I made a bet that keeps getting worse

Turns out compounding obligations are dangerous—in bar bets and credit documents.

Dan Wertman

Don’t make the same mistake I did.

When I was in college, I made an ill-advised wager: I bet my friend $50 that the New Jersey Devils would win the Stanley Cup before the Philadelphia Flyers.

But here’s the catch: each year neither team wins, the bet goes up by $50—and, neither team has won the Cup since we made the bet...

The lesson here? Determining how much has to be paid based on a step-up/down function can lead to extreme results. “𝗔𝘀𝘀𝗲𝘁 𝗦𝗮𝗹𝗲 𝗦𝘄𝗲𝗲𝗽 𝗦𝘁𝗲𝗽-𝗱𝗼𝘄𝗻𝘀” in credit deals are no different.

“𝗔𝘀𝘀𝗲𝘁 𝗦𝗮𝗹𝗲 𝗦𝘄𝗲𝗲𝗽” terms in credit transactions require that proceeds from the sale of collateral be used to prepay the loan. It’s a pretty reasonable idea: if the borrower sells the assets underlying the loan, the loan should be repaid with the proceeds from the sale.

However, if the deal includes “𝘀𝘁𝗲𝗽-𝗱𝗼𝘄𝗻𝘀”, when the company meets certain leverage ratio tests it's only required to use a fraction of the proceeds to prepay the loan. Taken to its logical extreme: borrowers can hit the step-down targets, sell all their collateral, and effectively end up with an unsecured loan at secured loan prices.

Asset sale sweep step-downs remain relatively rare, but are increasing—of publicly filed high yield term loans that included an asset sale sweep, 11% included step-downs in Q3 ’24, increasing from none in Q3 ’23.