Envision Healthcare Corp. recently completed its second major debt restructuring in the past 100 days, and has now utilized each of the two primary tactics underlying aggressive out-of-court restructurings that S&P Global Ratings has seen in recent years. The first tactic is known as a "collateral transfer" (sometimes more benignly referred to as an "asset dropdown"), wherein a company removes important assets from the lender's collateral package and raises new debt supported by these newly unencumbered assets. The second tactic, known as a "priming uptiering loan exchange," is where a subset of existing lenders (often slightly more than half) agrees to amend the existing credit agreement to allow new super-priority priming debt while typically also elevating some (or all) of their existing exposure above the other lenders that are not a part of the subset. We viewed each of these transactions as selective defaults for Envision since they involved material concessions from existing creditors--including significant haircuts to par as well as maturity extensions--and because we believe creditors likely felt pressure to accept these terms to help the company avoid a payment default.

Institutional loan investors have become increasingly concerned about the risk of out-of-court restructurings such as these, which can materially disadvantage their recovery prospects by altering their status as first-lien lenders sitting atop the debt structure in terms of collateral and repayment priority. Insulation against these risks was a long-time hallmark of the loan market but has come under pressure as credit agreements for broadly syndicated loans have become more flexible and bond-like over the years. (We note that protection against these risks remains largely intact in the market for pro rata term loans that banks originate and typically hold to maturity, and to a lesser extent pro rata revolving loan facilities that sit beside the covenant-lite term loans that dominate the broadly syndicated loan market).

While the number of aggressive restructurings like these has increased in recent years (especially during the COVID-induced recession), they are still relatively infrequent. Even so, they tend to be high profile and alarming to many institutional loan investors, as they can materially erode the credit quality of existing lenders.

In light of questions we've received from investors and some unique elements to Envision's restructurings, we thought it would be useful to review various aspects of these restructuring transactions.

Credit FAQ

What are the main aspects of Envision's collateral transfer transaction?

Envision implemented its first major restructuring on April 29, 2022, when it designated its AmSurg LLC subsidiary (including its immediate parent company AmSurg Holdco LLC; hereafter AmSurg), which represents about 83% of its ambulatory services business, as an unrestricted subsidiary under its existing debt agreements. With this entity outside of the restricted group it was no longer a guarantor of Envision's existing debt and its assets no longer served as collateral for those lenders. Further, as an unrestricted subsidiary, this entity was no longer subject to the constraints in its existing debt agreements (in terms of adding debt, distributing value, etc.). This restructuring was significant because the ambulatory business segment represents only about 15% of Envision's consolidated revenue but generates a much larger portion of its consolidated EBITDA, given its higher margins and steadier results than Envision's physician services business. For context, the estimated value of the transferred collateral, according to a Wall Street Journal report, was $2.5 billion.

Chart 1 

The second step in this restructuring involved borrowing roughly $2.4 billion of new money at AmSurg, secured by the transferred assets. As with other collateral transfer transactions in recent years, the flexibility to transfer the collateral utilized existing capacity under the provisions in Envision's credit agreement. The new capital raised at AmSurg consisted of a $1.1 billion first-lien term loan (with flexibility to increase this by $200 million via a delayed draw term loan tranche) and a second-lien term loan of $1.35 billion. The first-lien debt provided the company with much needed incremental liquidity, while AmSurg lent the proceeds from the second-lien debt to Envision via an intercompany loan. The company used the proceeds to fund the below-par repurchase of roughly $1.9 billion in principal of existing term loans and unsecured debt at Envision. Specifically, it repurchased approximately $1.5 billion of its first-lien term loan B at a blended price of 66% of par, $326 million of its incremental first-lien term loans at a price equal to 90% of par, and $87 million of its senior unsecured notes at a price equal to 46% of par. All in, even with the discounted repurchases (and ignoring the intercompany loan, which nets to zero on a consolidated basis), consolidated debt increased by about $519 million to roughly $8.1 billion. So while this restructuring provided a significant and much needed liquidity boost, it did not address what we viewed as an overleveraged balance sheet.

Is the intercompany loan a common feature in other collateral transfer transactions? How did this aspect of the restructuring impact the recovery prospects (and credit quality) of Envision's legacy lenders?

To our knowledge, an intercompany loan from an unrestricted subsidiary to its parent company as part of a collateral transfer is unusual--if not unique to the Envision restructuring. Because this intercompany loan is secured by a first lien on the assets of Envision and its other material subsidiaries (excluding AmSurg), it shares a pro rata claim against the value of Envision's other assets that still serve as collateral for Envision's legacy first-lien debt. (Hereafter we will refer to Envision together with its subsidiaries other than AmSurg as RemainCo). Even so, because the company used proceeds from the $1.3 billion intercompany loan to retire $1.8 billion of RemainCo's first lien debt (as well as $87 million of unsecured debt), this aspect of the restructuring did not further impair the legacy lender's recovery prospects. In fact, on its own, this aspect of this restructuring slightly boosted first lien recovery prospects by reducing the size of the potential claims secured by the collateral. We assume the indirect lien on RemainCo's remaining assets (that is, indirectly provided to AmSurg's lenders via a pledge of its intercompany loan) was an important credit consideration for AmSurg's lenders, since they provided the funds to pay for the discounted debt repurchases.

Chart 2 

Nonetheless, the recovery prospects of RemainCo's legacy first-lien lenders were significantly impaired by this transaction overall, because of the transfer of AmSurg outside of the credit group. This made the legacy lender's claims to the enterprise value at AmSurg (which represented a large portion of its consolidated value) structurally subordinate to the debt at AmSurg. As noted in our published recovery analysis following this transaction, we attribute roughly 40% of Envision's consolidated enterprise value to AmSurg under our recovery analysis. As a result, we revised our recovery rating on this debt to '4' (30%-50%; rounded estimate: 30%) from '3' (50%-70%; rounded estimate: 50%). Trading prices on the legacy term loans before and after the collateral transfer provide some insight into the market's view on the impact to the credit quality of these loans. Average bid/offer prices for April were just above 60% of par, while average bid/offer prices following the exchange dropped to about 44% of par in May, 37% of par in June, and 32% of par in July.

What were the mechanics of the collateral transfer transaction and how were they different from similar transactions in the recent past?

A common feature of credit agreements over the last several years is a negative covenant (see footnote 1) preventing "investments" in any other person or entity, followed by a number of exceptions to the covenant, including a few that allow for the transferring of assets to unrestricted subsidiaries (see footnote 2)--either directly or in a multistep process. This multistep process involves first transferring the assets to a restricted subsidiary that is not a guarantor, and then transferring them to the unrestricted subsidiary (a so-called "trapdoor"). Moreover, the dollar amounts for the allowances (sometimes called "baskets" (see footnote 3))will often be tied to some percentage of last-12-month (LTM) EBITDA (occasionally there will be further dollar amount allowances for what's available, under the general-purpose builder basket (see footnote 4)--often called the "available amount"--as well as a fixed dollar amount "starter" basket).

These are the features that generally provide the capacity for collateral transfers, as these exceptions and the corresponding dollar amounts tied to them are meant to provide the necessary flexibility for the borrower to operate as it sees fit. Although the location of these terms can change from credit agreement to credit agreement, borrowers negotiate with originators for specific terms that may be of use, with the difference between stricter and looser credit agreements being mostly the number and type of exceptions as well as the size of the baskets associated with those exceptions. In this case, to complete the collateral transfer, Envision did not amend its credit agreement to create more capacity, but relied on existing provisions to find the capacity for roughly $2.5 billion to be removed from the existing lenders' collateral package. Based upon our review of Envision's credit agreement, two provisions stand out for their contribution in facilitating the transfer: 1) the capacity to transfer assets (as an investment) to unrestricted subsidiaries is based off the "available amount" builder basket (as well as a few other clauses with potentially smaller baskets); and 2) there isn't a requirement for pro forma compliance with the springing (revolver-only) financial maintenance covenant, because this test is specifically excluded from these restricted investment transactions.

Restricted investments and the available amount:   One of the components of the "available amount" basket includes a proviso that allows this builder basket to accumulate 100% of the consolidated EBITDA from the beginning of the quarter in which the deal closed until the most recently tested quarter, less 1.5 times the defined fixed charges (which only include consolidated interest payments and cash dividends) on a cumulative basis. This level of flexibility leaves the borrower with a large amount of capacity available to "invest" collateral assets in unrestricted subsidiaries.

Springing financial maintenance covenant:   The credit agreement included an active springing financial maintenance covenant that applied to the revolver only. In many credit agreements, this would allow the revolving lenders to have a say in the restructuring transaction if the company was over the covenant threshold on a current or pro forma basis when tested (as this is typically considered a default). However, the investment provisions in this credit agreement were not subject to the requirement that no event of default have occurred and be continuing as it relates to the financial maintenance covenant.

Capacity for the intercompany loan   Based upon our review, Envision had a few avenues within its first-lien credit agreement to facilitate the $1.32 billion pari passu (as of the completion of phase one) first-lien intercompany loan from the newly designated unrestricted subsidiary to Envision (RemainCo). There are several exceptions to the "indebtedness" negative covenant (which places restrictions on the type and amount of new debt the company can incur) that provide capacity for new debt. There is an exception serving as a general-purpose basket providing capacity of over $500 million. There is also an exception that provides capacity for additional debt as long as the borrower remains in compliance with a certain leverage ratio (that would put it well beyond S&P Global Ratings' "highly leveraged" threshold for corporate ratings--the highest designation).

Still, the mechanism used to provide the intercompany loan most likely fell under the negative covenant exception that allowed the additional debt to the extent that cash proceeds are applied to the prepayment of existing term loans. Since the cash proceeds from the intercompany loan were used to retire over $1.8 billion in existing term loans, that provision presumably would work. However, in our view, the company also had flexibility for this debt from a provision tied to incremental debt capacity, which includes a starter basket of approximately $1.016 billion.

Of the approximately $1.35 billion new intercompany term loan, approximately $821 million is designated as "short term" loans with maturity dates of 364 days from incurrence. The short-term tranche may be taking advantage of the maturity restriction carveout that allows up to approximately $1.016 billion of the incremental debt capacity to mature before the existing loans' maturity date (which is in October 2025).

Even without a requirement that Envision be in pro forma compliance with the financial maintenance covenant on the revolving loan facility at the time the collateral transfer was completed, wouldn't the company need to be in compliance at the end of the second quarter? Why didn't this affect the company's ability to complete the restructuring?

The financial maintenance covenant under RemainCo's $300 million revolving facility (which is a separate tranche under the same credit agreement that governs its legacy term loan), is only tested (quarterly) anytime the company's borrowings under the facility exceed 35% of the total revolving credit commitment. At the time of the restructuring the revolver was fully drawn, so compliance would be required at the end of the second quarter.

Further, the company had already received a waiver on its consolidated first-lien secured debt-to-consolidated EBITDA ratio at the end of the first quarter, but this waiver was only granted for that quarter. So, while the revolving lenders couldn't stop the transaction from being completed in April, the company also could not ignore the potential for a covenant violation on June 30th. This is especially true since the ability to be in compliance with this covenant in the second quarter would be dramatically impaired by the designation of AmSurg as an unrestricted subsidiary, at which point its EBITDA would no longer factor into covenant calculations.

Now that Envision has completed its second major restructuring, which included a refinancing of RemainCo's legacy revolver with a new super-senior revolver at AmSurg LLC, we see that the company built in capacity within its AmSurg debt agreements to address this issue. We also note that the company could have made the covenant test moot by using $195 million of their replenished cash to repay the revolving facility down sufficiently so that the covenant would no longer be actively tested.

In any event, if RemainCo's (covenant-lite) term lenders were hoping that the (springing) covenants applicable to the revolving loan tranche would indirectly help them by restricting actions that could hurt the credit quality of all lenders (as we sometimes hear), this didn't come to pass.

Did EBITDA addbacks affect Envision's ability to complete the collateral transfer restructuring?

In our view, addbacks found in the credit agreement definition of "EBITDA" likely influenced Envision's ability to complete the restructuring because they can significantly inflate the denominator (EBITDA) for the incurrence-style leverage tests that must be passed in order to take certain actions under the credit agreement (such as incurring debt, making restricted payments, selling assets). This also affects the ability to comply with financial maintenance covenants. In particular, basket capacity is generally tied to a percentage of the greater of adjusted EBITDA at inception or on a trailing-12-month basis, so this capacity often does not shrink even when a company's performance deteriorates. As we've noted in other research, addbacks are often substantial and the resulting "adjusted EBITDA" as defined in loan documents does not provide a realistic indication of future EBITDA, which is ostensibly the rationale for them in the first place.

This is because adjusted EBITDA includes addbacks for various items that are recurring cash operating costs (e.g. management fees, restructuring costs, hedging costs) and/or real cash outlays (e.g. transaction fees, start-up costs, unusual items), making the adding back of these items fairly dubious. Further, addbacks also often include categories that allow for a substantial amount of judgment about expected benefits (revenue and cost synergies, estimated impact from COVID-19, expected cost savings, etc.) over multiple future reporting periods. These addbacks provide companies with immediate "credit" for future benefits that may or may not be ultimately achieved and, so long the estimates were made in good faith, they are not reversed even if they prove unachievable. For Envision, its credit agreement provided addbacks for "run rate" cost savings and revenue synergies over the subsequent 24-month period that likely provided ample addbacks, especially given the disruption to its business caused by COVID. It also included addbacks for losses related to newly opened or acquired facilities (new projects) for up to 24 months.

What are the main aspects of Envision's second major restructuring this year?

Envision's Aug. 5 transaction was its second major restructuring in a 14 week span, this time in the form of a priming uptier loan exchange. This restructuring required amendments to Envision's existing first-lien credit agreement to allow for a new-money $300 million first-out term loan tranche and the conversion of the existing term loans into three different tranches with junior repayment priorities (although all loans remain secured on a first-lien basis). The transaction, which was backstopped by a group of existing lenders holding a majority position, was offered to all existing lenders and approved by creditors holding 96% of the existing loans. The lenders choosing to participate in the new money funding proportionally funded the new-money first-out loan. All participating lenders converted a portion of their existing loans into a $2.196 billion second-out loan at a 17% discount to par (with the bulk of the allocation allotted to the backstop group), and converted their remaining $1.029 billion loans into a third-out loan tranche at par. All of these loans mature in March 2027, versus the original maturity of October 2025. Non-participating lenders hold the remaining $153 million in loans at par but now have a fourth-out position, and maintain the original October 2025 maturity date.

Also relevant is that, just prior to the second restructuring, Envision permanently repaid the legacy $300 million revolving loan tranche under the original credit facility and raised an equivalent amount of new funds via a new $300 million super-senior revolver at AmSurg. This transaction inhibits the company's option to draw on the delayed-draw tranche under AmSurg's first-lien credit agreement, as it pushes the borrower beyond a certain ratio test found in the first lien documentation. In combination with the discounted conversion in the uptier loan exchange, total lender claims against RemainCo were reduced by about $450 million.

What were the mechanics of the type of uptiering priming loan exchange under Envision's second major restructuring?

In an uptier exchange transaction the borrower negotiates with the necessary lenders to amend its existing credit agreement to allow for new, so-called "priming" debt that will take a first-out priority position in terms of access to the value of the collateral serving as security for the existing lenders. This new priming debt usually comes with a new-money tranche as well as rollup tranches, whereby the lenders participating in the transaction are able to roll up a portion of the outstanding debt owed to them into the junior priming position behind the new money (but ahead of the position of non-participating lenders, which are sometimes better referred to as excluded lenders since they may not be offered the option to participate). For the new money, the borrower may already have capacity under its incremental debt allowances and only need to amend the credit agreement to allow the new money to be senior to the existing debt. If this capacity is not there, the participating lenders (who typically must account for at least 50.1% of the outstanding loans by amount on the credit agreement being amended) can add provisions to allow for this capacity.

The amendments needed to complete the rollup portion can be a bit trickier. Like the new money component, there is a priority debt amendment, but potentially problematic to this portion of the transaction are pro rata sharing requirements under the credit agreement. Typically credit agreements require that lenders receive, at par, their pro rata share of prepayments (or cash proceeds from the sale of collateral). These pro rata provisions are often included as a so-called "sacred right," meaning the threshold to amend those provisions requires the approval of "all" or "all affected" lenders. Therefore, in credit agreements with strong pro rata provisions and an "all" or "all affected lenders" requirement to alter those provisions, members of the majority group attempting to amend the credit agreement to allow the transaction must find creative ways to work around the restrictions. One way they do this is to take advantage of the pro rata exception often found in the "assignment" section of credit agreements, whereby lenders can assign (see footnote 5) their outstanding debt holdings to the borrower on a non-pro rata basis and receive the new superpriority loans in a cashless workaround.

However, in some credit agreements there is a broader exception for open market purchases that allows the borrower to make cash purchases on a non-pro rata basis at market prices (i.e. below par). Likewise, there are even credit agreements that do not have the pro rata sharing provisions as a sacred right, leaving those provisions open to amendment by just the required lenders. A credit agreement with language like that would provide the borrower the least amount of possible resistance to effecting the uptier exchange, as the borrower and lenders would 1) have a direct exception for non-pro rata open market cash transactions, or 2) could amend the credit agreement for non-pro rata payments as necessary with the required lenders making up the participating lenders in the uptier exchange.

Charts 3 and 4 show the before and after of the uptier transaction at RemainCo, while chart 5 shows the new full debt structure after phases one and two of this restructuring.

Chart 3 

Chart 4 

Chart 5 

Now that Envision has completed a second major restructuring this year, has it resolved its credit pressures?

These actions alleviated significant near-term liquidity and maturity pressures. All in, consolidated cash balances increased by more than $1.2 billion and debt maturing through 2025 was reduced about $5.8 billion.

Even so, the company's credit profile remains burdened by significant longer-term pressures, and we continue to view the company's debt structure as unsustainable. Consolidated debt is now slightly higher than before these restructurings (at about $7.9 billion, excluding intercompany debt that nets to zero on a consolidated basis), although it is slightly lower than after its first restructuring. Further, consolidated debt leverage remains extremely high at roughly 20x, excluding management addbacks, as of June 30, 2022.

From an operational perspective, the company's physician services business segment (the non-ambulatory services portion of Envision) continues to post poor operating results due to reduced elective patient volumes, higher than normal labor costs, and persistent payor pressure on service rates. We expect these challenges to persist and result in meaningful discretionary cash flow deficits over the next few years.

Near-term balance sheet pressures (excluding the maturities on the intercompany loans from AmSurg to Envision/RemainCo) are, in our view, relatively manageable given the company's liquidity, with the company's $550 million asset based lending facility, which is nearly fully utilized (including roughly $100 million used for undrawn letters of credit) maturing in October 2023 and RemainCo's legacy fourth-out term loan maturing in October 2025. However, maturities escalate substantially in 2026 at $1.2 billion, 2027 at over $4 billion, and 2028 at more than $1 billion. As a result, the company will need to be able to significantly improve its operating results and/or further revise its capital structure to remain viable. We note the company maintains some flexibility and capacity to make additional below-par open market purchases and secured loans from AmSurg to RemainCo.

What are the differences in outcomes with this transaction and other similar transactions from the recent past?

First restructuring (collateral transfer):   We have seen a number of these so-called "drop-down" transactions since July 2017 when the J. Crew restructuring demonstrated how aggressively the flexibility embedded in loan documents could be used. Although the companies that have transferred significant collateral assets differ in sector, size, and market power, they all suffered for lack of liquidity needed to service what we considered unsustainable debt burdens and they were owned by private equity firms. For the most part, these transactions, through the new money raised, are meant to provide liquidity, some debt reduction, maturity extensions, and a longer runway for the company to effect a turnaround sufficient to handle its debt load.

Each of the borrowers that completed these restructurings got the liquidity they were seeking. All, however, also came out of the transaction with a negative rating outlook--meaning analysts believed there was a meaningful chance that the company could see its rating lowered in the following 12 months. Moreover, each of the companies that S&P Global Ratings rates that did a drop-down transaction were rated in the 'CCC' category after completing that transaction, signaling that we believe the restructured balance sheets remained unsustainable. Further, from a recovery perspective, most collateral transfers had a material negative impact on recovery expectations with average and median declines in recovery given default of about 25% of par (within a range of impact from 0% to 75%, with a lower impact for transactions with limited amounts of new priority claims against the transferred assets) (for more detail, please refer to "A Closer Look at How Uptier Priming Loan Exchanges Leave Excluded Lenders Behind," Published June 15, 2021).

More than half of the companies went on to have additional significant restructuring events followed by bankruptcy. We note that the actual bankruptcies were largely COVID-influenced, but so were Envision's recent restructurings. Two of the companies--PetSmart and Party City--with the help of favorable market conditions, improved sufficiently to be upgrade out of the 'CCC' category over the next few years.

Envision follows in this pattern. After completing its transaction Envision was rated 'CCC' and placed on CreditWatch negative, meaning analysts believed there was a higher probability of the company being downgraded in the next 90 days, as the company had indicated it may complete additional below-par debt repurchases. From a recovery perspective, the impairment of recovery prospects for Envision's first-lien lenders from the collateral transfer was slightly below average at about 20% of par (reflecting a decline in estimated recovery to 30% from 50%).

Second restructuring (priming uptier loan exchange):   While Envision's second restructuring provides a longer runway to resolve its operational and balance sheet pressures, we continue to view the company's debt structure as unsustainable, as indicated by our issuer credit rating of 'CCC'. Further, we have a negative outlook on the firm, which indicates a meaningful chance of a downgrade within the next 12 months.

From a recovery perspective, impairments to estimated recovery given defaults tend to be larger for priming loan exchanges than for collateral transfers (as we discussed in our uptier exchange report) with average and median declines in recovery given default of about 36% and 50% of par, respectively, within a larger range of 10% to 65%. Reasons for larger recovery impairments for these transactions include a propensity (based on lender incentives) for participating lenders to roll up a portion of their existing debt into a priming position relative to the nonparticipating lenders. Envision's ratings outcomes follow in this trend. Of the four tranches (with the priority set by contractual seniority) in the restructured term loan, two (accounting for approximately a third of the total term loan) have received a '6' recovery rating with a 0% expected recovery. Participating lenders are expected to receive a 100% recovery on the $300 million new money portion of the term loan and a 40% recovery on the $2.2 billion rolled up portion of their existing debt, although this tranche was exchanged at a 17% discount to par.

Are there any protections being put in place to mitigate these outcomes?

First restructuring (collateral transfer):   A larger portion (though not nearly all) of 2021 and 2022 credit agreements have language designed to curb or reduce the potential impact of a collateral transfer transaction. Many of these types of provisions are addressing only one issue, such as limiting the transfer of intellectual property to unrestricted subsidiaries, but in many cases the provisions are plugging only one hole in a boat taking on water from multiple locations. As we mentioned in "A Look At 'J. Crew Blocker' Provisions in Loan Agreements," published Sept. 2019, some distressed companies will pursue any available avenue in a credit agreement to reduce their obligations.

What hasn't been a common approach is an explicit blanket statement, or section, addressing the concepts, motivations, and investor outcomes of these liability management transactions, or a general asset threshold limit for unrestricted subsidiaries as a collective.

Second restructuring (priming uptier loan exchange):   After the spurt of uptier loan exchanges in the middle of 2020, an increasing number of new credit agreements have included language designed to prevent uptier exchanges from happening without the consent of all lenders or all affected lenders. Often seen in the "amendments" section--where the credit agreement spells out what amendments can be made to the credit agreement and by what threshold of lenders--that any amendment causing the subordination of the obligations related to the credit agreement be done on the approval of all or all affected lender, thereby making such an amendment a so-called "sacred right."

Footnotes:

(1) A contractual promise not to do something.

(2) A subsidiary of the borrower that is not subject to the restrictions and covenants of the borrower's credit agreement.

(3) The dollar value of certain exceptions, allowances, and capacities that are otherwise generally restricted by the credit agreement.

(4) A general-purpose basket (a "basket" being the dollar value of certain exceptions, allowances, and capacities that are otherwise generally restricted by the credit agreement) that is cumulative in its construction and is typically based on a percentage of retained excess cash flows. Sometimes referred to as an "available amount" or "cumulative credit."

(5) As opposed to participation, where one party transfers only a limited bundle of rights to another party and does not necessarily create privity of contract between transferee and borrower, assignment is the sale or transfer of all rights to a loan from an assignor to assignee.

Related research

• EBITDA Addbacks Continue To Stack, Feb. 8, 2022
• A Closer Look At How Uptier Priming Loan Exchanges Leave Excluded Lenders Behind, June 15, 2021
• A Look At "J. Crew Blocker" Provisions In Loan Agreements, Sept. 23, 2019
• Credit FAQ: When The Cycle Turns: Assessing How Weak Loan Terms Threaten Recoveries, Feb 19, 2019