Relevant Item:
Sears Debt Documents

As reported, Sears Holding Corp., the parent company of Kmart Corp. (“Kmart”) and Sears, Roebuck and Co. (“SRC”) (together with their subsidiaries, “Sears”), announced on Jan. 4 that certain of its subsidiaries have entered into a $500 million committed secured loan facility (the “2017 Real Estate Facility”) with “[e]ntities affiliated with ESL Investments, Inc.” In addition to this new loan, the company has received additional financing from affiliates of ESL Investments Inc. in the form of a $500 million secured standby letter of credit facility entered into on Dec. 28, 2016 (the “LC Facility”), which was discussed in a recent Reorg Covenants piece here. The company has not only been active in raising capital - on Jan. 5, Sears announced that it would be closing an additional 150 non-profitable stores, and on the same date the company also announced that it would be selling its Craftsman brand to Stanley Black & Decker. These activities all follow a potential Forbearance Termination Event under the company’s agreement with the Pension Benefit Guaranty Corp., which Reorg Covenants has previously discussed (here and here). Sears’ capital structure as of Oct. 29, 2016, as adjusted for the recent issuances, is illustrated below.
 
In September, Reorg Covenants covered Sears’ ability to incur additional secured debt. That piece concluded that while the company’s 1L Credit Agreement, 2L Credit Agreement and 2018 Secured Notes restrict debt and liens on certain current assets (subject to certain exceptions), they generally do not restrict liens on non-collateral, which likely includes certain real estate. Additionally, we concluded that Sears’ unsecured notes do not include debt and lien covenants, and the Loan Agreement, dated as of April 8, 2016, governing the company’s $500 million real estate facility (the “2016 Real Estate Facility”) includes debt and lien covenants that likely only restrict incurrences of debt secured by liens on the 21 properties pledged as collateral under such facility. This led us to confirm Sears’ management's suggestions that Sears’ unencumbered real estate assets may provide the company with substantial secured financing flexibility.

Since the company has entered into a new LC Facility and 2017 Real Estate Facility, each of which includes certain covenants, this piece will analyze debt and lien covenants in these new facilities to determine whether such provisions affect Sears’ ability to incur additional secured debt. Note that this article excludes an analysis of SRAC’s notes and 2018 Secured Notes (for an analysis of 2018 Secured Notes, please refer to our previous article). Unless otherwise defined in this article, defined terms used here have the meanings given to such terms in our previous coverage of Sears.

Covenant Conclusions
 

• After the execution of the LC Facility, the 1L Credit Agreement, 2L Credit Agreement and LC Facility likely collectively permit (i) about $1.4 billion of additional second lien debt secured by the same collateral securing the existing first and second lien debt, (ii) an unlimited amount of debt, provided that such debt does not mature before the bank debt (among other conditions), which may be secured by non-collateral, including unencumbered real estate, and (iii) other debt in an amount not to exceed $250 million, which may be secured by non-collateral.
   
• Debt and liens covenants under the Real Estate Facilities, including the new 2017 Real Estate Facility, likely continue to permit Sears and any of its subsidiaries to incur unsecured debt and debt secured by properties that are not included as collateral under such Real Estate Facilities.

Secured Debt Capacity Under the LC Facility, Bank Debt and Real Estate Facilities

As previously discussed, Sears’ 1L Credit Agreement and 2L Credit Agreement include similar debt and lien covenants restricting certain secured debt incurrences, while the company’s 2016 Real Estate Facility includes substantially different debt and lien covenants. Notably, debt and lien covenants in the new LC Facility are similar to those in the 1L Credit Agreement and 2L Credit Agreement, while debt and lien covenants in the 2017 Real Estate Facility are similar to those in the 2016 Real Estate Facility. Given these similarities, debt and lien covenants under the 1L Credit Agreement, 2L Credit Agreement and LC Facility (together, the “Bank Debt Agreements”) will be discussed together below, while the corresponding covenants under the 2016 Real Estate Facility and 2017 Real Estate Facility (together, the “Real Estate Facilities”) will be addressed separately.

Secured Debt Capacity Under the 1L Credit Agreement, 2L Credit Agreement and the LC Facility

As mentioned above, the Bank Debt Agreements include similar debt and lien covenants. These covenants and related baskets are illustrated in the chart below.
 
Note that we assume that the “December Real Estate Loan” as defined in the LC Facility refers to the 2017 Real Estate Facility.

Notably, while the debt covenants in each of the Bank Debt Agreements generally restrict Sears, SRAC, Kmart and their subsidiaries from incurring any debt, subject to certain exceptions, the liens covenant only prohibits liens on certain collateral (which generally includes current assets in the case of the 1L Credit Agreement and 2L Credit Agreement, and current assets plus certain real estate in the case of the LC Facility). Therefore, while there are certain liens baskets under the Bank Debt Agreements, if debt is otherwise permitted, it is possible that these agreements continue to permit such debt to be secured by non-collateral, which likely includes certain unencumbered real estate.

Nevertheless, the Bank Debt Agreements do also explicitly permit certain additional debt secured by collateral. Notably, the Bank Debt Agreements generally permit, collectively, (i) second lien debt not to exceed $2 billion less (a) the 2018 Secured Notes and (b) any debt incurred under the 2L Credit Agreement. These baskets likely continue to permit about $1.4 billion of additional second lien debt (after accounting for the 2018 Secured Notes and the 2L Debt) after the execution of the LC Facility. However, after the execution of the LC Facility, additional first lien debt may now only be permitted to the extent it was outstanding as of the effective date of the LC Facility (or as committed as of the effective date, and certain refinancings thereof), as debt and lien covenants under the LC Facility are likely the limiting factor for first lien debt incurrences.

The Bank Debt Agreements also include debt baskets generally permitting, collectively, (i) an unlimited amount of debt, provided that such debt does not mature before the bank debt (among other conditions) under a Longer-Dated Debt basket, and (ii) other debt in an amount not to exceed $250 million (as the LC Facility suggests that the 2016 Real Estate Facility decreases capacity under this basket in the LC Facility) under a General Debt basket. In each case, this permitted debt likely can be secured by non-collateral (provided such secured debt is otherwise permitted under other debt documents).

Given the maturity dates included in the capital structure chart at this beginning of this piece, it is likely that the 2016 Real Estate Facility was incurred under the General Debt basket under the 1L Credit Agreement and 2L Credit Agreement, while the 2017 Real Estate Facility may have been incurred under the Longer-Dated Debt basket in each of the Bank Debt Agreements (note that the LC Facility includes a specific liens basket permitting the liens securing the 2017 Real Estate Facility, which is also part of the collateral securing the LC Facility). Additionally, the LC Facility likely constitutes “Obligations” under the 1L Credit Agreement and may be incurred under the 1L Debt baskets as summarized above - the recitals in the LC Facility state that “the Existing Agent and the Loan Parties have agreed that this [LC Facility] Agreement, the Letters of Credit issued hereunder, and all other Obligations constitute ‘Bank Products,’ an ‘Other LC Facility’ and ‘Obligations’ as each such term is defined under the Existing Credit Agreement.”

Taken together, after the execution of the LC Facility, the Bank Debt Agreements likely collectively permit (i) about $1.4 billion of additional second lien debt, (ii) an unlimited amount of debt, provided that such debt does not mature before the bank debt (among other conditions), which may be secured by non-collateral, including unencumbered real estate, and (iii) other debt in an amount not to exceed $250 million, which may be secured by non-collateral.

Secured Debt Capacity Under the Real Estate Facilities

The Real Estate Facilities also include certain debt and lien covenants as summarized below. Notably, the debt covenant under the 2016 Real Estate Facility prohibits the Borrower, or SRC, Sears Development Co., Innovel Solutions Inc., Big Beaver of Florida Development LLC and Kmart, collectively, from incurring any debt other than Permitted Debt. Meanwhile, the debt covenant under the 2017 Real Estate Facility prohibits the Borrower, or SRC, Kmart Stores of Illinois LLC, Kmart of Washington LLC and Kmart, collectively, from incurring any debt other than Permitted Debt.

However, under both Real Estate Facilities, Permitted Debt includes any debt that is not secured by a lien on the Properties, which generally include only the properties pledged as security to the lenders under such respective agreement, or effectively, the collateral under such agreement. Meanwhile, the liens covenant under each agreement prohibits liens on any of the respective Properties that are senior to the liens securing the obligations under the respective agreements. The chart below summarizes the debt and lien covenants and related provisions under the Real Estate Facilities.
 
Taken together, the debt and liens covenants under the Real Estate Facilities likely continue to permit Sears and any of its subsidiaries to incur unsecured debt and debt secured by properties that are not included as collateral under the Real Estate Facilities. Notably, Sears disclosed that the 2016 Real Estate Facility is secured by “a first priority lien on 21 real properties owned by the Secured Loan Borrowers,” and it disclosed that the 2017 Real Estate Facility is secured by “a first priority lien on 46 real properties owned by the Borrowers, and is required to be secured by additional real properties if the remaining $179 million loan commitment is drawn.” Meanwhile, the company’s latest 10-K discloses that the company owns 419 properties.

Conclusion

Sears recently announced that it was entering into a new LC Facility and term loan secured by various real properties, along with disclosing that it would be closing an additional 150 non-profitable stores and would be selling its Craftsman brand to Stanley Black & Decker. Given these recent debt issuances, this piece analyzed the company’s ability to incur additional secured debt. Notably, similarly to the company’s 1L Credit Agreement and 2L Credit Agreement, the new LC Facility generally does not restrict liens on non-collateral, which likely includes the company’s real property. Also, similarly to the company’s 2016 Real Estate Facility, the 2017 Real Estate Facility generally includes debt and lien covenants that likely only restrict incurrences of debt secured by liens on the properties pledged as collateral under such facility. Taken together, Sears’ unencumbered real estate assets may continue to provide the company with secured financing flexibility after the company’s recent debt issuances.