This basket bites back

You thought it was for shareholder treats—now it's funding debt you didn't price.

Dan Wertman

Credit deals and Halloween have at least one thing in common: sometimes, you get tricked. Let me explain.

Last Halloween, I left a bowl of Kit-Kats out for trick-or-treaters. While I fully expected all of the candy to be transferred to trick-or-treater Halloween bags by the end of the night—what I didn’t expect was to see the entire bowl, Kit-Kats and all, in front of another house, who apparently had forgotten to buy their own candy to distribute.

Did I care about the candy? Of course not—I was willing to part with it in the first place. But somehow it feels different when it was “repurposed” by someone else, even if it was going to the same trick-or-treaters.

“𝗔𝘃𝗮𝗶𝗹𝗮𝗯𝗹𝗲 𝗥𝗲𝘀𝘁𝗿𝗶𝗰𝘁𝗲𝗱 𝗣𝗮𝘆𝗺𝗲𝗻𝘁 𝗖𝗮𝗽𝗮𝗰𝗶𝘁𝘆” baskets in debt covenants permit borrowers to incur additional debt, often on a 𝘱𝘢𝘳𝘪 basis with the credit facility, by "repurposing" dividend capacity from the restricted payments covenant. A lender might not have minded parting with cash being distributed to stockholders—but the prospect of that capacity being “repurposed” to incur diluting or priming debt that significantly affects lender recovery: well, that can feel like a trick.

At Noetica, we’ve primarily seen this term relegated to sponsor deals, remaining rare in liquid credit markets: no instances of the term appeared in publicly-filed high yield credit agreements in Q3 ‘24 or Q3 ‘23. However it remains a term to watch—as creep from the private to the liquid market is common.