Most Favored Nation (“MFN”) provisions are designed to protect lenders in situations where borrowers add additional debt with higher margins under existing loan agreements. MFN provisions raise interest rate margins of the existing tranche, if the new tranche of debt’s all-in yield exceeds the existing debt’s all-in yield by a given amount.

The issue: with the recent rapid rise in interest rates, many leveraged loan borrowers who are looking to finance add-on acquisitions or corporate purposes find themselves bumping up against the MFN provisions in the loan agreements. The key issue is that, once a borrower taps the incremental facility, which has a higher margin, the MFN raises the interest rate margin of the existing debt as well, making the borrower’s entire debt facility more expensive. 

This has two fold consequences: (a) it chills any add-on acquisitions; and (b) it makes any additional borrowing, even for corporate/working capital purposes, more expensive. Consequently, this makes it harder to organically grow the business.

A potential solution is to structure the new debt as a security or have the new debt incur interest at a fixed rate. The MFN is not triggered by the new issuance because the new debt is not substantially similar to the existing debt (i.e. applies only if the new debt is issued as a term loan).  

Another solution is to issue 1.5 lien debt. This creates an add-on tranche that is secured but junior to the existing debt. Obviously, this increases interest costs, but it will avoid re-pricing the entire facility.

We understand the need for lender protection. However, this protection must be balanced against the borrower's ability to run and grow the business.  A détente must be achieved, if not both borrowers and lenders will suffer in the long run.