fees, and closing costs — see Appendix C) will be deposited to VHG's accounts and will augment the cash position available for future acquisitions and general corporate purposes. For conservatism, the net refinancing proceeds are not included in the unrestricted cash figure used in this analysis, as such proceeds are expected to be deployed relatively quickly in furtherance of VHG's acquisition pipeline.
Dollar Headroom Calculation. Based on the pro forma closing leverage of 2.52x and the 4.5x maximum covenant level, VHG could incur approximately $675,180,000 to $676,500,000 in additional net debt before the 4.5x covenant would be breached. This is calculated as follows:
Maximum Net Debt at 4.5x = $341,000,000 × 4.5 = $1,534,500,000
Current Net Debt = $858,000,000
Dollar Headroom = $1,534,500,000 − $858,000,000 = $676,500,000
This dollar headroom figure is further enhanced by the springing mechanism, which means that the covenant is not even tested unless RCF exposure exceeds $140,000,000. As a practical matter, VHG enjoys both significant leverage headroom and protection from covenant testing under normal operating conditions.
C. Sensitivity Analysis
To assess the robustness of VHG's covenant compliance under various stress scenarios, we present the following sensitivity analyses:
Scenario 1 — Full RCF Draw ($400,000,000)
If VHG were to draw the full $400,000,000 available under the RCF (for example, in connection with a large acquisition or to fund seasonal working capital needs), the impact on the leverage calculation would be as follows:
Under this scenario, the financial covenant would be tested, as aggregate RCF exposure of $400,000,000 exceeds the 35% springing trigger of $140,000,000. However, VHG would remain well within the 4.5x maximum, with 0.81x of headroom. We note that in practice, if VHG drew $400,000,000, it is likely that a significant portion of those funds would remain as cash on the balance sheet pending deployment, which would reduce the effective net debt and further improve the ratio. The simplified calculation above assumes cash remains constant at $87,000,000 for conservatism.
Scenario 2 — 15% Adjusted EBITDA Decline
If VHG experienced a 15% decline in Adjusted EBITDA (for example, due to an industry-wide downturn, increased competition, or operational disruptions at key properties), with Consolidated Net Debt remaining constant at $858,000,000:
Under this scenario, VHG remains well within the 4.5x maximum, and the financial covenant is not tested (assuming the RCF is undrawn). VHG would still have 1.54x of headroom.
Scenario 3 — Combined Stress (Full RCF Draw + 15% EBITDA Decline)
This scenario combines the two stress factors above — a full $400,000,000 RCF draw together with a 15% decline in Adjusted EBITDA:
Under this combined stress scenario, VHG would remain within the 4.5x maximum, but with only 0.16x of headroom — approximately $46,376,000 in dollar terms ($289.85M × 0.16 = ~$46.4M). This scenario underscores the importance of (i) the springing mechanism (the covenant would be tested given the $400M RCF draw), (ii) the broad Adjusted EBITDA definition (which maximizes the denominator), and (iii) active management of RCF utilization during periods of earnings softness. If VHG anticipates a simultaneous earnings decline and need for significant revolver draws, management should consider strategies to enhance the cash netting offset (e.g., delaying discretionary capital expenditures or deferring acquisitions).
Scenario 4 — Maximum Incremental Debt Test
This scenario assesses VHG's capacity to incur additional secured indebtedness under the incurrence-based leverage test (pro forma Total Net Leverage Ratio ≤ 4.0x for pari passu secured debt):
Accordingly, VHG could incur up to approximately $506,000,000 in additional pari passu secured debt (in the form of incremental term loans or revolving commitments) while maintaining pro forma compliance with the 4.0x incurrence test. This capacity is further augmented by the freebie basket of the greater of $150,000,000 and 100% of LTM Adjusted EBITDA ($341,000,000), which does not require satisfaction of the incurrence test.
D. Springing Covenant Trigger Analysis
As noted throughout this memorandum, the 4.5x Maximum Total Net Leverage Ratio financial covenant is springing in nature and is tested only when aggregate revolving credit exposure exceeds 35% of total revolving commitments.
At closing, the RCF is fully undrawn. Accordingly, the financial covenant is not being tested at closing, and VHG is not required to demonstrate compliance with the 4.5x maximum as a condition to closing. In practice, this means that VHG can operate with significant leverage headroom and without being in technical covenant testing mode, so long as aggregate RCF draws (including outstanding letters of credit) remain at or below $140,000,000.
C&H successfully negotiated the 35% springing trigger (increased from WGP's initial proposal of 30%), providing VHG with an additional $20,000,000 of revolving capacity before the covenant springs. This enhanced threshold is particularly valuable in a hospitality business, where seasonal working capital fluctuations may require periodic revolver draws that should not, in VHG's view, trigger a quarterly leverage test.
V. COMPARISON TO EXISTING GREYSTONE FACILITY DEFINITIONS
The following is a brief comparison of the key defined terms and covenant structure in the existing $625,000,000 Term Loan B credit agreement (the "Existing Credit Agreement") with Greystone Federal Credit Corp. as administrative agent, originated on February 14, 2020, versus the proposed new Credit Agreement with Crescent Harbor Bank, N.A.
Pricing. The Existing TLB bore interest at LIBOR + 425 basis points. The New TLB will bear interest at Adjusted Term SOFR + 375 basis points — a 50 basis point reduction in the applicable margin. After accounting for the SOFR credit spread adjustment (approximately 10–25 basis points depending on the interest period), the all-in cost of the new facility is meaningfully lower than the existing facility, resulting in estimated annual interest savings of approximately $3,500,000.