PRIVILEGED & CONFIDENTIAL ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP
INTERNAL MEMORANDUM
May 20, 2022
TO: Ian Blackwood, Partner, Banking & Finance, Calderwood & Harkness LLP
FROM: Sophie Tremblay, Lead Associate, Banking & Finance, Calderwood & Harkness LLP
CC: Stephanie Okafor (Billing Partner); Daniel Obi (Working Associate); Leonard Cross (Tax)
RE: Verimark Hospitality Group Inc. — $700,000,000 Senior Secured Term Loan B — Summary of Open Negotiation Points Following Initial Comments from Whitfield Gage & Partridge LLP
Engagement No.: 1016-00009
Matter: Refinancing of existing $625,000,000 Term Loan B (Greystone Federal Credit Corp. as Administrative Agent) with new $700,000,000 Term Loan B (Crescent Harbor Bank, N.A. as Administrative Agent, Collateral Agent, Lead Arranger, and Bookrunner)
This memorandum has been prepared in connection with the above-referenced engagement and is based on our review of Calderwood & Harkness LLP's first draft of the Credit Agreement circulated on May 16, 2022, and initial informal comments received via email from Whitfield Gage & Partridge LLP ("WGP"), counsel to Crescent Harbor Bank, N.A. ("Crescent Harbor"), prior to receipt of WGP's full revised draft (which we understand is forthcoming). This memorandum is subject to the attorney-client privilege and the work product doctrine and is intended solely for internal use and for communication with VHG's in-house legal and finance teams. Nothing herein constitutes legal advice to any party other than Verimark Hospitality Group Inc. ("VHG" or the "Borrower").
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I. EXECUTIVE SUMMARY AND PURPOSE OF MEMORANDUM
This memorandum catalogues and analyzes the principal open negotiation points in the Credit Agreement (the "Credit Agreement") governing the proposed $700,000,000 Senior Secured Term Loan B (the "Term Loan B" or "TLB") to be entered into by Verimark Hospitality Group Inc. (as Borrower), the Guarantors named therein, Crescent Harbor Bank, N.A. (as Administrative Agent and Collateral Agent), and the Lenders party thereto. The Credit Agreement is being drafted and negotiated in connection with VHG's refinancing of its existing $625,000,000 Term Loan B facility (the "Existing TLB"), under which Greystone Federal Credit Corp. serves as Administrative Agent.
The purpose of this memorandum is twofold:
(a) To organize and prioritize the open issues for discussion with VHG's management team — specifically, Priya Narayanan (General Counsel), Glenn Fischbach (Treasurer), and Renata Haines (Chief Financial Officer) — so that we may obtain authorization on acceptable negotiating ranges for each issue prior to the next round of negotiations with WGP; and
(b) To provide a structured framework for the next negotiating session with WGP — specifically, Harrison Whitfield III (Partner) and Megan Yeung (Associate) — in order to facilitate efficient resolution of outstanding points and advance toward a mutually acceptable Credit Agreement.
Parties to the Credit Agreement. The principal parties to the Credit Agreement are as follows:
• Borrower: Verimark Hospitality Group Inc., a Delaware corporation
• Guarantors: Verimark Resort Properties LLC (a Delaware limited liability company), VHG Management Services Inc. (a Delaware corporation), Verimark Convention Holdings LLC (a Delaware limited liability company), Palmetto Beachfront Hotels LLC (a South Carolina limited liability company), and Cascadia Hospitality Corp. (a Washington corporation)
• Administrative Agent and Collateral Agent: Crescent Harbor Bank, N.A.
• Lead Arranger and Bookrunner: Crescent Harbor Bank, N.A.
• Lenders: To be determined upon completion of syndication; expected to include a mix of institutional investors, CLO funds, and bank lenders
Governing Law. The Credit Agreement is governed by the laws of the State of New York, without regard to conflicts of law principles (other than Section 5-1401 of the New York General Obligations Law).
Reference Documents. This memorandum references and is based upon the following documents:
1. Calderwood & Harkness LLP first draft of the Credit Agreement, circulated May 16, 2022 (the "C&H First Draft");
2. The Term Sheet agreed in principle between VHG and Crescent Harbor Bank, N.A. (the "Term Sheet");
3. The Commitment Letter and Fee Letter, which are being finalized in parallel and are targeted for execution on or about May 27, 2022 (the "Commitment Letter" and "Fee Letter," respectively); and
4. Initial informal comments received from WGP via email prior to the date of this memorandum (the "WGP Initial Comments").
We note that WGP's full revised markup of the C&H First Draft has not yet been received as of the date of this memorandum. The issues identified herein are based on the WGP Initial Comments and our anticipation of likely areas of negotiation based on the positions outlined therein. We will supplement this memorandum upon receipt and review of WGP's complete revised draft.
Summary of Open Issues. We have identified a total of eighteen (18) principal open issues, which are organized by subject matter category across Sections II through IX below. Each issue is flagged with a priority designation (High, Medium, or Low) reflecting our assessment of its commercial significance to VHG and the likelihood of contentious negotiation. The issues are further classified in the Summary and Prioritization Matrix at Section X as either (a) "Must-Win" for VHG, (b) "Negotiate to Acceptable Middle Ground," or (c) "Acceptable / Lower Priority."
In our view, the most commercially significant cluster of issues relates to the MFN provisions (Issues 4, 5, and 6), the repricing protection provisions (Issues 7, 8, and 9), and the incremental facility provisions (Issue 12), all of which interact with one another and should be negotiated as an integrated package. We recommend that VHG approach these issues holistically, offering measured concessions on less critical points to secure favorable outcomes on the provisions that most directly affect VHG's strategic flexibility — particularly its ability to raise incremental term loans to fund acquisitions and to reprice the TLB in the event of favorable market movement.
II. PRICING AND INTEREST RATE ISSUES
Issue 1: SOFR Credit Spread Adjustment
Priority: MEDIUM
Background. The C&H First Draft defines "Adjusted Term SOFR" as CME Term SOFR plus a credit spread adjustment (the "CSA") intended to account for the structural basis between legacy LIBOR and SOFR. The CSA is a legacy of the LIBOR-to-SOFR transition and reflects the historical spread differential between the two rates. Although the CSA is expected to become less significant over time as SOFR-based lending becomes fully established, it remains a live pricing issue for the near term.
C&H/VHG Position. The C&H First Draft includes a tenor-based CSA structure, consistent with the Alternative Reference Rates Committee ("ARRC") recommendations for LIBOR-to-SOFR transition, as follows:
This tenor-differentiated approach reflects the fact that the historical LIBOR-SOFR basis differential varied by tenor, with longer tenors exhibiting a wider spread. The tenor-based CSA is the approach recommended by the ARRC and adopted in the majority of syndicated loan transactions during the transition period.
WGP/Crescent Harbor Position. WGP has proposed replacing the tenor-based CSA with a flat CSA of 0.11448%, irrespective of the interest period selected by VHG. WGP cites administrative simplicity as the primary rationale and notes that a flat CSA was used in several recent Crescent Harbor-led syndicated facilities. We understand that Crescent Harbor's loan operations platform may favor a single CSA for ease of calculation and reconciliation across its portfolio.
Analysis. The practical impact of the two approaches depends on VHG's borrowing patterns. Under the existing Greystone TLB (LIBOR-based), VHG has historically elected 1-month interest periods in the vast majority of cases, consistent with VHG's preference for flexibility in managing prepayment timing without incurring breakage costs. Assuming VHG maintains this practice under the new TLB:
• Under the C&H draft (tenor-based CSA), VHG would pay SOFR + 10.0 bps CSA + 375 bps margin for 1-month borrowings, for a total all-in rate of SOFR + 385.0 bps.
• Under the WGP proposal (flat CSA), VHG would pay SOFR + 11.448 bps CSA + 375 bps margin for 1-month borrowings, for a total all-in rate of SOFR + 386.448 bps.
• The difference is 1.448 bps per annum, which on a $700 million principal balance equates to approximately $101,360 per annum in additional interest cost under the WGP proposal.
Conversely, if VHG were to elect 3-month or 6-month interest periods, the flat CSA would be more favorable (0.11448% vs. 0.15% for 3-month; 0.11448% vs. 0.25% for 6-month). However, given VHG's historical preference for 1-month periods, the tenor-based approach is marginally more favorable on a net basis.
We also note that the tenor-based CSA is the approach most consistent with ARRC guidance and has been widely adopted in the broadly syndicated loan market. Although some administrative agents (including Crescent Harbor in certain transactions) have utilized a flat CSA, the tenor-based approach remains the predominant market convention as of the date of this memorandum.
Recommendation. We recommend maintaining the C&H First Draft position (tenor-based CSA at 0.10%/0.15%/0.25%). This position is well-supported by ARRC guidance and market convention. If WGP insists on a flat CSA, we recommend offering to accept a flat CSA only if it is set at 0.10% (10.0 bps) — equivalent to the 1-month tenor-based CSA — which would be revenue-neutral for VHG given its borrowing patterns while addressing Crescent Harbor's administrative convenience concerns. We do not recommend accepting the 0.11448% flat rate proposed by WGP without a corresponding concession elsewhere.
Issue 2: SOFR Floor
Priority: HIGH
Background. The SOFR floor establishes a minimum reference rate for purposes of calculating interest on the Term Loan B. When the prevailing Term SOFR rate is below the floor, interest is calculated as if Term SOFR were equal to the floor, thereby providing a minimum yield to lenders. The floor is an important economic term because it determines the effective minimum all-in interest rate on the facility.
C&H/VHG Position. The C&H First Draft includes a SOFR floor of 0.50%, which is the rate set forth in the Term Sheet agreed in principle between VHG and Crescent Harbor. This level is consistent with the floor that was included in the Term Sheet after arm's-length negotiation and reflects VHG's expectation of the economic terms of the refinancing.
WGP/Crescent Harbor Position. WGP has proposed increasing the SOFR floor to 0.75%, an increase of 25 basis points. WGP's stated rationale is that the current rate environment (1-month Term SOFR was approximately 0.83% as of the date of the WGP Initial Comments) renders the floor academic in the near term, but that the higher floor provides additional lender protection against a potential reversal in monetary policy in the medium to long term.
Analysis. While WGP's characterization of the floor as "academic" in the current environment is technically correct — 1-month Term SOFR has been above both 0.50% and 0.75% since approximately March 2022, and the Federal Reserve's ongoing tightening cycle makes it likely that SOFR will continue to rise in the near term — this analysis ignores the long-term duration of the facility. The Term Loan B has a 7-year tenor (maturing July 21, 2029), and over that horizon, it is entirely possible that SOFR could fall below 0.75%. The macroeconomic cycle, potential recessionary scenarios, and the Federal Reserve's demonstrated willingness to cut rates aggressively in response to economic distress (as evidenced by the near-zero rate environment of 2020-2021) all support the possibility that the floor could become binding during the life of the facility.
The economic impact of the floor differential is significant:
• If SOFR were to fall to 0.25% (a plausible scenario in a recessionary environment), the 0.50% floor would result in VHG paying an effective all-in rate of 4.25% (0.50% floor + 375 bps margin), while the 0.75% floor would result in an effective all-in rate of 4.50% (0.75% floor + 375 bps margin).
• The 25 bps differential on $700,000,000 in principal equates to $1,750,000 per annum in additional interest expense.
• Over a hypothetical 3-year period in which SOFR remains below both floors, the cumulative additional cost to VHG would be approximately $5,250,000.
Critically, the Term Sheet clearly states a SOFR floor of 0.50%. WGP's proposal to increase the floor to 0.75% represents a departure from the agreed economic terms and, if accepted, would effectively increase the minimum yield to lenders by 25 bps — a repricing of the deal in Crescent Harbor's favor. We believe VHG should resist this change vigorously. The Commitment Letter and Fee Letter, which are being finalized in parallel and targeted for execution on May 27, 2022, should expressly reference the 0.50% SOFR floor to lock in this term.
Recommendation. We recommend holding firm at the 0.50% SOFR floor as specified in the Term Sheet. This is a clear case where the agreed term sheet economics should govern. If WGP continues to insist on 0.75%, we recommend escalating this issue directly to Crescent Harbor's deal team (outside of WGP counsel) and, if necessary, to VHG's General Counsel for a principal-to-principal discussion with Crescent Harbor. Under no circumstances should VHG concede on this point without a corresponding economic concession elsewhere (e.g., a reduction in the applicable margin).
Issue 3: Default Rate Mechanics
Priority: MEDIUM
Background. The default rate provision specifies the increased rate of interest applicable upon the occurrence of an Event of Default. Default interest serves a dual purpose: it compensates lenders for the increased credit risk associated with a defaulting borrower and provides an economic incentive for the borrower to cure defaults promptly.
C&H/VHG Position. The C&H First Draft provides that the default rate of interest shall be equal to the applicable rate plus 200 basis points (i.e., the otherwise-applicable interest rate plus 2.00% per annum), and that the default rate shall apply only upon written notice from the Administrative Agent or the Required Lenders following the occurrence and during the continuance of an Event of Default. This formulation provides VHG with the opportunity to cure a default before incurring additional interest expense at the default rate and is consistent with borrower-favorable market practice in broadly syndicated TLB transactions. The default rate under the C&H First Draft applies only to overdue principal and interest, and not to fees or other amounts.
WGP/Crescent Harbor Position. WGP has proposed two modifications to the default rate mechanics:
(a) Automatic application. WGP proposes that the default rate apply automatically upon the occurrence of any Event of Default, without the requirement of notice from the Administrative Agent or the Required Lenders. Under this formulation, default interest would begin accruing immediately upon the occurrence of an Event of Default (including, potentially, Events of Default of which VHG is not yet aware, such as technical covenant breaches discovered only upon delivery of compliance certificates).
(b) Expanded scope. WGP proposes that default interest accrue not only on overdue principal and interest, but on all outstanding obligations, including fees (such as the administrative agent fee, letter of credit fees, and commitment fees under the revolving credit facility).
Analysis. The automatic application of default interest without notice is an aggressive position that is not consistent with market practice in broadly syndicated TLB transactions. In the vast majority of recent syndicated credit facilities, default interest is triggered either (i) by notice from the Administrative Agent or Required Lenders, or (ii) automatically with respect to payment Events of Default only (i.e., failures to make scheduled payments of principal or interest), with notice required for all other Events of Default. The WGP proposal would result in default interest accruing even in the case of technical or inadvertent defaults that VHG may not be aware of and that are subject to applicable cure periods.
The application of default interest to fees is unusual and not supported by broad market practice. Fees under the Credit Agreement (such as the administrative agent fee and commitment fees) are relatively small in amount, and applying a 200 bps surcharge to such fees would create disproportionate complexity relative to the economic impact. Moreover, the inclusion of fees in the default interest calculation could create disputes regarding the base amount on which default interest accrues.
From a practical standpoint, the automatic default rate provision could have adverse consequences for VHG in the event of a technical default that is promptly cured. For example, if VHG inadvertently fails to deliver a compliance certificate within the required timeframe (an Event of Default under the Credit Agreement), the automatic default rate would begin accruing immediately — potentially before VHG is even aware of the deficiency — and would continue until the default is cured. Under the C&H draft approach, VHG would have the benefit of the notice requirement, which effectively provides an additional period in which to cure the default before incurring additional interest expense.
Recommendation. We recommend insisting that default interest be triggered only upon written notice from the Administrative Agent or Required Lenders following the occurrence and during the continuance of an Event of Default. As an alternative compromise, we could accept automatic application of the default rate for payment Events of Default only (i.e., failures to pay principal or interest when due), with notice required for all other Events of Default. We further recommend that default interest be limited to overdue principal and accrued interest only, and not extended to fees or other obligations. This is a defensible position well within market norms.
III. MOST FAVORED NATION (MFN) PROVISION
The MFN provision is among the most commercially significant terms in the Credit Agreement for VHG, given VHG's stated intention to use a portion of the incremental proceeds to fund its acquisition pipeline. The MFN provision requires that, if VHG incurs incremental term loans at a yield exceeding the yield on the initial TLB by more than the specified threshold, the margin on the initial TLB must be increased to eliminate the excess spread. This provision protects existing lenders from yield dilution but can significantly constrain VHG's flexibility in pricing incremental debt. Issues 4, 5, and 6 below address the three principal components of the MFN provision: the sunset period, the threshold, and the yield calculation methodology. These three issues should be negotiated as an integrated package, together with Issue 12 (Incremental Facility Provisions).
Issue 4: MFN Sunset Period
Priority: HIGH — CRITICAL COMMERCIAL TERM
Background. The MFN sunset period determines the duration during which the MFN provision remains in effect following the closing of the TLB. After the sunset period expires, VHG may incur incremental term loans at any yield without triggering an upward adjustment to the margin on the initial TLB. A shorter sunset period provides VHG with greater flexibility; a longer sunset period provides greater protection to existing lenders.
C&H/VHG Position. The C&H First Draft proposed a 12-month MFN sunset period commencing on the Closing Date. Based on an anticipated Closing Date of July 21, 2022, the MFN provision would expire on July 21, 2023, after which VHG could incur incremental term loans at market pricing without triggering an adjustment to the initial TLB margin.
WGP/Crescent Harbor Position. WGP has countered with a 24-month MFN sunset period, stating that the syndicate lenders — particularly CLO fund investors such as Ridgeline Capital Partners, LP and Ironbridge Loan Management LLC, which are expected to be significant holders of the TLB — require a longer protection window to ensure yield stability within their portfolios. WGP notes that CLO managers are under pressure from their own investors to maintain portfolio yield and that a shorter MFN sunset period exposes them to the risk that VHG could raise cheaper incremental debt that effectively dilutes the yield on the initial TLB.
Analysis. Market data from recent hospitality-sector TLB transactions indicates that MFN sunset periods have generally settled in the range of 12 to 18 months, with the majority clustering at 12 or 18 months. A 24-month sunset period is above market and would constrain VHG's financing flexibility through July 2024. This is particularly significant because the additional $75 million in net proceeds from the refinancing (above and beyond the amount needed to repay the Existing TLB) is specifically earmarked for VHG's acquisition pipeline, and VHG may need to raise additional incremental term loans to fund acquisitions during the 2022-2024 period.
We have reviewed comparable transactions in the hospitality and leisure sector from the past twelve months and note the following:
As shown above, the range is 12 to 18 months, with no recent precedent for a 24-month sunset in the hospitality sector at comparable credit quality (BB-/Ba3 corporate family rating). WGP's 24-month proposal is an outlier.
From VHG's perspective, the MFN sunset period directly affects the cost and feasibility of the acquisition pipeline. If VHG identifies an acquisition target in Q4 2022 or Q1 2023, it would need to raise incremental term loans to finance the acquisition. A 12-month sunset (expiring July 2023) would mean the MFN is still in effect for any such financing, requiring VHG to price the incremental term loan within the MFN threshold of the initial TLB yield — or accept an upward adjustment to the initial TLB margin. An 18-month sunset (expiring January 2024) would extend this constraint by an additional six months, but provides a reasonable outer boundary.
Recommendation. We recommend countering at 18 months (sunset date: January 21, 2024, based on the anticipated July 21, 2022 Closing Date). An 18-month sunset represents a reasonable compromise between VHG's preferred 12-month period and WGP's 24-month proposal and is within the established market range. We recommend discussing this position with VHG (Renata Haines and Glenn Fischbach) before making the counter-offer, as the sunset period has significant implications for the timing and pricing of VHG's acquisition financing strategy. The 18-month counter should be presented as part of a package with Issues 5, 6, and 12.
Issue 5: MFN Threshold
Priority: HIGH
Background. The MFN threshold is the maximum yield differential between incremental term loans and the initial TLB that VHG may incur without triggering an upward adjustment to the initial TLB margin. For example, if the initial TLB yields SOFR + 375 bps and the MFN threshold is 50 bps, VHG could incur incremental term loans yielding up to SOFR + 425 bps without triggering an adjustment. If the incremental term loan yields SOFR + 430 bps, the initial TLB margin would be increased by 5 bps (to SOFR + 380 bps) to bring the differential within the 50 bps threshold.
C&H/VHG Position. The C&H First Draft proposed a 75 basis point MFN threshold. Under this approach, VHG could incur incremental term loans at a yield up to 75 bps higher than the initial TLB yield without triggering an adjustment. At the initial TLB yield of SOFR + 375 bps (plus applicable floor economics), this would allow incremental term loans to be priced at up to approximately SOFR + 450 bps before the MFN is triggered.
WGP/Crescent Harbor Position. WGP has proposed a 25 basis point MFN threshold, which would significantly restrict VHG's pricing flexibility. At a 25 bps threshold, any incremental term loan priced above approximately SOFR + 400 bps would trigger an upward adjustment to the initial TLB margin.
Analysis. The 25 bps threshold proposed by WGP is highly restrictive and below the range observed in comparable syndicated TLB transactions. In the BB-/Ba3 rated TLB market, MFN thresholds generally fall in the 50 to 75 basis point range, with 50 bps being the most commonly observed threshold in recent transactions. A 25 bps threshold would effectively limit VHG's ability to price incremental term loans at market without triggering an adjustment to the initial TLB margin.
The practical impact can be illustrated as follows:
• Assume VHG seeks to raise $150 million in incremental term loans in Q1 2023 to fund an acquisition. At that time, market conditions may require pricing at SOFR + 425 bps (reflecting widening credit spreads or deterioration in the broadly syndicated loan market).
• Under a 75 bps threshold, VHG could price the incremental term loan at SOFR + 425 bps without triggering any adjustment to the initial TLB margin (because 425 - 375 = 50 bps, which is within the 75 bps threshold).
• Under a 25 bps threshold, VHG's incremental term loan at SOFR + 425 bps would exceed the threshold by 25 bps (425 - 375 = 50 bps; 50 - 25 = 25 bps excess), requiring the initial TLB margin to be increased from 375 bps to 400 bps. On $700 million of initial TLB principal, this 25 bps increase would cost VHG approximately $1,750,000 per annum in additional interest expense.
• Under a 50 bps threshold, VHG could price at SOFR + 425 bps without triggering the MFN (50 bps differential = equal to threshold).
The 50 bps threshold represents the midpoint of the market range and provides a reasonable balance between lender yield protection and borrower flexibility. It is also the level most commonly observed in recent hospitality-sector TLB transactions at comparable credit quality.
Recommendation. We recommend countering at 50 basis points, which represents the midpoint of the observed market range and a reasonable compromise between VHG's 75 bps position and WGP's 25 bps proposal. This issue should be negotiated as a package with the MFN sunset period (Issue 4) and the yield calculation methodology (Issue 6). If we achieve favorable outcomes on the sunset period (18 months) and the yield methodology (exclusion of arrangement fees), VHG may consider accepting 50 bps rather than insisting on 75 bps.
Issue 6: MFN Yield Calculation Methodology
Priority: HIGH
Background. The methodology for calculating "yield" for purposes of the MFN provision determines which components of incremental term loan pricing are captured in the MFN comparison. A broader yield definition (capturing more pricing components) is more protective for existing lenders; a narrower definition provides VHG with greater structuring flexibility.
C&H/VHG Position. The C&H First Draft defines "yield" for MFN purposes as the sum of:
(i) the applicable margin on the incremental term loan; plus
(ii) any SOFR floor included in the incremental term loan to the extent such floor exceeds the then-prevailing SOFR rate (i.e., only the "in-the-money" portion of the floor is included in the yield calculation).
The C&H First Draft excludes original issue discount ("OID") and upfront fees from the yield calculation, except in the case of incremental term loans with a maturity of less than 12 months (in which case OID and upfront fees are included). This exclusion provides VHG with the ability to structure incremental term loans with OID or upfront fees without triggering the MFN provision, even if the total economic cost to VHG (inclusive of such fees) exceeds the yield on the initial TLB by more than the MFN threshold.
WGP/Crescent Harbor Position. WGP proposes an "all-in yield" calculation that includes:
(i) the applicable margin;
(ii) any SOFR floor in excess of the then-prevailing rate;
(iii) OID, amortized over a 3-year assumed average life; and
(iv) upfront fees, amortized over the same 3-year assumed average life.
Under the WGP proposal, arrangement and structuring fees paid to the arrangers of the incremental facility would also be included in the all-in yield calculation.
Analysis. The all-in yield methodology is more commonly seen in recent syndicated TLB transactions and provides a more comprehensive measure of the economic return to lenders on incremental term loans. In principle, VHG should not object to the concept of an all-in yield calculation, as it reflects the economic reality that OID and upfront fees are components of the total cost of borrowing. However, the specific parameters of the methodology proposed by WGP are unfavorable in two key respects:
(a) Assumed average life. WGP proposes a 3-year assumed average life for purposes of amortizing OID and upfront fees. A shorter assumed average life results in a higher imputed annual yield, making it more likely that the MFN threshold will be triggered. The C&H position (if an all-in yield methodology were to be accepted) would be a 4-year assumed average life, which is more commonly used and reflects the typical duration of a broadly syndicated TLB (taking into account expected prepayments).
To illustrate: if VHG offers a 1.50% OID on an incremental term loan, the imputed annual yield from OID would be:
• Under a 3-year assumed average life: 1.50% ÷ 3 = 50 bps per annum
• Under a 4-year assumed average life: 1.50% ÷ 4 = 37.5 bps per annum
The difference of 12.5 bps could be the difference between triggering and not triggering the MFN adjustment.
(b) Inclusion of arrangement and structuring fees. WGP's proposal includes arrangement and structuring fees paid to the arrangers of the incremental facility in the all-in yield calculation. These fees are compensation for the arrangers' underwriting and distribution services and are not a component of the yield to investors (the ultimate holders of the incremental term loans). Including such fees in the MFN yield calculation inflates the imputed yield and penalizes VHG for standard market-rate arrangement fee payments.
Recommendation. We recommend accepting the all-in yield methodology in principle but negotiating the following modifications:
(i) OID and upfront fees should be amortized over a 4-year assumed average life (not 3 years);
(ii) Arrangement and structuring fees paid to the arrangers of the incremental facility should be excluded from the all-in yield calculation; and
(iii) The yield comparison should be based on the yield to the incremental term loan lenders (i.e., the investors), not the all-in cost to VHG inclusive of arranger compensation.
This is a significant technical issue that interacts directly with the MFN threshold (Issue 5) and the MFN sunset period (Issue 4). A broader yield definition combined with a tighter threshold (25 bps) and a longer sunset (24 months) would be exceptionally restrictive; accordingly, concessions on yield methodology should be conditioned on favorable outcomes on threshold and sunset. We also recommend flagging for Leonard Cross (Tax) the interaction between the MFN yield calculation methodology and OID treatment for purposes of the applicable high-yield discount obligation ("AHYDO") analysis under Section 163(i) of the Internal Revenue Code.
IV. REPRICING PROTECTION / SOFT CALL
The repricing protection (or "soft call") provision restricts VHG's ability to reprice the TLB during a specified period following closing by imposing a premium on prepayments or amendments that reduce the effective yield on the TLB. The repricing protection is closely related to the MFN provision, as both are designed to protect existing lenders' yield expectations. Issues 7, 8, and 9 below address the duration, premium amount, and scope of the repricing protection.
Issue 7: Repricing Protection Period (Duration)
Priority: HIGH
C&H/VHG Position. The C&H First Draft proposed no repricing protection. Under this approach, VHG could voluntarily prepay or reprice the TLB at par at any time, without the imposition of any prepayment premium. This position reflects VHG's desire to maximize flexibility in the event that credit market conditions improve or VHG's credit profile strengthens, enabling a yield-reducing repricing transaction.
WGP/Crescent Harbor Position. WGP proposes a 12-month repricing protection period commencing on the Closing Date, with a 1.00% prepayment premium on any voluntary repricing transaction occurring within the repricing protection period. Based on an anticipated Closing Date of July 21, 2022, the repricing protection would remain in effect through July 21, 2023, during which time VHG could not prepay or reprice the TLB without paying a 1.00% premium on the principal amount prepaid or repriced.
Analysis. While the C&H First Draft position of no repricing protection is the most favorable to VHG, it is not realistic in the current market environment. Market practice for broadly syndicated TLB transactions in the current environment generally includes a repricing protection period, most commonly of 6 months duration. A 12-month repricing protection period is above market and would constrain VHG's ability to reprice the TLB through July 2023.
The importance of this provision is underscored by the current rate environment and VHG's credit trajectory. VHG is achieving a 50 bps spread reduction in connection with this refinancing (from LIBOR + 425 bps under the Existing TLB to SOFR + 375 bps under the new TLB), reflecting an improvement in VHG's credit profile since the original financing. If VHG's credit profile continues to improve — for example, through de-leveraging as a result of strong cash flow generation or favorable acquisition activity — VHG may be in a position to reprice the TLB at a tighter spread within the first 12 months. A 12-month repricing protection period would prevent VHG from capturing this benefit.
Market data from recent comparable transactions is as follows:
As the table demonstrates, a 6-month repricing protection period with a 1.00% premium is the dominant market standard. A 12-month period is above market and is not supported by recent precedent in the hospitality sector.
Recommendation. We recommend countering at a 6-month repricing protection period (sunset date: January 21, 2023, based on the anticipated July 21, 2022 Closing Date). This is a well-established market standard and is likely to be the landing zone. If WGP accepts a 6-month period, we recommend accepting the 1.00% premium (see Issue 8 below), which is within market.
Issue 8: Repricing Protection Premium Amount
Priority: MEDIUM
C&H/VHG Position. As a fallback position (if any repricing protection is included), the C&H First Draft contemplated a premium of 0.50% of the principal amount prepaid or repriced. On a $700 million TLB, a 0.50% premium equates to $3,500,000 if the full principal balance were prepaid or repriced within the repricing protection period.
WGP/Crescent Harbor Position. WGP proposes a premium of 1.00% of the principal amount prepaid or repriced. On a $700 million TLB, a 1.00% premium equates to $7,000,000 if the full principal balance were prepaid or repriced within the repricing protection period.
Analysis. The difference between a 0.50% and 1.00% premium on $700 million is $3,500,000 in the maximum-case scenario (full prepayment within the repricing protection period). However, as noted in the market data cited under Issue 7, the standard premium amount for a 6-month repricing protection period is 1.00%. A 0.50% premium is below the current market standard for broadly syndicated TLB transactions.
From a practical standpoint, if VHG were to execute a repricing transaction within the first six months, the savings from a tighter spread would need to exceed the cost of the premium over the remaining life of the facility. For example, if VHG repriced from SOFR + 375 bps to SOFR + 350 bps (a 25 bps reduction) on the full $700 million, the annual interest savings would be $1,750,000. The payback period on a 1.00% premium ($7,000,000) would be approximately 4 years; the payback period on a 0.50% premium ($3,500,000) would be approximately 2 years. Given the 7-year tenor of the facility, a repricing transaction would be economically rational in either case.
Recommendation. We recommend accepting a 1.00% premium if we successfully negotiate the repricing protection period down to 6 months (Issue 7). The 1.00% premium is market standard and is unlikely to deter VHG from executing a repricing transaction if the economics are favorable. We should reserve the 0.50% premium as a negotiating chip to be deployed only if needed to secure concessions on other, more commercially significant issues (such as the MFN sunset period or threshold).
Issue 9: Scope of Repricing Protection Trigger
Priority: MEDIUM
C&H/VHG Position. The C&H First Draft limits the repricing protection trigger to voluntary prepayments or amendments that have the primary purpose or effect of reducing the effective yield on the TLB. Under this formulation, the repricing protection premium would not apply to:
(a) mandatory prepayments (including excess cash flow sweeps and asset sale prepayments);
(b) prepayments required in connection with a Change of Control; or
(c) any other prepayment that is not undertaken for the primary purpose of reducing the effective yield on the TLB.
WGP/Crescent Harbor Position. WGP's draft includes broad repricing protection language that could be read to apply to any prepayment (including mandatory prepayments) if the proceeds are applied to reduce the effective yield on the TLB. The WGP language does not include express carve-outs for mandatory prepayments, Change of Control prepayments, or excess cash flow sweep prepayments. While WGP may contend that the provision is not intended to apply to mandatory prepayments, the absence of express carve-outs creates ambiguity and potential for dispute.
Analysis. Applying repricing protection premiums to mandatory prepayments is inconsistent with market practice and would create perverse outcomes. For example:
• If VHG is required to prepay a portion of the TLB with proceeds from an asset sale (a mandatory prepayment under the Credit Agreement), VHG should not be penalized with a 1.00% premium for complying with a contractual obligation to which VHG did not voluntarily consent (the mandatory prepayment obligation itself being a lender-protective provision).
• Similarly, if VHG is required to make an excess cash flow sweep prepayment, the imposition of a repricing protection premium would reduce the cash available for debt reduction — a result that is adverse to both VHG and the lenders.
• In the event of a Change of Control, VHG (or its successor) may be required to offer to prepay the TLB. Imposing a repricing premium in this context would penalize VHG for a transaction that may generate substantial value for its stakeholders.
The absence of express carve-outs in the WGP draft is likely an inadvertent overbreadth in the drafting rather than a deliberate attempt to capture mandatory prepayments, but we should ensure that the Credit Agreement unambiguously excludes mandatory prepayments from the scope of the repricing protection.
Recommendation. We recommend insisting on express carve-outs from the repricing protection provision for (a) all mandatory prepayments (including excess cash flow sweeps and asset sale prepayments), (b) Change of Control prepayment offers, and (c) prepayments funded with the proceeds of casualty events or condemnation awards. The repricing protection should apply only to voluntary repricing transactions — i.e., voluntary prepayments, refinancings, or amendments that have the primary purpose or effect of reducing the effective interest rate or yield on the TLB. This is a clear market-standard position and should not be controversial.
V. FINANCIAL COVENANT ISSUES
Issue 10: Financial Covenant Testing Trigger (Springing Mechanism)
Priority: HIGH
Background. The Credit Agreement contains a single financial maintenance covenant — a maximum total net leverage ratio of 4.5x, tested quarterly on a trailing four-quarter basis. Consistent with the "covenant-lite" structure typical of broadly syndicated TLB transactions, this financial covenant is not tested on a continuous basis; rather, it "springs" into effect only when VHG's aggregate revolving credit facility exposure exceeds a specified percentage of total revolving commitments. The springing mechanism is designed to avoid imposing financial covenant testing on VHG when the revolving credit facility is lightly drawn, while providing lender protection when revolving exposure is significant.
C&H/VHG Position. The C&H First Draft provides that the maximum total net leverage ratio of 4.5x is tested quarterly on a trailing four-quarter basis, but only when aggregate revolving credit facility exposure exceeds 35% of total revolving commitments. Total revolving commitments under the $400 million revolving credit facility (the "RCF," for which Crescent Harbor Bank, N.A. also serves as agent) are $400 million, resulting in a springing threshold of $140 million. Revolving credit facility exposure is defined as drawn amounts plus undrawn letters of credit, excluding up to $25 million of undrawn letters of credit. The $25 million carve-out reflects VHG's use of standby letters of credit in the ordinary course of its hospitality business (primarily for insurance programs, utility deposits, and performance guarantees with hotel brand franchisors).
WGP/Crescent Harbor Position. WGP proposes two modifications:
(a) Lower springing threshold. WGP proposes reducing the springing threshold from 35% to 25% of total revolving commitments — i.e., from $140 million to $100 million.
(b) Removal of LC carve-out. WGP proposes including all letters of credit (including undrawn letters of credit) in the calculation of revolving exposure, without the $25 million carve-out.
Analysis. The springing threshold is of critical practical significance to VHG given its seasonal borrowing patterns. The hotel industry is characterized by significant seasonality in cash flows and working capital requirements:
• Q1 (January–March): VHG typically draws $80–120 million on the RCF to fund seasonal hotel renovations, pre-summer working capital needs, and franchise fee payments. This is the period of peak revolving borrowing.
• Q2 (April–June): RCF utilization typically declines as hotel occupancy and revenue increase with the spring and early summer travel season. Draws are typically reduced to $40–60 million.
• Q3 (July–September): Peak revenue season; RCF is typically fully repaid or drawn at minimal levels ($0–20 million).
• Q4 (October–December): Moderate borrowing ($20–40 million) as the fall travel season generates steady but declining cash flows, and VHG begins to fund year-end capital expenditures.
Under the WGP proposal ($100 million threshold, no LC carve-out), VHG's Q1 seasonal draws of $80–120 million, combined with approximately $15 million in outstanding letters of credit, would result in aggregate revolving exposure of $95–135 million. This means that in many quarters during the Q1 seasonal peak, VHG's revolving exposure would exceed the $100 million threshold, triggering the financial covenant test. Under the C&H draft ($140 million threshold, with $25 million LC carve-out), VHG's revolving exposure for covenant-testing purposes would be $70–110 million (after the LC carve-out), which would fall below the $140 million threshold in most quarters.
It is important to note that VHG's current pro forma net leverage is 2.52x ($858 million net debt ÷ $341 million Adjusted EBITDA), which is well within the 4.5x maximum covenant level. Accordingly, even if the financial covenant were tested, VHG would be in compliance by a significant margin. However, the concern is that over the life of the 7-year facility, VHG's leverage may increase (particularly if VHG pursues acquisitions) and the 4.5x maximum may become more binding. In such a scenario, the springing threshold becomes critically important, as it determines whether VHG is subject to covenant testing during seasonal borrowing peaks.
Furthermore, the combination of a lower springing threshold and the removal of the LC carve-out creates a compounding effect. VHG currently has approximately $15 million in outstanding letters of credit. If these are included in the revolving exposure calculation (as WGP proposes), VHG's effective springing threshold — in terms of drawn revolving loans — would be reduced from $125 million ($140M - $15M LCs) under the C&H draft to $85 million ($100M - $15M LCs) under the WGP proposal. At $85 million, VHG would trigger covenant testing in virtually every Q1 period.
Recommendation. We recommend holding firm at the 35% springing threshold ($140 million). This is a must-win issue for VHG given its seasonal borrowing patterns. As a potential compromise, we could accept the removal of the $25 million LC carve-out only if the 35% threshold is retained, as this would result in an effective springing threshold of approximately $125 million (after deducting $15 million in outstanding LCs), which is still above VHG's typical peak Q1 borrowing levels. We should not accept a 25% threshold under any circumstances, as this would subject VHG to covenant testing during routine seasonal borrowing — an outcome inconsistent with the covenant-lite structure of the TLB.
Issue 11: Adjusted EBITDA Definition — Add-Backs
Priority: MEDIUM
Background. The definition of "Adjusted EBITDA" is one of the most consequential definitions in the Credit Agreement, as it serves as the denominator in the total net leverage ratio (the financial covenant), the numerator in the debt service coverage calculations, and the reference metric for numerous incurrence-based baskets (including the incremental facility basket, the restricted payments basket, and the permitted indebtedness basket). The add-backs to Adjusted EBITDA determine the extent to which VHG may adjust its reported EBITDA upward to reflect non-cash charges, non-recurring items, and pro forma cost savings and synergies.
C&H/VHG Position. The C&H First Draft defines Adjusted EBITDA to include the following add-backs to consolidated net income:
(i) Non-cash charges: Unlimited add-back for non-cash charges and losses (including stock-based compensation, impairment charges, and unrealized gains and losses on hedging instruments), subject to the requirement that cash charges actually paid in a subsequent period are deducted.
(ii) Restructuring charges: Add-back capped at the greater of $20 million and 6% of Adjusted EBITDA per fiscal year, for restructuring, integration, and business optimization charges, including severance, facility closure costs, and lease termination charges.
(iii) Transaction fees and expenses: Unlimited add-back for fees, costs, and expenses incurred in connection with the Credit Agreement, any permitted acquisition, any permitted disposition, or any equity or debt issuance, whether or not consummated.
(iv) Non-recurring items: Add-back for extraordinary, non-recurring, or unusual charges and expenses, provided that such items are identified with specificity in VHG's compliance certificates.
(v) Pro forma cost savings and synergies: Add-back for projected cost savings and synergies from acquisitions or other operational initiatives, to the extent reasonably identifiable, factually supportable, and expected to be realized within 18 months of the relevant acquisition or initiative, capped at 15% of Adjusted EBITDA (calculated before giving effect to such add-backs).
(vi) Management fees: Add-back for management fees, advisory fees, and similar charges paid to affiliates of VHG.
WGP/Crescent Harbor Position. WGP proposes the following modifications:
(a) Restructuring charge cap. Reduce the restructuring charge add-back cap from the greater of $20 million and 6% of Adjusted EBITDA to a flat $15 million per fiscal year (with no EBITDA-based grower component).
(b) Pro forma synergy cap. Reduce the pro forma synergy add-back cap from 15% to 10% of Adjusted EBITDA.
(c) CFO certification. Require that any pro forma synergy add-back be supported by a certificate from VHG's Chief Financial Officer (currently Renata Haines) setting forth in reasonable detail the factual basis for the projected cost savings or synergies and the expected timeline for realization.
Analysis. VHG's FY2021 reported EBITDA was $318 million. Adjusted EBITDA was $341 million, reflecting approximately $23 million in add-backs, primarily composed of non-cash charges ($11.4 million, including stock-based compensation and unrealized hedging losses), restructuring charges ($8.2 million, related to the optimization of VHG's West Coast hotel portfolio), and non-recurring items ($3.4 million, including costs associated with the refinancing evaluation process). The gap between reported and Adjusted EBITDA is moderate at approximately 7.2%, which is within the range typically observed in the hospitality sector and should not raise concerns for the lender group.
The pro forma synergy add-back is particularly important for VHG's acquisition strategy. The incremental $75 million in net proceeds from the refinancing is earmarked for VHG's acquisition pipeline, and VHG expects to realize cost savings and operational synergies in connection with acquired hotel properties. A 15% synergy add-back cap (approximately $51.2 million at current Adjusted EBITDA levels) provides VHG with meaningful headroom to incorporate projected synergies into its leverage calculations; a 10% cap (approximately $34.1 million) is more restrictive but still provides substantial capacity.
The CFO certification requirement proposed by WGP is reasonable and consistent with market practice. Requiring a certificate from VHG's CFO that identifies the factual basis for projected synergies and the expected realization timeline provides the lender group with transparency and accountability without limiting VHG's ability to claim synergies that are genuinely achievable.
Recommendation. We recommend the following positions:
(a) CFO certification: Accept. The CFO certification requirement is reasonable, consistent with market practice, and should not be a point of contention. Priya Narayanan and Renata Haines should be advised of this requirement so that VHG's finance team is prepared to prepare and deliver compliant certificates.
(b) Pro forma synergy cap: Hold at 15%. The 15% cap is within the range typically observed in borrower-favorable TLB transactions (10–20%) and is important to VHG's acquisition strategy. If necessary, VHG can offer to accept a 12.5% cap as a compromise, but 10% is too restrictive.
(c) Restructuring charge cap: Compromise at $17.5 million per fiscal year, or accept the $15 million cap if we secure favorable outcomes on the synergy cap and other more commercially significant issues. VHG's historical restructuring charges ($8.2 million in FY2021) are well below either proposed cap, so this issue is of secondary importance. However, VHG should maintain some headroom above historical levels to accommodate potential future portfolio optimization activities.
VI. INCREMENTAL FACILITY PROVISIONS
Issue 12: Incremental Term Loan Capacity and Interaction with MFN
Priority: HIGH
Background. The incremental facility provisions of the Credit Agreement allow VHG to incur additional term loans and/or revolving commitments after the Closing Date, subject to specified conditions and limitations. The incremental facility is one of the most important flexibility provisions in the Credit Agreement, as it provides VHG with the ability to raise additional debt to fund acquisitions, capital expenditures, and other corporate purposes without the need to negotiate a new credit agreement. The incremental facility provisions interact directly with the MFN provision (Issues 4, 5, and 6), as incremental term loans incurred during the MFN sunset period are subject to the MFN yield comparison.
C&H/VHG Position. The C&H First Draft provides for incremental facility capacity consisting of two components:
(a) Free-and-Clear Basket. VHG may incur incremental term loans or revolving commitments in an aggregate principal amount up to the greater of $175 million and 50% of LTM Adjusted EBITDA (currently approximately $170.5 million, based on FY2021 Adjusted EBITDA of $341 million). The free-and-clear basket may be utilized without satisfying any pro forma leverage test. Incremental term loans incurred under the free-and-clear basket are subject to the MFN provision during the MFN sunset period (but see Issues 4 and 5 regarding the parameters of the MFN).
(b) Ratio-Based Basket. In addition to the free-and-clear basket, VHG may incur incremental term loans or revolving commitments in unlimited amounts, provided that, after giving pro forma effect to such incurrence, the total net leverage ratio does not exceed 3.5x (i.e., 1.0x inside the 4.5x financial covenant level).
(c) MFN Exemption for Revolving Commitments. Incremental revolving commitments are not subject to the MFN provision, regardless of whether they are incurred under the free-and-clear basket or the ratio-based basket.
WGP/Crescent Harbor Position. WGP proposes the following modifications:
(a) Reduced Free-and-Clear Basket. WGP proposes reducing the free-and-clear basket to a flat $125 million (with no EBITDA-based grower component). This represents a $50 million reduction from the C&H draft position (which, at current EBITDA levels, would result in a free-and-clear basket of approximately $175 million). By eliminating the EBITDA-based grower, WGP's proposal also prevents the free-and-clear basket from increasing over time as VHG's Adjusted EBITDA grows.
(b) Higher Ratio-Based Incurrence Test. WGP proposes increasing the ratio-based incurrence test from 3.5x to 4.0x total net leverage. While this is counterintuitively more favorable to VHG in isolation (as it allows incremental debt at higher leverage levels), the higher test reflects WGP's view that a more restrictive free-and-clear basket should be offset by a more permissive ratio-based basket.
(c) MFN for All Incremental Debt. WGP proposes subjecting all incremental debt — including incremental revolving commitments — to the MFN provision during the sunset period.