medium · Debt Capital Markets credit-ratings-risk
In a springing covenant structure, why might a lender exclude 'Letters of Credit' from the utilization calculation used to trigger the test?
- Because issued letters of credit rank higher than cash revolver draws in the bankruptcy waterfall, giving them seniority over drawn loan principal.
- To encourage the borrower to substitute LCs for cash draws so the company can deliberately hide its true leverage profile from the public debt and equity markets.
- Because outstanding letters of credit are classified as equity rather than indebtedness under the standard accounting principles applied to revolving credit facilities.
- To allow the borrower to perform ordinary course business activities, like posting LCs for rent or insurance, without triggering a full leverage audit.
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