MEMORANDUM
PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
TO: Ian Blackwood, Partner, Banking & Finance, Calderwood & Harkness LLP
FROM: Sophie Tremblay, Lead Associate, Banking & Finance; Daniel Obi, Associate, Banking & Finance
DATE: June 15, 2022
RE: Verimark Hospitality Group Inc. — $700,000,000 Senior Secured Term Loan B Refinancing: Analysis of Incremental Facility Provisions and Interaction with "Most Favored Nation" Clause
ENGAGEMENT: 1016-00009
CONFIDENTIALITY NOTICE: This memorandum is protected by attorney-client privilege and the work product doctrine. It has been prepared solely for internal use by Calderwood & Harkness LLP in connection with the representation of Verimark Hospitality Group Inc. ("VHG" or the "Borrower"). This memorandum contains confidential attorney analysis and mental impressions and should not be disclosed to any third party without the express authorization of Ian Blackwood and the client. Unauthorized dissemination may constitute a waiver of privilege.
I. EXECUTIVE SUMMARY
This memorandum analyzes the incremental term loan provisions as currently drafted in the second Calderwood & Harkness revised draft of the Credit Agreement, dated June 8, 2022 (the "Credit Agreement" or the "Second Revised Draft"), among Verimark Hospitality Group Inc. (as Borrower), the Guarantors party thereto, Crescent Harbor Bank, N.A. (as Administrative Agent and Collateral Agent), and the Lenders party thereto. Specifically, this memorandum addresses the interaction of those incremental facility provisions with the "most favored nation" ("MFN") clause governing yield protection for the initial $700,000,000 Term Loan B facility (the "Initial TLB").
Based on our review and analysis, we note the following key findings:
1. Incremental Capacity. The Credit Agreement permits VHG to incur incremental term loans after closing, subject to specified capacity baskets (a fixed dollar basket of $175,000,000 and a ratio-based basket requiring pro forma Total Net Leverage not to exceed 3.50x) and customary conditions precedent. These provisions afford VHG meaningful flexibility to fund its acquisition pipeline and general corporate purposes through additional debt incurrence under the existing credit facility framework.
2. MFN Applicability and Sunset. The MFN clause applies to any Incremental Term Loans incurred under the Credit Agreement during the 18-month MFN sunset period running from the closing date (July 21, 2022) through January 21, 2024. The MFN is operative only during this window; after the sunset date, VHG may incur incremental term loans at any yield without triggering any adjustment to the Initial TLB margin.
3. MFN Threshold. The negotiated MFN Threshold is 50 basis points. If the "Effective Yield" of any Incremental Term Loan incurred during the sunset period exceeds the Effective Yield of the Initial TLB by more than 50 basis points, the Applicable Margin on the Initial TLB is automatically adjusted upward such that the Initial TLB's Effective Yield is within 50 basis points of the Effective Yield of the triggering Incremental Term Loan. The approximate Effective Yield of the Initial TLB at closing is ~400 basis points over Adjusted Term SOFR (comprising the 375 basis point margin plus approximately 25 basis points attributable to the amortized original issue discount).
4. Post-Sunset Flexibility. After the MFN sunset date of January 21, 2024, VHG may incur incremental term loans at any Effective Yield without consequence to the Initial TLB pricing. This provides VHG with unrestricted pricing flexibility for its medium-term capital structure planning.
5. Open Drafting Points. This memorandum identifies several open drafting points requiring discussion with Whitfield Gage & Partridge LLP ("WGP"), counsel to Crescent Harbor Bank, N.A., including (a) the treatment of the SOFR floor differential in the Effective Yield definition, (b) the standard of discretion afforded to the Administrative Agent in yield calculations, (c) the dollar threshold for the Acquisition MFN Carve-Out, and (d) the permanence of MFN-triggered margin adjustments. We provide recommended negotiating positions on each of these points in Section VIII below.
Companion Memoranda. This memorandum should be read in conjunction with the following previously circulated analyses:
• MFN Detailed Analysis and Market Comparison — dated June 10, 2022 (prepared by S. Tremblay), which provides benchmarking data on MFN thresholds, sunset periods, and carve-out structures across comparable hospitality-sector Term Loan B transactions closed between Q3 2021 and Q2 2022;
• Repricing Protection / Soft Call Analysis — dated May 19, 2022 (prepared by D. Obi), which examines the 6-month soft call provision and its interplay with the broader repricing and refinancing framework; and
• Key Defined Terms and Covenant Build Analysis — dated June 3, 2022 (prepared by S. Tremblay and D. Obi), which provides a comprehensive review of critical defined terms (including "Adjusted EBITDA," "Total Net Leverage Ratio," "Permitted Acquisition," and "Incremental Equivalent Debt") and the covenant architecture.
II. BACKGROUND AND TRANSACTION OVERVIEW
A. The Refinancing Transaction
Verimark Hospitality Group Inc. is undertaking a refinancing of its existing $625,000,000 senior secured Term Loan B facility (the "Existing TLB"), which was originally closed on February 14, 2020 with Greystone Federal Credit Corp. as administrative agent (CUSIP 92347LAA0). The Existing TLB was arranged in connection with VHG's acquisition of the Cascadia resort portfolio and has been outstanding since that date, with quarterly amortization payments of 0.25% of original principal reducing the outstanding balance to approximately $621,875,000 as of the anticipated payoff date.
The new $700,000,000 senior secured Term Loan B facility (CUSIP 92347LAB8) is being arranged by Crescent Harbor Bank, N.A. as sole lead arranger and bookrunner. The new facility will replace the Existing TLB in its entirety and provide VHG with incremental liquidity for permitted acquisitions and general corporate purposes.
Pricing Comparison. The Initial TLB under the new facility is priced at Adjusted Term SOFR plus 375 basis points, with a SOFR floor of 0.50%. By comparison, the Existing TLB was priced at LIBOR plus 425 basis points (with a LIBOR floor of 0.75%). After accounting for the LIBOR-to-SOFR transition and the applicable credit spread adjustment, the new facility represents an effective reduction in spread of approximately 50 basis points, generating estimated annual interest expense savings of approximately $3,500,000 for VHG. This savings estimate is based on the outstanding principal of the new facility ($700,000,000) applied against the spread differential, and does not account for the incremental principal amount or variations in benchmark rates over time.
Original Issue discount. The Initial TLB is being issued at an original issue discount of 1.00%, resulting in aggregate OID of $7,000,000 and net funding proceeds to VHG of $693,000,000.
Use of Proceeds. Proceeds of the Initial TLB will be applied as follows:
• Payoff of Existing TLB: Approximately $627,916,667, comprising:
• Outstanding principal balance: $621,875,000
• Accrued and unpaid interest (estimated through payoff date): approximately $2,916,667
• Prepayment premium: $3,125,000 (calculated as 0.50% of the original $625,000,000 principal amount, as required under Section 2.10(a) of the existing Greystone credit agreement)
• Net Incremental Proceeds: The facility size of $700,000,000 exceeds the Existing TLB principal by $75,000,000. After deducting the OID of $7,000,000, accrued interest payoff of approximately $2,916,667, the prepayment premium of $3,125,000, and estimated closing costs and arrangement fees (approximately $1,475,000), net proceeds available to VHG for permitted acquisitions and general corporate purposes are approximately $60,483,333.
B. VHG Capital Structure (Pro Forma, Post-Refinancing)
The following table sets forth VHG's pro forma capital structure immediately following closing of the refinancing transaction, assuming a closing date of July 21, 2022:
Key Credit Metrics (Pro Forma, at Closing):
• Total funded debt: $945,000,000 ($700,000,000 TLB + $245,000,000 senior unsecured notes)
• Unrestricted cash on hand: $87,000,000
• Total net debt: $858,000,000
• LTM Adjusted EBITDA (as of March 31, 2022, per the Compliance Certificate delivered in connection with closing): $341,000,000
• Pro forma Total Net Leverage Ratio: 2.52x ($858,000,000 ÷ $341,000,000)
• Pro forma Total Net Leverage Ratio headroom to maintenance covenant (4.5x springing): approximately 1.98x turns
• Pro forma Total Net Leverage Ratio headroom to incurrence test (3.50x): approximately 0.98x turns
Credit Ratings:
The credit ratings reflect VHG's position as a mid-cap lodging and hospitality operator with a diversified portfolio of resort, convention, and beachfront hotel properties across the southeastern United States and the Pacific Northwest. Both KRG and PCS have assigned "stable" Outlooks to the corporate family ratings.
C. Parties and Counsel
Borrower:
• Verimark Hospitality Group Inc., a Delaware corporation
• NYSE: VMRK
• Headquarters: 8200 West Palmetto Park Road, Suite 1500, Boca Raton, Florida 33433
• Chief Executive Officer: Marcus Delvecchio
• Chief Financial Officer: Renata Haines
• General Counsel: Priya Narayanan
• Treasurer: Glenn Fischbach
Administrative Agent / Collateral Agent / Lead Arranger:
• Crescent Harbor Bank, N.A.
• 600 Lexington Avenue, 34th Floor, New York, New York 10022
• Ted Marchetti, Managing Director, Leveraged Finance
• Anika Holm, Director, Loan Syndications
Guarantors:
• Verimark Resort Properties LLC (a Delaware limited liability company)
• VHG Management Services Inc. (a Delaware corporation)
• Verimark Convention Holdings LLC (a Florida limited liability company)
• Palmetto Beachfront Hotels LLC (a Florida limited liability company)
• Cascadia Hospitality Corp. (a Washington corporation)
Agent's Counsel:
• Whitfield Gage & Partridge LLP
• Harrison Whitfield III (Partner)
• Megan Yeung (Associate)
Borrower's Counsel:
• Calderwood & Harkness LLP
• Ian Blackwood (Partner, Banking & Finance)
• Sophie Tremblay (Lead Associate, Banking & Finance)
• Daniel Obi (Associate, Banking & Finance)
III. INCREMENTAL FACILITY PROVISIONS — DETAILED ANALYSIS
A. Overview of the Incremental Facility Framework
Section 2.14 of the Credit Agreement (entitled "Incremental Facilities") sets forth the framework pursuant to which VHG may incur additional term loan indebtedness ("Incremental Term Loans") and/or additional revolving credit commitments ("Incremental Revolving Commitments") after the closing date, in each case subject to the conditions and limitations described below. Collectively, Incremental Term Loans and Incremental Revolving Commitments are referred to in the Credit Agreement as "Incremental Facilities."
The incremental facility framework is a critical component of the Credit Agreement from VHG's perspective, as it provides the Borrower with the capacity to raise additional secured debt within the existing credit facility structure — thereby avoiding the need to negotiate a separate credit agreement, establish new security arrangements, or enter into intercreditor agreements — in connection with future capital needs, including acquisitions, capital expenditures, and general corporate purposes. The incurrence of Incremental Facilities is effected through the execution of an "Incremental Amendment" (as defined in Section 1.01 of the Credit Agreement), which constitutes a supplement to the Credit Agreement executed by VHG, the Administrative Agent, and each lender providing the incremental commitments (each, an "Incremental Lender"). Existing lenders under the Credit Agreement are not required to consent to the incurrence of Incremental Facilities (provided the conditions set forth in Section 2.14 are satisfied), and no existing lender is obligated to provide any portion of the incremental commitments unless it affirmatively elects to do so.
Incremental Term Loans and Incremental Revolving Commitments, once incurred, are treated as additional tranches under the Credit Agreement on a pari passu basis with the Initial TLB and the existing revolving credit facility, respectively. They share equally and ratably in the collateral securing the obligations under the Credit Agreement (subject to the terms of the Security Agreement and the Collateral Trust Agreement) and benefit from the same guarantees provided by the Guarantors. This pari passu treatment is fundamental to the credit facility architecture and ensures that Incremental Lenders have recourse to the same collateral pool and guarantee package as the initial lender syndicate.
B. Incremental Capacity Baskets
The Credit Agreement establishes two separate capacity baskets under which VHG may incur Incremental Facilities, each with distinct requirements and limitations:
1. Fixed Dollar Basket. Section 2.14(a)(i) permits VHG to incur Incremental Term Loans and/or Incremental Revolving Commitments in an aggregate principal amount not to exceed $175,000,000 (the "Fixed Dollar Basket"). This amount represents approximately 25% of closing date Adjusted EBITDA of $341,000,000, rounded to reflect the negotiated figure. The Fixed Dollar Basket may be utilized without any requirement that VHG satisfy a leverage-based incurrence test or demonstrate pro forma compliance with any financial ratio. It is a "freebie" basket in the parlance of the leveraged lending market — VHG has an unconditional right (subject to the other conditions precedent discussed in Section III.C below) to incur up to $175,000,000 in aggregate incremental facilities regardless of its leverage profile at the time of incurrence.
We note that the $175,000,000 Fixed Dollar Basket was a negotiated figure. Crescent Harbor's initial commitment letter (dated April 6, 2022) proposed a fixed basket of $125,000,000 (approximately 18% of closing date EBITDA). Calderwood & Harkness, on VHG's behalf, proposed $200,000,000 (approximately 29% of closing date EBITDA) in its initial markup of the commitment letter terms. The parties ultimately agreed to $175,000,000 as reflected in the Second Revised Draft, which is consistent with the upper range of fixed dollar baskets observed in comparable BB-/Ba3-rated hospitality-sector transactions (see the June 10, 2022 Market Comparison memo for detailed benchmarking).
2. Ratio-Based Basket (Incurrence Test). Section 2.14(a)(ii) permits VHG to incur an unlimited amount of Incremental Term Loans, provided that after giving pro forma effect to such incurrence (and the use of proceeds thereof, including any acquisitions or other permitted investments funded therefrom), the Total Net Leverage Ratio does not exceed 3.50x (the "Incurrence Test"). The 3.50x threshold represents a ratio that is 1.0x inside the 4.5x springing maintenance covenant, providing meaningful incurrence headroom while ensuring that incremental borrowings do not push VHG's leverage profile to levels approaching the maintenance covenant trigger.
The pro forma calculation under the Incurrence Test requires that VHG give effect to the incremental incurrence as if it had occurred on the first day of the most recently ended four-quarter period for which financial statements have been delivered, with Adjusted EBITDA calculated on an LTM basis (with customary pro forma adjustments for acquisitions, dispositions, cost savings initiatives, and other items set forth in the definition of "Adjusted EBITDA"). The pro forma calculation must also account for any reduction in unrestricted cash resulting from the use of proceeds and any additional debt assumed in connection with an acquisition.
3. Combined Use. Importantly, Section 2.14(a)(iii) provides that the Fixed Dollar Basket and the Ratio-Based Basket may be utilized simultaneously. That is, VHG may incur incremental facilities using both baskets in a single transaction or across multiple transactions, applying capacity from either or both baskets. The Fixed Dollar Basket may be accessed without satisfying the Incurrence Test, while any amounts incurred under the Ratio-Based Basket must satisfy the 3.50x pro forma leverage test.
4. Classification Flexibility. Section 2.14(a)(iv) grants VHG the right to reclassify amounts between the Fixed Dollar Basket and the Ratio-Based Basket at the time of incurrence (and at any time thereafter upon notice to the Administrative Agent), subject to satisfaction of the applicable conditions at the time of reclassification. This "reclassification" mechanic provides VHG with flexibility to optimize its basket utilization — for example, if VHG initially designates an incremental incurrence against the Fixed Dollar Basket (when it would also have satisfied the Incurrence Test), it may later reclassify the amount against the Ratio-Based Basket, thereby restoring capacity under the Fixed Dollar Basket for future use. This is a borrower-favorable provision that is increasingly common in the current leveraged lending market and was included in the initial Calderwood & Harkness draft at VHG's request.
C. Conditions to Incremental Incurrence
Section 2.14(b) of the Credit Agreement sets forth the conditions precedent that must be satisfied (or waived by the Administrative Agent) in connection with each incurrence of Incremental Facilities. These conditions are summarized below:
1. No Default. No Event of Default or Default (each as defined in Article VIII of the Credit Agreement) shall have occurred and be continuing at the time of incurrence, or would result from such incurrence and the application of the proceeds thereof. This is a standard condition designed to ensure that the Borrower does not increase its indebtedness at a time when it is in breach of its existing obligations.
2. Pro Forma Financial Covenant Compliance. To the extent the springing financial covenant is then in effect (i.e., to the extent aggregate revolving credit exposure exceeds 35% of total revolving commitments, or $140,000,000), VHG shall be in pro forma compliance with the 4.5x maximum Total Net Leverage Ratio after giving effect to the incremental incurrence. We note that this condition tests compliance with the maintenance covenant (4.5x), not the incurrence test (3.50x) applicable to the Ratio-Based Basket — the two tests serve different purposes and apply independently.
3. Accuracy of Representations and Warranties. The representations and warranties of VHG and each Guarantor set forth in Article V of the Credit Agreement shall be true and correct in all material respects (or, in the case of any representation or warranty qualified by materiality or "Material Adverse Effect," in all respects) as of the date of such incurrence, except to the extent such representations and warranties expressly relate to an earlier date, in which case they shall be true and correct in all material respects as of such earlier date.
4. Execution and Delivery of Incremental Amendment. VHG shall have executed and delivered to the Administrative Agent an Incremental Amendment, duly executed by VHG, the Administrative Agent, and each Incremental Lender, specifying the terms of the Incremental Facility (including the principal amount, applicable margin, maturity date, amortization schedule, and any other terms that differ from those of the Initial TLB or existing revolving facility, as applicable).
5. Legal Opinions and Officer's Certificates. VHG shall have delivered to the Administrative Agent (a) a customary legal opinion of borrower's counsel (Calderwood & Harkness LLP) addressing enforceability, due authorization, no conflict, and other customary matters, (b) an officer's certificate of VHG (signed by the Chief Financial Officer or Treasurer) certifying compliance with the conditions set forth in this Section 2.14(b), and (c) updated good standing certificates from applicable jurisdictions of organization to the extent requested by the Administrative Agent.
6. Reaffirmation of Guarantees and Security Interests. Each Guarantor shall have executed and delivered a reaffirmation agreement confirming that its guaranty obligations and the security interests granted under the Security Agreement and related collateral documents extend to the Incremental Facility obligations.
7. Prior Written Notice. VHG shall have provided the Administrative Agent with at least three (3) business days' prior written notice of the proposed Incremental Facility incurrence, specifying the proposed principal amount, anticipated funding date, and identity of the Incremental Lenders (to the extent known).
8. Minimum Tranche Size. Each Incremental Facility shall have an aggregate principal amount of at least $25,000,000 (or such lesser amount as constitutes all remaining capacity under the applicable basket). This minimum threshold is intended to prevent a proliferation of small, administratively burdensome incremental tranches.
D. Terms of Incremental Term Loans
Section 2.14(c) of the Credit Agreement sets forth the permitted terms for Incremental Term Loans. These provisions establish guardrails that protect the interests of the initial TLB lender syndicate while affording VHG flexibility to tailor incremental debt to market conditions and investor demand at the time of incurrence:
Maturity. The final maturity date of any Incremental Term Loan must be no earlier than the maturity date of the Initial TLB, which is July 21, 2029. This "no earlier than" requirement ensures that incremental term debt does not mature in advance of the Initial TLB, which would create a structural seniority issue by requiring repayment of the incremental tranche before the initial lenders receive their principal. VHG may, however, issue Incremental Term Loans with a maturity date that is later than July 21, 2029, which would be structurally subordinate to the Initial TLB from a duration perspective.
Weighted Average Life to Maturity (WALM). The weighted average life to maturity of any Incremental Term Loan must be no shorter than the remaining weighted average life to maturity of the Initial TLB at the time of incurrence. This requirement operates in tandem with the maturity requirement to prevent the structuring of incremental tranches with aggressive front-loaded amortization that would result in a shorter effective duration than the Initial TLB, even if the stated maturity is the same.
Amortization. Incremental Term Loans may have an amortization schedule that differs from the Initial TLB's 1.00% per annum quarterly amortization (0.25% per quarter), provided that the WALM requirement set forth above is satisfied. For example, an Incremental Term Loan with bullet maturity (no amortization) would satisfy the WALM requirement, while an Incremental Term Loan with 5.00% per annum amortization would need to be assessed against the remaining WALM of the Initial TLB at the time of incurrence.
Interest Rate / Pricing. Incremental Term Loans may be priced at any rate agreed between VHG and the Incremental Lenders, subject to the MFN provision during the MFN sunset period (discussed in detail in Section IV below). Outside the MFN sunset period, there is no constraint on the pricing of Incremental Term Loans. The interest rate may be a floating rate (referencing Adjusted Term SOFR or any successor benchmark) or a fixed rate, at VHG's election in consultation with the Incremental Lenders.
Covenants, Events of Default, Guarantees, and Collateral. The covenants and events of default applicable to any Incremental Term Loan must be no more restrictive than those applicable to the Initial TLB (applying a "no more favorable to the lenders" standard), unless (i) the benefit of any more restrictive terms is extended equally and ratably to the initial TLB lenders, or (ii) such more restrictive terms apply only after the maturity date of the Initial TLB. Incremental Term Loans share the same guarantees and collateral as the Initial TLB on a pari passu basis.
Currency. Incremental Term Loans must be denominated in United States Dollars. Multicurrency incremental tranches are not permitted under the current draft.
E. Incremental Revolving Commitments
Section 2.14(d) of the Credit Agreement addresses Incremental Revolving Commitments, which are subject to the same capacity baskets described in Section III.B above but differ from Incremental Term Loans in several important respects.
Most significantly for purposes of this memorandum, Incremental Revolving Commitments are not subject to the MFN clause. The MFN provision set forth in Section 2.14(c)(iv) applies exclusively to Incremental Term Loans. This exclusion reflects the market convention that revolving credit commitments serve a different function (providing liquidity for working capital and general corporate purposes) than term loans (which represent permanent capital), and that revolving pricing is typically driven by different market dynamics and competitive considerations.
Incremental Revolving Commitments, once incurred, are treated as additional revolving commitments under the existing $400,000,000 revolving credit facility on a pari passu basis. They share the same maturity date (July 21, 2027), letter of credit subfacility, and swingline subfacility as the existing revolving commitments, and are subject to the same terms, covenants, and pricing structure. Incremental Revolving Lenders become party to the Credit Agreement as Revolving Lenders and share ratably in all revolving credit advances, letter of credit participations, and swingline loan participations.
F. Incremental Equivalent Debt
Section 2.15 of the Credit Agreement separately permits VHG to incur "Incremental Equivalent Debt" — defined as pari passu or junior lien indebtedness incurred outside the Credit Agreement facility structure but subject to the same aggregate capacity baskets applicable to Incremental Facilities under Section 2.14. Incremental Equivalent Debt is typically structured as a standalone term loan agreement or a note issuance with a separate group of lenders or noteholders, rather than as an additional tranche under the Credit Agreement.
The principal distinction between Incremental Equivalent Debt and Incremental Term Loans for purposes of this memorandum is that Incremental Equivalent Debt is not subject to the MFN clause. Because Incremental Equivalent Debt is not incurred "under" the Credit Agreement (even though it shares capacity with Incremental Facilities), the MFN yield protection mechanism in Section 2.14(c)(iv) does not apply. This creates a potential structuring opportunity for VHG, as discussed further in Section VIII.E and Section IX below: if VHG wishes to incur higher-yielding pari passu secured debt during the MFN sunset period without triggering an upward adjustment to the Initial TLB margin, it may consider structuring such debt as Incremental Equivalent Debt rather than as an Incremental Term Loan under the Credit Agreement.
We note, however, that Incremental Equivalent Debt carries certain practical disadvantages relative to Incremental Term Loans incurred under the Credit Agreement: (a) separate documentation (a standalone credit agreement or note purchase agreement) is required, increasing transaction costs; (b) an intercreditor agreement (or amendment to the existing Collateral Trust Agreement) may be required to govern the relative rights of the Incremental Equivalent Debt holders and the lenders under the Credit Agreement; and (c) the syndication and distribution of Incremental Equivalent Debt may be less efficient than an incremental incurrence under an existing credit facility with established administrative infrastructure.
IV. MOST FAVORED NATION PROVISION — MECHANICS AND INTERACTION WITH INCREMENTAL TERMS
A. Overview of the MFN Clause
Section 2.14(c)(iv) of the Credit Agreement sets forth the MFN provision applicable to Incremental Term Loans. The MFN clause, as reflected in the Second Revised Draft (June 8, 2022), operates as follows:
If at any time during the period beginning on the Closing Date (July 21, 2022) and ending on the date that is 18 months after the Closing Date (January 21, 2024) (the "MFN Sunset Period"), VHG incurs any Incremental Term Loan under the Credit Agreement, and the Effective Yield (as defined below) applicable to such Incremental Term Loan exceeds the Effective Yield applicable to the Initial TLB by more than 50 basis points (the "MFN Threshold"), then the Applicable Margin on the Initial TLB shall be automatically increased to the extent necessary such that the Effective Yield on the Initial TLB is equal to the Effective Yield of such Incremental Term Loan minus 50 basis points (the "MFN Adjustment").
The MFN clause is a lender-protective mechanism that ensures the initial TLB lender syndicate is not economically disadvantaged relative to subsequent incremental lenders who receive more favorable pricing. It reflects the fundamental bargain between the Borrower and the initial lenders: in exchange for committing to fund the Initial TLB at a specified yield, the initial lenders receive a degree of protection against yield dilution during the 18-month sunset period. After the MFN Sunset Period expires on January 21, 2024, VHG is free to incur Incremental Term Loans at any yield without consequence to the Initial TLB pricing. This temporal limitation balances the initial lenders' interest in yield protection against VHG's interest in long-term pricing flexibility.
B. Definition of "Effective Yield"
The operation of the MFN clause depends critically on the definition of "Effective Yield," which determines the all-in pricing metric against which the Initial TLB and any Incremental Term Loan are compared. As defined in Section 1.01 of the Credit Agreement, "Effective Yield" means, with respect to any term loan, the sum of:
(i) the Applicable Margin for such term loan;
(ii) the interest rate floor (i.e., the SOFR floor or other benchmark floor) applicable to such term loan, but only to the extent such floor exceeds the then-prevailing applicable reference rate; and
(iii) any original issue discount ("OID") or upfront fees (in each case, amortized over the shorter of (A) the expected weighted average life of such term loan and (B) four (4) years from the date of incurrence of such term loan),
in each case as determined by the Administrative Agent.
This definition is designed to capture the comprehensive economic yield of a term loan — not merely the stated interest rate spread, but the full cost of carry including embedded discount and floor economics. Each component merits separate discussion:
Applicable Margin. For the Initial TLB, the Applicable Margin is 375 basis points (3.75% per annum) over Adjusted Term SOFR. This is the most straightforward component of the Effective Yield calculation and is the primary pricing variable that VHG and the Incremental Lenders will negotiate in connection with any Incremental Term Loan.
SOFR Floor. The Initial TLB includes a SOFR floor of 0.50% (50 basis points). The floor component is included in the Effective Yield calculation only to the extent the floor exceeds the then-prevailing applicable reference rate (i.e., the relevant tenor of Term SOFR). As of the anticipated closing date of July 21, 2022, the 1-month Term SOFR rate is approximately 2.29%, which significantly exceeds the 0.50% floor. Accordingly, the SOFR floor is not currently "in the money" and does not contribute to the Effective Yield calculation at current rate levels. However, in a declining rate environment (which, while not the current trajectory, cannot be excluded over the 18-month MFN sunset period), the floor could become operative and would then contribute to the Effective Yield differential between the Initial TLB and any Incremental Term Loan. The treatment of the SOFR floor in the Effective Yield definition is an open drafting point, discussed further in Section VIII.A below.
OID/Upfront Fees. The Initial TLB is being issued at an OID of 1.00% ($7,000,000 on the $700,000,000 principal amount). For purposes of the Effective Yield calculation, this OID is amortized over the shorter of the expected weighted average life of the term loan and four years. Given the Initial TLB's 7-year tenor with 1.00% per annum amortization, the expected average life exceeds four years, and accordingly the OID is amortized over the four-year period for Effective Yield purposes. The annualized OID component is therefore approximately 25 basis points per annum (1.00% ÷ 4 years = 0.25% = 25 bps).
The inclusion of OID and upfront fees in the Effective Yield definition is an important anti-avoidance feature. Without it, VHG could circumvent the MFN by pricing an Incremental Term Loan with a low stated margin but a substantial OID (or, equivalently, by paying upfront fees to Incremental Lenders), thereby providing the Incremental Lenders with a higher economic yield than the Initial TLB lenders without triggering the spread-based MFN comparison. The Effective Yield definition prevents this arbitrage by capturing the full economic cost of the debt instrument.
Illustrative Effective Yield Calculation for the Initial TLB at Closing:
This ~400 basis point Effective Yield establishes the baseline against which the pricing of any Incremental Term Loan will be measured for MFN purposes. Adding the 50 basis point MFN Threshold, VHG has a "cushion" of approximately 450 basis points in Effective Yield on any Incremental Term Loan before the MFN Adjustment would be triggered.
C. MFN Threshold — 50 Basis Points
The negotiated MFN Threshold is 50 basis points. This threshold represents the permissible differential between the Effective Yield of the Initial TLB and the Effective Yield of any Incremental Term Loan incurred during the MFN Sunset Period. In practical terms, VHG may incur an Incremental Term Loan with an Effective Yield of up to approximately 450 basis points over Adjusted Term SOFR (i.e., the Initial TLB's ~400 basis point Effective Yield plus the 50 basis point threshold) without triggering an upward adjustment to the Initial TLB margin.
If the Effective Yield of the Incremental Term Loan exceeds approximately 450 basis points over Adjusted Term SOFR, the MFN Adjustment is triggered. The Initial TLB Applicable Margin is then increased such that the Initial TLB's Effective Yield is within 50 basis points of the Incremental Term Loan's Effective Yield. To illustrate with a simple example: if VHG incurs an Incremental Term Loan at an Effective Yield of 500 basis points over Adjusted Term SOFR, the Initial TLB margin must adjust upward so that the Initial TLB's Effective Yield reaches at least 450 basis points (i.e., 500 - 50 = 450). Since the Initial TLB's current Effective Yield of ~400 basis points includes ~25 basis points of OID component that is fixed, the required margin increase would be 50 basis points (from 375 bps to 425 bps), resulting in a new Effective Yield of approximately 450 basis points (425 bps margin + 25 bps OID = 450 bps).
Market Context. As discussed in greater detail in the June 10, 2022 MFN Detailed Analysis and Market Comparison memo, a 50 basis point MFN Threshold is consistent with the prevailing market standard for leveraged Term Loan B facilities in the hospitality sector. Of the 14 comparable hospitality-sector TLB transactions surveyed in that memo (closed between Q3 2021 and Q2 2022), 10 featured a 50 basis point MFN threshold, two featured a 75 basis point threshold, and two featured a 25 basis point threshold. The 50 basis point threshold represents a balanced approach: it provides VHG with meaningful pricing flexibility on incremental issuances while affording the initial lender syndicate reasonable protection against yield dilution.
D. MFN Sunset Period — 18 Months
The MFN provision is operative only during the MFN Sunset Period, which runs from the closing date of July 21, 2022 through January 21, 2024 — a period of 18 months. After the MFN Sunset Date of January 21, 2024, VHG may incur Incremental Term Loans at any Effective Yield without triggering any adjustment to the Initial TLB Applicable Margin. The sunset mechanism ensures that the MFN protection is time-limited, reflecting the market reality that initial lenders' reasonable expectation of yield stability diminishes over time as market conditions, credit fundamentals, and pricing benchmarks evolve.
Negotiation History. The 18-month sunset period was a negotiated outcome. In Crescent Harbor's initial term sheet circulated on April 6, 2022, the proposed MFN sunset period was 24 months (expiring July 21, 2024). Calderwood & Harkness, on VHG's behalf, proposed a 12-month sunset period in our initial markup, arguing that VHG's active acquisition pipeline necessitated near-term flexibility to incur incremental debt at competitive pricing without triggering MFN adjustments. Following discussions between Ian Blackwood and Harrison Whitfield III during the week of May 9, 2022, the parties agreed to an 18-month sunset period, which was reflected in WGP's first revised draft (May 16, 2022) and has been maintained through the Second Revised Draft. The 18-month period is consistent with borrower-favorable market precedent in the hospitality sector; the June 10, 2022 Market Comparison memo identified sunset periods ranging from 12 to 24 months across comparable transactions, with a median of 18 months.
Strategic Significance. The 18-month MFN Sunset Period has direct implications for VHG's capital structure planning. During the period from closing through January 21, 2024, VHG's ability to incur Incremental Term Loans at yields exceeding the ~450 basis point Effective Yield threshold is constrained by the MFN Adjustment mechanism. This constrains VHG's near-term flexibility to issue higher-yielding incremental debt without repricing the Initial TLB upward, potentially eroding the 50 basis point annual interest savings (~$3,500,000 per year) achieved through the refinancing. However, after January 21, 2024, VHG will have unrestricted pricing flexibility on incremental incurrences, allowing it to respond to market conditions and acquisition opportunities without concern for MFN-driven repricing of the Initial TLB. As discussed in Section IX below, VHG should carefully consider the timing of any material acquisition-funded incremental issuance relative to the sunset date.
E. Mechanics of Automatic Margin Adjustment
Section 2.14(c)(iv)(B) of the Credit Agreement establishes the following step-by-step process for the MFN Adjustment when the MFN Threshold is exceeded:
Step 1: Notice of Proposed Incurrence. VHG delivers notice to the Administrative Agent (Crescent Harbor Bank, N.A.) of the proposed Incremental Term Loan incurrence, specifying the proposed principal amount, anticipated funding date, Applicable Margin, SOFR floor (if any), OID or upfront fees, and other material terms. This notice must be delivered at least three (3) business days prior to the proposed funding date.
Step 2: Effective Yield Calculation. Upon receipt of such notice, the Administrative Agent calculates the Effective Yield of the proposed Incremental Term Loan based on the terms specified in the notice, applying the definition of "Effective Yield" set forth in Section 1.01 of the Credit Agreement and the methodology described in Section IV.B above.
Step 3: Comparison to Initial TLB Effective Yield. The Administrative Agent compares the Effective Yield of the proposed Incremental Term Loan against the Effective Yield of the Initial TLB as of the proposed funding date. The Initial TLB's Effective Yield is determined using the same methodology, with the OID component recalculated based on the remaining amortization period.
Step 4: Determination of MFN Adjustment. If the differential between the Incremental Term Loan's Effective Yield and the Initial TLB's Effective Yield exceeds the 50 basis point MFN Threshold, the Administrative Agent calculates the required upward adjustment to the Applicable Margin on the Initial TLB. The adjustment is the amount necessary to bring the Initial TLB's Effective Yield to within 50 basis points of the Incremental Term Loan's Effective Yield.
Step 5: Effective Date of Adjustment. The MFN Adjustment to the Initial TLB's Applicable Margin takes effect as of the funding date of the Incremental Term Loan. From and after such date, all interest accruing on the Initial TLB will be calculated using the adjusted Applicable Margin.
Step 6: Notice to Initial TLB Lenders. Promptly following the funding of the Incremental Term Loan and the effectiveness of the MFN Adjustment, the Administrative Agent provides written notice to all initial TLB lenders of the adjusted Applicable Margin, the effective date of the adjustment, and the calculation supporting the determination.
Permanence of Adjustment. A critical feature of the MFN Adjustment as currently drafted is that the adjustment is permanent. Once the Initial TLB's Applicable Margin is increased as a result of an MFN-triggered adjustment, it is not subsequently reduced if the Incremental Term Loan that triggered the adjustment is later repaid, refinanced, or otherwise retired. This "one-way ratchet" ensures that the initial TLB lenders retain the benefit of the yield increase regardless of subsequent changes to VHG's debt structure. As discussed in Section VIII.D below, Calderwood & Harkness recommends proposing a reversible (or "step-down") adjustment mechanism as a borrower-favorable modification, though we anticipate significant lender resistance to this approach.
Administrative Agent Discretion. Under the current draft, the Administrative Agent has "sole" discretion in determining the Effective Yield of any term loan for purposes of the MFN calculation. This discretion standard is discussed as an open drafting point in Section VIII.B below.
F. Carve-Outs and Exceptions to MFN
Section 2.14(c)(iv)(C) of the Credit Agreement provides that the MFN clause does not apply to the following categories of incremental indebtedness:
1. Acquisition MFN Carve-Out. Incremental Term Loans incurred to finance a "Permitted Acquisition" (as defined in Section 1.01 of the Credit Agreement) are excluded from the MFN calculation, provided that the aggregate principal amount of such acquisition-related Incremental Term Loans does not exceed $100,000,000 (the "Acquisition MFN Carve-Out"). This carve-out permits VHG to incur acquisition financing at yields that may exceed the MFN Threshold without triggering an upward adjustment to the Initial TLB margin, subject to the $100,000,000 dollar cap.
The Acquisition MFN Carve-Out was a VHG-requested provision, reflecting VHG's stated intention to pursue acquisitions in the lodging and hospitality sector during the near term. VHG's management team, led by CEO Marcus Delvecchio and CFO Renata Haines, has communicated to Calderwood & Harkness that VHG's acquisition pipeline includes at least two identified targets in the mid-market resort segment, with anticipated acquisition costs in the range of $50,000,000 to $120,000,000 per target. The Acquisition MFN Carve-Out provides VHG with the flexibility to finance these acquisitions with incremental term debt at market-competitive yields without repricing the Initial TLB.
An important structural note regarding the Acquisition MFN Carve-Out: the $100,000,000 cap operates as a dollar threshold, not a per-dollar exclusion. That is, if VHG incurs an acquisition-related Incremental Term Loan with an aggregate principal amount that does not exceed $100,000,000, the entire amount is excluded from MFN testing. However, if the aggregate principal amount of such acquisition-related Incremental Term Loan exceeds $100,000,000, the entire amount (not merely the excess above $100,000,000) becomes subject to the MFN calculation. This is a meaningful distinction that VHG's treasury team (Glenn Fischbach) should understand clearly when sizing any acquisition-funded incremental issuance during the MFN Sunset Period. As discussed in Section VIII.C below, Calderwood & Harkness recommends seeking to increase the Acquisition MFN Carve-Out to $150,000,000 or, alternatively, proposing that only the amount exceeding the threshold be subject to MFN testing.
2. Post-Sunset Incurrences. Incremental Term Loans incurred after the MFN Sunset Date of January 21, 2024 are excluded from the MFN clause by operation of the sunset mechanism itself. This is not a "carve-out" in the traditional sense but rather a temporal limitation on the MFN's applicability.
3. Other Excluded Indebtedness. As noted in Section III.E and Section III.F above, the following categories of indebtedness are not subject to the MFN clause:
• Incremental Revolving Commitments: Not subject to MFN (Section 2.14(d) expressly excludes revolving facilities from the yield protection mechanism).
• Incremental Equivalent Debt: Pari passu or junior lien debt incurred outside the Credit Agreement facility structure pursuant to Section 2.15 is not subject to MFN, as the MFN applies only to Incremental Term Loans incurred "under" the Credit Agreement.
V. ILLUSTRATIVE SCENARIOS — MFN INTERACTION WITH INCREMENTAL INCURRENCE
To assist in understanding the practical operation of the MFN clause, we present below four illustrative scenarios involving Incremental Term Loan incurrences at various pricing levels and timeframes. These scenarios are intended to demonstrate the range of potential outcomes and to inform VHG's strategic planning regarding the timing and pricing of future incremental issuances.
A. Scenario 1: Incremental Term Loan Within MFN Threshold
Assumptions:
• VHG incurs a $100,000,000 Incremental Term Loan in December 2023 (within the MFN Sunset Period)
• Pricing: Adjusted Term SOFR + 400 bps with 0.50% OID
• Purpose: General corporate purposes (not a Permitted Acquisition)
Effective Yield Calculation for Incremental Term Loan:
Initial TLB Effective Yield: ~400 bps (as calculated in Section IV.B above)
Differential: 412.5 - 400.0 = 12.5 bps
Analysis: The 12.5 basis point differential is well below the 50 basis point MFN Threshold.
Result: No adjustment to the Initial TLB Applicable Margin. The Initial TLB remains at Adjusted Term SOFR + 375 bps. VHG incurs the $100,000,000 Incremental Term Loan at the proposed pricing without any impact on its existing debt service costs.
B. Scenario 2: Incremental Term Loan Exceeding MFN Threshold
Assumptions:
• VHG incurs a $150,000,000 Incremental Term Loan in October 2023 (within the MFN Sunset Period)
• Pricing: Adjusted Term SOFR + 475 bps with 1.00% OID
• Purpose: General corporate purposes (not a Permitted Acquisition)
Effective Yield Calculation for Incremental Term Loan:
Initial TLB Effective Yield: ~400 bps
Differential: 500.0 - 400.0 = 100.0 bps
Analysis: The 100 basis point differential exceeds the 50 basis point MFN Threshold by 50 basis points.
MFN Adjustment Calculation:
• Required Initial TLB Effective Yield: 500.0 - 50.0 = 450.0 bps
• Current Initial TLB Effective Yield: ~400.0 bps (comprising 375.0 bps margin + ~25.0 bps OID)
• Required increase in Effective Yield: 450.0 - 400.0 = 50.0 bps
• Since the OID component of the Initial TLB is fixed (the OID has already been paid and is being amortized), the entire 50.0 bps increase must come from an increase in the Applicable Margin
• New Initial TLB Applicable Margin: 375.0 + 50.0 = 425.0 bps (i.e., Adjusted Term SOFR + 4.25%)
Result: The Initial TLB Applicable Margin is permanently increased from 375 bps to 425 bps, effective as of the funding date of the Incremental Term Loan. The Initial TLB's new Effective Yield is approximately 450 bps (425 bps margin + ~25 bps OID), which is exactly 50 bps below the 500 bps Effective Yield of the Incremental Term Loan.
Financial Impact to VHG:
• Annual incremental interest cost on the Initial TLB: $700,000,000 × 0.50% = $3,500,000 per annum
• This $3,500,000 annual increase in interest expense on the Initial TLB fully offsets the estimated annual interest savings of approximately $3,500,000 that VHG achieved by refinancing the Existing TLB at a 50 basis point lower spread
• In other words, an MFN-triggered 50 basis point margin increase on the Initial TLB would effectively negate the economic benefit of the refinancing transaction
This scenario underscores the importance of careful pricing analysis before VHG commits to any Incremental Term Loan incurrence during the MFN Sunset Period.
C. Scenario 3: Incremental Term Loan After MFN Sunset
Assumptions:
• VHG incurs a $200,000,000 Incremental Term Loan in March 2024 (after the January 21, 2024 MFN Sunset Date)
• Pricing: Adjusted Term SOFR + 525 bps with 2.00% OID
• Purpose: Acquisition financing
Effective Yield Calculation for Incremental Term Loan:
Initial TLB Effective Yield: ~400 bps
Differential: 575.0 - 400.0 = 175.0 bps
Analysis: Although the 175 basis point differential far exceeds the 50 basis point MFN Threshold, the Incremental Term Loan is being incurred after the MFN Sunset Date. The MFN clause, by its terms, does not apply to Incremental Term Loans incurred after January 21, 2024.
Result: No adjustment to the Initial TLB Applicable Margin. The Initial TLB remains at Adjusted Term SOFR + 375 bps regardless of the Effective Yield differential. VHG captures the full benefit of the lower-priced Initial TLB while incurring the higher-yielding Incremental Term Loan at the market-clearing price for the acquisition financing.