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High-yield debt securities versus bank loans
Discuss the major differences between high-yield debt securities and bank loans in your jurisdiction. What are some of the critical advantages and disadvantages?
The major differences between high-yield bonds and bank loans in France are similar to those in other jurisdictions. Among other elements, there are differing approaches to covenants, repayment terms and amendment mechanics.
High-yield bond covenants are incurrence-based (tested at the time of a transaction only), whereas loan covenants are maintenance-based, meaning that they must be respected at all times. Loans have traditionally also required that leverage and interest coverage ratios be respected quarterly and that these ratios tighten over time with a view to the borrower deleveraging.
Even where bond and bank covenants cover the same ground, high-yield bond covenants tend to provide greater flexibility to the issuer than bank loans, for example, by allowing acquisitions as long as the acquirer takes control of the target and by providing baskets that evolve with the growth of the business. This is in part due to the relatively cumbersome process needed to get waivers from bondholders compared with a group of relationship banks in a loan. However, with the expansion of covenant-lite loans (with bond or term loan B covenants) in Europe, the distinctions between bond and loan covenants are blurring.
From the issuer standpoint, however, loans provide significantly greater scope for prepayment without penalty. Bonds have non-call periods during which the issuer can only redeem them by paying a costly make-whole premium or by using the proceeds of certain equity offerings to redeem a portion of the bonds. Floating rate notes, which have shorter non-call periods, can be attractive for issuers seeking faster redemption possibilities, but covenant-lite loans will also be attractive for this type of borrower and are likely to have less onerous prepayment and non-call provisions.
When it comes to waivers and amendments, bonds require a consent solicitation to be made to holders, which must then approve with a simple majority for most matters or a 90 per cent or 100 per cent super majority for certain specified matters generally affecting economic terms. Loans must generally be approved by a two-thirds majority or, for certain matters, a 100 per cent majority. This may be easier in the loan context compared to bonds if a large stake is held by relationship lenders. Some movement towards a 50.1 per cent threshold in the covenant-lite context has also been observed.
Issuing a bond requires a considerable investment of time by the company to prepare a thorough disclosure document and to provide the underwriters and legal advisers with the documentation and information they need to carry out their due diligence exercise. This is particularly true for a first-time issuance, and companies should find that repeat issuances in the market are much faster and less labour-intensive. The due diligence aspect stems from the fact that both issuer and underwriter will be exposed to potential securities law liability for the offer and sale of bonds, unlike for bank debt. Issuing a bond will also bring with it public (or semi-public) reporting requirements, compared with the non-public transmission of information in a bank loan.
Are you seeing increased regulation regarding either high-yield debt securities or bank loans in your jurisdiction?
High-yield bonds are not typically listed on a regulated market in France and are only privately placed with institutional investors, so there has been no recent French regulation that has affected them in particular.
Rules regarding bank loans have not changed much recently, although banking monopoly rules are being relaxed, which will, in particular, allow certain alternative lenders (mainly French funds) to enter the market.
However, stricter rules on the deductibility of interest have affected the attractiveness of leveraged structures in certain circumstances and have affected the structuring of the security packages (see question 28).
Current market activity
Describe the current market activity and trends in your jurisdiction relating to high-yield debt securities financings.
France has seen issuers from a wide range of industries coming to the high-yield market as a way to achieve covenant flexibility or to diversify their funding sources. Sponsor transactions are common, but so are companies that are majority-owned by families or individuals. Issuance activity has been relatively busy in recent years, with both new and repeat issuers coming to market, although political uncertainty has generated some volatility.
This period has also seen a number of high-yield issuers carrying out initial public offerings (IPOs), typically using the proceeds to reduce debt. Although high-yield bonds are sometimes seen as more onerous than bank debt because of the reporting and disclosure requirements, these can actually be good preparation for the IPO process and the level of communication that is expected of public companies.
Identify the main participants in a high-yield debt financing in your jurisdiction and outline their roles and fees.
The main participants in France are the same as in other European markets. Entities such as Citibank, Deutsche Bank, The Bank of New York Mellon and Wilmington Trust that have a track record of acting as New York law trustees act frequently on high-yield transactions as trustees, paying agents and collateral agents. The usual big rating agencies are also active in the French market, and the ratings process is an important workstream for the issuer, on which the underwriters or financial advisers will provide critical assistance. European and US investment banks that are active in the high-yield market elsewhere in Europe are also present in France. The large French banks are particularly visible given their historical relationships with many issuers.
Describe any new trends as they relate to the covenant package, structure, regulatory review or other aspects of high-yield debt securities.
Portability has become a common feature of high-yield bond terms in cases where a sponsor has communicated to bondholders that it is seeking to sell the asset. If this flexibility is provided, it removes the issuer’s requirement to carry out a change of control offer at 101 per cent if, at the time of the change of control, the group’s leverage is below an agreed level.
An important feature in French transactions continues to be the analysis of what guarantees and security can be provided in respect of the bonds. If French subsidiaries are not receiving the proceeds of the bond offering, through a debt pushdown or otherwise, then corporate benefit concerns can make it very difficult to get upstream guarantee coverage. Where these guarantees are possible, they will be limited to the amount allowed by corporate benefit considerations, which constrains their practical usefulness as credit support (see question 19).
Similarly, there continues to be discussion as to whether the costs of putting in place a double Luxco structure justify the perceived benefits in terms of creditor protection. The presence of two Luxembourg companies above a French company is intended to allow creditors to enforce their pledges granted by the top Luxembourg company over the shares of the lower Luxembourg company and thereby gain the power to control the board of directors of the French company.
How are high-yield debt securities issued in your jurisdiction? Are there particular precedents or models that companies and investors tend to review prior to issuing the securities?
High-yield bonds are generally issued under a New York law indenture and cleared through Euroclear and Clearstream although, in some cases, they may clear through the Depository Trust Company in the US.
Issuers and banks will typically look to recent transactions with similar characteristics (industry, geography, sponsor, size) and seek to agree which of these deals will be the most relevant reference points for the working group and the investor base. Bank feedback about investor reactions to those precedent transactions can then help the working group to adapt the structure and terms of the new transaction to address the needs of the issuer and the market.
Maturity and call structure
What is the typical maturity and call structure of a high-yield debt security? Are high-yield securities frequently issued with original issue discount? Describe any yield protection provisions typically included in the high-yield debt securities documentation.
Maturities are typically between five and 10 years, with the non-call period generally lasting two to five years depending on the maturity, although the non-call period can be shorter for floating rate notes and, more rarely, for fixed-rate notes. During the non-call period, the issuer will nevertheless have the option to redeem the bonds by paying a make-whole premium. It is also common to have an option to redeem 35 per cent or 40 per cent of a series of bonds with the proceeds of equity offerings, and in some transactions, the issuer may redeem up to 10 per cent of the bonds at a price of 103 per cent at any time.
Issuers seek to avoid issuing bonds with original issue discount beyond what is considered de minimis for US tax purposes so as not to dissuade US investors.
How are high-yield debt securities offerings launched, priced and closed? How are coupons determined? Do you typically see fixed or floating rates?
The launch, pricing and closing process is not substantively different in France from that in other European countries. Following launch there is a management roadshow in the major European financial capitals and, if there is a Rule 144A placement, in the US too. During the course of the roadshow, indications of investor interest will allow the banks to determine a coupon range, which is then further tested with investors to come up with a firmer range and finally the exact pricing proposal that will be agreed with the issuer.
Fixed-rate bonds are more common than floating rate bonds.
Describe the main covenants restricting the operation of the debtor’s business in a typical high-yield debt securities transaction. Have you been seeing a convergence of covenants between the high-yield and bank markets?
In a typical high-yield bond transaction, there will be covenants limiting the following:
- incurring indebtedness and issuing preferred stock;
- making restricted payments (dividends, repurchases of equity or subordinated debt, minority investments);
- carrying out asset sales;
- incurring liens;
- entering into transactions with affiliates;
- agreeing restrictions on the payment of dividends by subsidiaries; and
- issuing guarantees.
Other covenants relating to security interests will apply to secured bonds, while bonds using an issuing vehicle or a double Luxco structure will have covenants intended to preserve the structure. There will also be an obligation to report to bondholders annually, quarterly and on the occurrence of material events.
There has been some convergence between high-yield and bank covenants in the bank markets particularly, as companies increasingly consider term loan B facilities containing incurrence covenants that are similar to those in bonds, with the addition of one or two maintenance covenants. These facilities provide the operational flexibility of bond covenants with the repayment flexibility of bank debt. In France, the terms of these loans are usually highly tailored to the situation of the particular issuer, unlike in the US where terms are more standardised in an effort to ensure wide syndication.
Are you seeing any tightening of covenants or are you seeing investor protections being eroded? Are terms of covenants often changed between the launch and pricing of an offering?
Covenants have not been changing significantly, but the gradual long-term trend towards greater issuer flexibility continues, particularly in sponsor transactions. For example, the ability to make restricted payments subject to a leverage test has become more common. In addition, there has been growing flexibility in some early redemption elements, with shorter non-call periods and options to redeem 10 per cent of a series at 103 per cent. This is of course a sensitive point for investors, which find that the scope for capital appreciation on the bonds is limited. In addition, portability has become a more frequent feature in bonds, even where a sale of the business is not expressed to be an element of the short-term strategy. It is relatively rare for the terms of covenants to change between the launch and pricing of an offering.
Are there particular covenants that are looser or tighter, based on a particular industry sector?
The covenant package will be driven more by the rating, size, category (sponsor versus corporate) and business model of an issuer than by the industry. Participants in the same industry may have different approaches to owning or leasing assets, for example, and the covenants will need to provide for the chosen model.
Change of control
Do changes of control, asset sales or similar typically trigger any prepayment requirements?
Changes of control trigger the obligation to make a repurchase offer to all bondholders at a price of 101 per cent of the bonds’ principal amount plus accrued interest. However, these provisions are sometimes subject to portability provisions that allow for the obligation to be avoided for a given time if a leverage ratio is respected.
Asset sales with proceeds above a given threshold that are not used for specified purposes set out in the covenant (typically, to reinvest in the business) must be used to make a repurchase offer to all bondholders at par plus accrued interest.
Do you see the inclusion of ‘double trigger’ change of control provisions tied to a ratings downgrade?
No, this is something that is typically seen only in crossover credits that have an investment grade-style covenant package.
Is there the concept of a ‘crossover’ covenant package in your jurisdiction for issuers who are on the verge of being investment grade? And if so, what are some of the key covenant differences?
Companies that are just below investment grade are in some cases able to issue on investment grade terms, using French law and avoiding any restrictive covenants (other than the customary Eurobond-style negative pledge and change of control provisions).
Describe the disclosure requirements applicable to high-yield debt securities financings. Is there a particular regulatory body that reviews or approves such disclosure requirements?
The French securities market regulator is not involved in reviewing high-yield offering documents because high-yield bonds are not customarily listed on a French-regulated securities market. Instead, the bonds are most often listed on the Euro MTF market of the Luxembourg Stock Exchange or on the Irish Stock Exchange. Consequently, the main drivers of disclosure are the expectations of high-yield investors and the US Securities and Exchange Commission disclosure regime, which is applied by analogy in Rule 144A offerings and many Regulation S offerings.
Disclosure standards have not changed significantly in recent times, although in response to the Association for Financial Markets in Europe recommendations, there is a tendency to provide greater detail about other indebtedness in the issuer group and to describe very extensively the intercreditor arrangements.
Use of proceeds
Are there any limitations on the use of proceeds from an issuance of high-yield securities by an issuer?
The issuer will usually have agreed with the underwriters in the purchase agreement that it will use the proceeds in the manner described in the offering document (and the issuer could also face securities law liability if it does not). The purchase agreement will also contain representations from the issuer not to use the proceeds in a way that would violate any relevant sanctions or cause others to violate them.
Restrictions on investment
On what grounds, if any, could an investor be precluded from investing in high-yield securities?
Because the bonds are privately placed in France and elsewhere exclusively with qualified investors, other investors will generally be ineligible to purchase them during the initial distribution.
Are there any particular closing mechanics in your jurisdiction that an issuer of high-yield debt securities should be aware of?
Guarantees and security
Outline how guarantees among companies in a group typically operate in a high-yield deal in your jurisdiction. Are there limitations on guarantees?
Security and guarantees granted by French companies will be affected by financial assistance and corporate benefit limitations. Most forms of French company will be unable to give security and guarantees to support debt that has served to finance the acquisition of its shares or the shares of its holding company. In addition, limitations as to corporate benefit mean that a guarantee will generally need to be limited to the amount of the high-yield proceeds actually on-lent to a French member of the issuer’s group.
Finally, thin capitalisation rules may mean that guarantees of (and security granted for) the debt of the issuer by other members of the group, including its holding company, need to be limited either in amount or to certain limited types of security to maintain tax-deductibility of the interest due to the bondholders (see question 28).
What is the typical collateral package for high-yield debt securities in your jurisdiction?
We would generally expect security to be granted over shares, inter-company debt (including the proceeds loans) and bank accounts. Depending on the type of business, security may also be granted over material intellectual property or business undertakings.
Are there any limitations on security that can be granted to secure high-yield securities in your jurisdiction? Are there any limitations on types of assets that can be pledged as collateral? Are there any limitations on which entities can provide security?
As discussed above, the general limitations as to the ability to grant guarantees as well as the thin capitalisation rules may dramatically reduce the scope of the security package that may be taken in practice. In addition, there are certain types of security that may not be taken in a high-yield context as they may only be granted for the benefit of credit institutions. This would be the case, for example, of receivables security in the form of an assignment (Dailly assignment).
Describe the typical collateral structure in your jurisdiction. For example, is it common to see crossing lien deals between high-yield debt securities and bank agreements?
The structure for holding the security will depend on the different classes of debt included in the structure. Generally, security for high yield will need to be granted to a security agent holding the security under a parallel debt structure. It is common to have financings in which bank and high-yield debt share a security package. In this context, an intercreditor agreement would be implemented under the terms of which a common security agent would manage enforcement of security. This intercreditor agreement would also manage ranking in relation to the security proceeds and also the ability to release debt claims in the context of an enforcement sale with corresponding value protection provisions.
Who typically bears the costs of legal expenses related to security interests?
We would expect legal fees to be covered by the issuer.
How are security interests recorded? Is there a public register?
There is no general public security register. Certain types of security (notably the business undertaking pledge) would need to be registered at the commercial registry of the place of business or, in the case of intellectual property, where there are specific registries in relation to that type of asset; but these are specific exceptions rather than a general requirement to publicly file all security.
How are security interests typically enforced in the high-yield context?
This will of course depend on the type of asset in question. The enforcement of share security, for example, would most likely be carried out by foreclosure. However, the ability to enforce does need to be considered in the context of the French pre-insolvency protection regimes, which may well prevent or limit the ability to enforce.
Debt seniority and intercreditor arrangements
Ranking of high-yield debt
How does high-yield debt rank in relation to other creditor interests?
Traditionally, bondholders in France have been subordinated to bank lenders structurally, contractually and by being unsecured or secured on a second-ranking basis. However, the rise of secured bonds as an alternative to bank lending has led to more transactions where bondholders rank pari passu with banks.
This can take the form of bondholders sitting side by side with term loans or where a company’s long-term debt is entirely made up of bonds and its working capital needs are met through a super senior revolving credit facility (RCF).
Regulation of voting and control
Describe how intercreditor arrangements entered into by companies in your jurisdiction typically regulate voting and control between holders of high-yield debt securities and bank lenders?
When it comes to voting, the trend continues towards equal voting power for banks and bondholders in pari bond structures. In bond or super senior RCF structures, the bondholders will drive the process subject to certain triggers that allow the RCF lenders to step in.
Offsetting of interest payments
May issuers set off interest payments on their securities against their tax liability? Are there any special considerations for the high-yield market?
As a general rule, interest paid or accrued on a loan agreement entered into by a French company or on high-yield bonds issued by a French company is deductible from that company’s taxable income in the same fiscal year, provided that the debt is incurred for bona fide business purposes and the interest rate is set at arm’s length. Nevertheless, over the past 10 years, a number of anti-avoidance rules have been introduced in French tax legislation that curb tax deductions for interest. While those rules do not specifically target high-yield bond issues, they are drafted in such a manner that high-yield bonds will generally fall within their scope. Listed below are two such anti-avoidance rules, but other anti-avoidance rules may be applicable too.
General measures limiting the deductibility of net financial charges (rabot)
Under article 212-bis of the French Tax Code, the net financial charges borne by French companies subject to corporate income tax are deductible for only 75 per cent of their amount. Certain exceptions are applicable, but in our experience most high-yield bond issues do not fall within the scope of such exceptions.
Thin capitalisation rules and debt secured by related-party guarantees
Article 212 section II of the French Tax Code may limit the deductibility of interest paid on loans granted by a related party within the meaning of article 39.12 of the French Tax Code or on loans granted by a third party that are guaranteed by a related party. Deduction for interest paid on such loans may be partly disallowed in the financial year during which it is accrued if such interest exceeds each of the following thresholds:
- the amount of interest multiplied by the ratio of:
- 1.5 times the company’s net equity; and
- the average amount of indebtedness owed to related parties (or to third parties when such loans are guaranteed by a related party) over the relevant financial year;
- 25 per cent of the company’s earnings before tax and extraordinary items (and as adjusted for the purpose of these limitations); and
- the amount of interest received by the company from related parties. Specific rules apply to companies that belong to French tax-consolidated groups.
Any financing (including high-yield bonds) in respect of which a related party grants a guarantee or security will be treated as related-party indebtedness for the purpose of these thin capitalisation rules. Both security interests in personam (personal guarantees, first demand guarantees, etc) and security interests in rem (third-party pledges over shares, collateral, mortgages, etc) are covered by these rules.
With respect to security interests in personam that are capped at a specific amount, the secured financing will be tainted only for a portion equal to the secured amount. Similarly, with respect to security interests in rem, a secured financing will be tainted only in the same proportion as the value of the collateral (as at the date the security interest is created) bears to the initial principal amount of the financing. The ratio may be adjusted if the security documentation is subsequently amended.
Several exceptions limit the effect of these new rules. In particular, a pledge over the shares in the borrower itself or over a receivable owed by the borrower will not be taken into account for the purpose of the thin capitalisation rules. Similarly, pledges over the shares in a direct or indirect parent company of the borrower will not be taken into account, provided, however, that the owner of the shares to be pledged and the borrower are consolidated for tax purposes. Also, the refinancing of outstanding borrowings that are triggered by a change of control of the borrower are not caught by the new rules, up to the principal amount being refinanced and interest falling due upon the change of control.
Another exception under article 212 section II.3.1 of the French Tax Code is available for a public offer of bonds within the meaning of article L411-1 of the French Monetary and Financial Code or equivalent foreign legislation, but most high-yield bonds issues do not fall within the scope of this exception.
High-yield bond issues in France take these thin capitalisation rules into account in the design of the security package to ensure that French issuers are able to maximise the deductibility of interest over the life of the bonds.
Is it common for issuers to obtain a tax ruling from the competent authority in your jurisdiction in connection with the issuance of high-yield bonds?
Update and trends
Update and trends
Updates and trends
French interest deductibility limitation rules may be modified upon implementation of the Anti Tax Avoidance Directive (ATAD) under French tax law, the timing of which remains unknown. The ATAD notably provides for common minimum rules on interest limitation, restricting the deduction of exceeding borrowing costs to the higher of (i) an amount of €3 million or (ii) 30 per cent of the taxpayer’s earnings before interest, tax, depreciation or amortisation. This rule does not distinguish between third-party and related-party interest. Member states can choose to introduce a group test. The 15 actions of the Base Erosion and Profit Shifting Project of the Organisation for Economic Co-operation and Development as well as the EU ATAD are likely to result in significant changes to French tax law and practices in the coming years.