We are delighted to unveil our latest comprehensive analysis of trends in European high yield bond documentation.
Continuing the trend over the past few years, 2018 saw further inroads made in the erosion of investor covenant protections in European high-yield documentation. In addition to significant weakening in the “usual” suspect areas, such as complex and flexible ratio-related definitions, we also saw an increase in off-market terms in the Restricted Payments and Asset Sale covenants, but which have not yet become “standard” aggressive.
An area that has come to prominence in recent years is the use of a “limited condition acquisition” (LCA) type flexibility in ratio calculations. This flexibility allows ratio compliance, determination of basket availability and/or the “no default/event of default” condition to be tested on the date of the acquisition agreement, rather than the date the deal actually closes, allowing the Issuer to preserve covenant compliance at the date of documentation signing against any deterioration that may occur subsequent to signing (and exist at closing)
- 49% of 2018 deals contained LCA-type flexibiity in any form compared to 43% of 2017 deals.
- 28% of 2018 deals that contained the LCA-type flexibility extended it beyond Limited Condition Acquisitions, compared to 19% of 2017 deals.
In addition, issuers continued to find ways to extend their ability to loosen restrictions on dividends. This was done in a variety of ways
- Upfront "free and clear" in the build up basket which can be paid out to "equity" at any time. When combined with a generous Restricted Payments basket, this increases the risk of value loss for investors. In 2018 24% of deals had a free and clear credit, up from 17% in 2017 and in each case, such deals also included a general Restricted Payments basket (e.g., Selecta Senior Secured 2023 and Cirsa Senior Secured 2023) .
- Reclassification of Restricted Payments is another high-risk feature in covenants, allowing Issuers to make “strategic” dividends. The ability to reclassify payments from applicable carve-outs to the CNI build-up basket allows Issuers to “game” the timing of dividends so that any applicable carve-outs are available to make dividends when the Issuer knows the CNI build-up basket will be unavailable in the future to make such dividends. Of the deals allowing reclassification of Restricted Payments in 2018, 87% (33% of 2017 deals) also allowed reclassification of Permitted Investments (e.g., Nidda Bondco GmbH (Stada) Senior 2025), as compared to 71% (25% of all deals) in 2017.
- Additional pressure on the Asset Sale covenant, and ability to use proceeds, for Restricted Payments. Issuers/sponsors included language carving out a specified % (in some cases 100%) of “excess proceeds” from the requirement that such “excess proceeds” be applied to make an Asset Sale offer, if a specified leverage is met. The “exceed proceeds” can either be used directly to make a Restricted Payment. Some 39% of 2018 deals allowed circumvention of the standard asset sale proceeds warterfall for the repayment of debt or reinvestment, this compares to 41% of deals in 2017. However, 5% of 2018 deals carved out a % (including 100%) of “excess proceeds” from being used for an Asset Sale offer. None of the deals we reviewed in 2017 had this provision.
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