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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 difference between high-yield debt securities and bank loans in the US is that securities are governed by securities laws. As a result, there are disclosure obligations that issuers must abide by. The regulatory aspect of a securities offering adds a layer of legal liability on parties participating in the offering, and parties generally have to follow the disclosure standards in accordance with the securities laws. Here is an example to illustrate the point. Assume that company A wants to buy company B. Company A would prefer to issue high-yield debt securities to finance the acquisition but company B is a private company that has no audited financial statements. Assuming this is a significant acquisition for company A, it would need company B’s historical financial statements as well as pro forma financial statements as part of its required disclosure to investors under the securities laws. In many situations such as this, instead of forcing company B to prepare the requisite financial statements, which may be costly and time-consuming, company A may instead decide to turn to the loan market, which is not subject to the same regulatory regime.
Another key difference is that high-yield indentures are generally difficult to amend and this is one of the primary reasons that high-yield covenant are more flexible than traditional credit agreements. Credit agreement amendments are fairly common and credit agreement covenant packages are often designed to require a borrower to seek consent from its lenders for material departures from its ordinary course of business. High-yield debt securities, however, are securities that are usually widely held and high-yield investors traditionally do not expect to be approached for consent, except in special circumstances.
In addition, unlike the administrative agent under a typical credit agreement, the trustee under a high-yield indenture is not expected to closely monitor or be in frequent contact with an issuer. Instead, amending a high-yield indenture requires a formal consent solicitation process that follows an established market practice, which is time-consuming and costly for the issuer and may create hold-up value for the investors.
Are you seeing increased regulation regarding either high-yield debt securities or bank loans in your jurisdiction?
Regulation regarding high-yield debt securities is always changing as the Securities and Exchange Commission (SEC) adds rules, clarifies rules or makes other changes to the regulations. In addition, following the 2008 global financial crisis, we are seeing more federal regulation. For example, there are certain limitations on banks’ ability to hold securities for their own account, which can create certain complicated issues in leveraged financing situations.
Further, we were starting to see more regulation of bank loans. Again, following the 2008 global financial crisis, more laws have been passed limiting the ability of banks to make loans in certain situations where leverage would be viewed as being too high.
Having said all that, the Trump administration has begun easing certain regulations imposed on banks during the 2008 global financial crisis. This is a constantly evolving issue and we will see how it unfolds in the coming months.
Current market activity
Describe the current market activity and trends in your jurisdiction relating to high-yield debt securities financings.
In general, 2017 was a very busy year for issuers, in part aided by President Trump’s pro-business agenda. Commodity prices rebounded and more oil and gas companies re-entered the high-yield market. In general, there was less volatility in 2017 compared with 2016. At the time of writing, market activity has been fairly robust but certainly more volatile than what we saw in 2017. There is a feeling that volatility is back driven by fears of inflation, a looming recession, rising interest rates and fear about the newly issued Trump tariffs on steel. As a result, we expect that issuance levels will be on par with 2017 but with increased volatility.
A typical high-yield covenant package will include incurrence-based covenants (ie, there are typically no maintenance covenants and companies must only test the covenants at the time of taking a certain action), which include limitations on:
- incurring debt;
- incurring liens;
- making restricted payments and investments;
- entering into transactions with affiliates;
- entering into mergers and sales of all or substantially all assets;
- consummating asset sales; and
- consummating change of control transactions.
Almost all high-yield debt securities are guaranteed by the issuer’s subsidiaries, which guarantee the bank facility and other material debt of the issuer.
Most high-yield debt securities are held by qualified institutional buyers (ie, institutions knowledgeable about the instrument). Increased overlap between investors in high-yield debt securities and loan financings has been noted.
Identify the main participants in a high-yield debt financing in your jurisdiction and outline their roles and fees.
The key participants in a high-yield debt financing in the United States are the banks, which play the role of the underwriters (or initial purchasers in an unregistered deal). The underwriters have three main responsibilities:
- they manage the process for the issuer. Among other things, they create the timeline, prepare the issuer for meetings with investors, create roadshow schedules, and bring the issuer on the roadshow to meet with investors;
- they are responsible for marketing the offering for the issuer. For example, the offering document for a high-yield debt security will typically have a summary section upfront, commonly referred to as the ‘box’, and it will contain, among other things, strengths and strategies of the company, which is the marketing element of the disclosure document. The underwriters play an important part in crafting the marketing story for the issuer; and
- they act as the gatekeepers for the market in terms of the covenant package being negotiated. As opposed to bank loans, the underwriters typically do not hold the high-yield debt securities on their books but are viewed as the experts in terms of what the market will and will not bear as it relates to covenant packages. For their services, the underwriters will receive a gross spread tied to their allocation of the aggregate principal amount of securities being offered.
There are other participants in a high-yield debt financing, but none play as big a role as the banks. Lawyers play a crucial role representing the company on the one hand and the banks on the other. Accountants also play an important role in advising the company on financial presentation in the offering document and delivering a comfort letter to the underwriters. Rating agencies are always involved because they have to provide a rating on the proposed high-yield debt security, which is obviously critical for execution of the deal. And finally, there is the trustee. The trustee retains its own counsel on any transaction and receives fairly standard flat fees in connection with each engagement.
Describe any new trends as they relate to the covenant package, structure, regulatory review or other aspects of high-yield debt securities.
The trends in high-yield are always changing based on the state of the market. For example, when the market is hot and there is much demand for high-yield paper, issuers and sponsors start to forge ahead. As a result, there tends to be flexibility in the covenants, primarily in terms of incurring debt and liens and making restricted payments. As the market cools off and investors become more selective in terms of the paper they are willing to buy, covenant packages start to tighten up.
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?
Every high-yield debt security is issued pursuant to an offering memorandum (or prospectus in a registered deal) provided to prospective investors. The offering memorandum describes the business of the company and the transaction being undertaken, and it contains the covenant package being offered to investors.
There are always precedents and models that need to be reviewed prior to issuing the securities. In a sponsor leveraged-buyout scenario, the issuer and sponsor will normally look to the last deal completed by that sponsor. Every sponsor has a form for its covenants and while every covenant package will be tailored to the particular needs of each issuer and its industry, the sponsor form is the starting point for such deals.
If the issuer has issued high-yield debt securities in the past, then the prior covenant package is the appropriate starting point for the new issuance. However, for debut high-yield issuers, typically, the deal team will look at a combination of the lead bank’s form, recent sponsor precedent, recent precedents in the issuer’s particular industry and recent precedents for issuers with a similar credit profile.
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.
High-yield debt securities generally tend to have either an eight-year or a 10-year maturity. However, in 2017, we saw an increased number of issuers issuing high-yield debt securities with a five-year maturity in order to get a cheaper coupon. In general, high-yield debt securities are not redeemable at the option of the issuer for a specified number of years, permitting investors to lock-in an interest rate for a significant period. For example, after a five-year non-call period, 10-year securities are typically redeemable at a redemption price equal to par plus half the coupon, and the premium then declines to par two years before maturity. For eight-year securities, the usual formulation is a four-year non-call period after which the securities are redeemable at a redemption price equal to par plus half the coupon, declining to par. Sometimes, however, eight-year securities with a three-year non-call period are issued, in which case the redemption price after the non-call period is typically equal to par plus 75 per cent of the coupon (although an increasing number of three-year non-call deals have the first step down at 50 per cent of the coupon), declining to par.
Make-whole redemption allows issuers to call the securities during the non-call period at a price equal to the present value of the optional redemption price on the first optional redemption date and scheduled interest payments up to that date. The present value is almost always calculated based on the Treasury rate plus 50 basis points, which approximates the price that investors would expect to receive in a tender offer.
Another significant exception to the non-call period is the ability of an issuer to redeem a portion of the securities with the proceeds of an equity offering during the first three years following the issuance date (commonly referred to as the ‘equity clawback’ or ‘equity claw’). This exception, which is nearly universal in high-yield offerings, permits the issuer to deleverage after an initial public offering or after raising additional equity capital. Typically, issuers may not redeem more than 35 per cent of the original principal amount of the securities in an equity claw, although 40 per cent is possible in some deals. The issuer must pay a redemption price to investors equal to par plus a premium equal to the full coupon, plus accrued interest.
A less common exception to the non-call period is, in the case of secured notes, the ability of the issuer to redeem a small portion (typically 10 per cent) of the outstanding securities during each of the three years after the issue date, at a specified premium to par (typically 103 per cent). This provision is much less common than the equity claw provision described above. One rationale for the inclusion of this provision is that secured notes became prevalent in the marketplace during the global financial crisis in 2008 and often substituted for secured term loans.
While term loans are generally prepayable at par, many terms loans include a soft call at 101 per cent feature for a short period after the closing date with the proceeds of another financing, so some issuers sought to mimic this type of redemption feature for secured notes.
As a result, in capital structures where secured notes exist alongside secured credit facilities, it is sometimes possible to redeem up to 10 per cent of the notes in any 12-month period during the first three years following issuance, at a price equal to 103 per cent plus accrued interest. Occasionally, such 10 per cent exception can also be found in unsecured notes too, particularly floating rate notes.
The redemption features are not mutually exclusive.
How are high-yield debt securities offerings launched, priced and closed? How are coupons determined? Do you typically see fixed or floating rates?
The timeline of a typical high-yield offering is as follows. An offering is launched by the distribution of the ‘red’ (ie, the preliminary offering memorandum or prospectus) to investors, which is often accompanied by a press release. For a debut issuer or a significant transaction, the issuer may then go on the road to meet with investors while the banks are building the order book. A formal roadshow can be as short as three days and as long as two weeks.
The bankers will determine the length of the roadshow and they will instruct accounts that books will close by a certain time on the final day of the roadshow, which is the deadline for submitting an order in the security. After the books have closed, the bankers will schedule a pricing call with the issuer and the bankers and the issuer will agree to the terms of the deal (eg, the coupon, issue price, maturity and call schedule).
Most high-yield debt securities are issued at a fixed coupon and the coupon is determined as a result of investor demand. Many factors lead to the determination of the coupon, including the general market, prevailing interest rates, the health and stability of the issuer, the issuer’s industry, the covenant package, the maturity of the high-yield debt securities, and the financial performance of the issuer.
After the pricing call, a pricing term sheet is sent to investors to confirm sales, coinciding with the signing of the underwriting agreement (or purchase agreement in an unregistered deal) between the issuer and the underwriters, pursuant to which the underwriters agree to purchase the securities from the issuer.
Once a securities transaction is priced, the securities begin trading. As part of the pricing terms, the parties will also schedule a closing date, which is typically done on a T+2 basis. Therefore, two business days after pricing, the securities offering will close. Under certain circumstances, however, closing may be done on a T+5 or even a T+10 basis.
Note that for a repeat high-yield issuer, launch and pricing are often accelerated to a single day, known as a drive-by offering. In other words, the offering launches before the market opens, followed by single or multiple investor calls, followed by pricing later that afternoon. If the market is familiar with the issuer, the need to have a formal roadshow to meet with accounts is generally not required, resulting in an accelerated process.
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?
High-yield covenants always need to strike a delicate balance. On the one hand, the covenants provide protection for high-yield investors against an issuer overextending itself or using cash unwisely. On the other hand, the covenants must provide flexibility for the issuer to operate its business and grow over the life of the high-yield debt securities. In other words, the covenants protect the investors’ ability to be paid principal and interest on the securities while preserving the issuer’s ability to run its business without undue restrictions.
The high-yield covenant package is focused on regulating the ability of the issuer and its restricted subsidiaries to service their debt and achieve the balance described above. High-yield covenants are generally flexible in permitting different types of transaction between the issuer and its restricted subsidiaries or among restricted subsidiaries - in many cases, regardless of whether those restricted subsidiaries are guarantors or non-guarantors.
While each high-yield covenant package is distinct, the main covenants are as follows:
- Limitation on restricted payments: this is often called the ‘RP covenant’. The RP covenant regulates the amount of cash and other assets that may flow out of the issuer and its restricted subsidiaries. It limits:
- cash dividends and other distributions;
- the redemption or repurchase of the issuer’s capital stock;
- the redemption or repurchase of subordinated debt obligations prior to their scheduled maturity; and
- restricted investments, which are investments that are not defined as permitted investments.
- Limitation on indebtedness: the debt covenant restricts the amount and the type of debt the issuer can incur.
- Limitation on liens: the lien covenant is focused on protecting the high-yield investors’ position in the capital structure by regulating the incurrence of secured debt that may be effectively senior to or pari passu with the high-yield debt securities, and ensuring that the securities have a senior priority lien on collateral that secures any junior debt.
- Limitation on asset sales: unlike a traditional credit agreement, high-yield debt securities do not place strict limits on asset sales. Instead, the high-yield asset sale covenant establishes guidelines that must be followed in any asset sale and permits the issuer to use the proceeds either to reinvest in the business or to prepay debt that ranks higher than or equal to the high-yield debt securities in the capital structure. If the issuer does not use the proceeds in this way, it is required to offer to repurchase the high-yield debt securities at par plus accrued interest.
- Limitation on affiliate transactions: the limitation on affiliate transactions covenant limits the issuer’s ability to enter into transactions with affiliates unless those transactions are on terms no less favourable than would be available for similar transactions with unrelated third parties. The covenants are designed to prevent value from leaking out from the issuer to affiliates that are not subject to the covenants of the indenture.
- Reporting: the reporting covenant is aimed at ensuring the flow of information that high-yield investors need to support trading in the high-yield debt securities, and to monitor the performance of the issuer.
- Mergers and consolidations: the merger and consolidation covenant is designed to prevent a business combination in which the surviving obligor for the high-yield debt securities is not financially healthy, as measured by a ratio test. The covenant also seeks to ensure that noteholders will have enforceable rights against the surviving entity in a merger, consolidation or transfer of all or substantially all the assets of the issuer or a subsidiary guarantor.
- Future guarantors: the future guarantors covenant is designed to make sure that if a subsidiary of the issuer is guaranteeing other debt, the noteholders get the benefit of that guarantee. As a result, the common formulation is that if a restricted subsidiary guarantees the bank facility of the issuer, that entity will guarantee the high-yield debt securities as well. In addition, if the issuer decides to issue new high-yield debt securities, the guarantor package will be the same across both tranches of securities.
- Change of control: the change of control covenant requires that the issuer purchase the high-yield debt securities from noteholders at a price equal to 101 per cent plus accrued interest if a ‘change of control’ of the issuer takes place. The change of control ‘put’ right is a defining feature of high-yield debt securities.
Note that for covenants appearing highly restrictive, there is a set of baskets and exceptions giving the issuer the flexibility it needs to operate its business and grow over the life of the high-yield debt securities. The exceptions are limitless and they are highly negotiated.
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?
As mentioned above, any tightening or loosening of covenants typically tracks the overall market or the particular industry. In the past couple of years or so, there have been more instances of covenants being changed between the launch and the pricing of an offering. As investors get more selective and as investors have more time to digest a particular covenant package, there are likely to be more changes to it. Sometimes, the changes can be fairly benign, such as reducing a particular basket size or tweaking a particular definition. At times, however, the change can be more drastic, such as the wholesale introduction of a new covenant.
Are there particular covenants that are looser or tighter, based on a particular industry sector?
The energy sector is a good example of an industry sector with looser covenants. Typically, the formation of a joint venture will trip the restricted payments covenant discussed above. Most high-yield covenant packages will have some kind of a basket specific to joint ventures that will allow an issuer to make investments in joint ventures up to a certain dollar threshold. As these structures are the backbone of the energy industry, however, there is a separate exception referred to as the ‘permitted business investment’ exception. This exception simply allows the issuer to make unlimited investments as long as it is the kind of investment that is customary or is becoming customary in the energy sector. As the sector has revived following the prolonged downturn, however, there have been increased instances of investors demanding tighter covenants.
Change of control
Do changes of control, asset sales or similar typically trigger any prepayment requirements?
As discussed in question 9, a change of control typically requires the issuer to offer to prepay the bonds at 101 per cent plus accrued interest.
Asset sales only trigger a prepayment obligation at par plus accrued interest if the issuer does not use the asset sale proceeds in a manner permitted by the asset sale covenant (ie, reinvest in the business or pay down debt).
If an issuer is unable to apply the net proceeds of an asset sale in the manner and in the time allowed under the covenant, it must then make an offer to acquire the bonds at par plus accrued interest once the excess proceeds reach a negotiated threshold.
If the offer is oversubscribed, then the issuer must purchase the bonds on a pro-rata basis. If the offer is undersubscribed, then the issuer can use the remainder for general corporate purposes, and the excess proceeds amount is reset to zero.
Do you see the inclusion of ‘double trigger’ change of control provisions tied to a ratings downgrade?
A double-trigger change of control put option has slowly crept into some high-yield debt securities from the investment grade world in recent years. In a double-trigger change of control put, the put is triggered only if there is both a change of control and a ratings downgrade from one or more rating agencies within a specified period following the announcement of a transaction that will be a change of control.
The double-trigger concept in effect shifts to rating agencies the determination as to whether the change of control is positive for investors. Rather than permitting individual noteholders to decide whether to put their securities based on their views of the transaction, the double-trigger provision puts rating agencies in the position of assessing the effect of the transaction on the financial health of the issuer on behalf of investors.
Double-trigger change of control provisions in high-yield offerings are more likely to be encountered for issuers which may be on the cusp of reaching investment grade status, such as issuers with split high-yield or investment grade ratings from the rating agencies. During the past year, however, there have been more instances of investors pushing back on the double-trigger concept and demanding a more standard change of control provision.
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?
Yes. Crossover covenant packages are common for issuers with split high-yield or investment grade ratings from rating agencies as well as for issuers on the cusp of being investment grade. A typical crossover covenant package will be similar to a typical high-yield covenant package except that there is usually only a limitation on secured debt and the covenant is often accompanied by an exception allowing an issuer to secure debt up to a negotiated percentage of its consolidated net tangible assets; there is typically no restricted payments covenant; and the change of control covenant is usually a double trigger.
Describe the disclosure requirements applicable to high-yield debt securities financings. Is there a particular regulatory body that reviews or approves such disclosure requirements?
High-yield debt securities are typically sold on either the public market or the 144A market. Securities sold on the 144A market typically include an obligation to complete a back-end exchange offer, which is an offer to allow holders to exchange the privately placed securities for freely transferable, SEC-registered securities within a specified period after the closing.
The back-end requirement reduces - or can even eliminate - any negative impact on the coupon of the notes from their having been sold as relatively less liquid 144A securities that can only be traded among sophisticated institutions, at least during a specified period. In addition, some buy-side investors operate under investment guidelines that limit the amount of securities they can buy without back-end registration rights.
After the adoption of Sarbanes-Oxley and the related SEC rules and regulations, however, private companies have begun to resist the obligation of back-end exchange offers and are increasingly opting for 144A for-life transactions that do not contemplate registration rights. These companies point to the added burdens of Sarbanes-Oxley and related SEC rules and the resulting increase in expenses. In addition, the number of 144A for-life deals has increased owing to a rise in the number of secured high-yield deals.
The reporting requirements of Rule 3-16 of Regulation S-X (which requires financial statements in SEC-registered deals for certain subsidiaries whose securities are pledged as collateral) are onerous and costly. Indentures for SEC-registered notes must also comply with the Trust Indenture Act of 1939, which imposes extra requirements on issuers of secured notes. Issuers of 144A for-life securities can avoid these complications.
To offer the securities on a registered basis, the issuer must meet the disclosure requirements set forth by the SEC, predominantly Regulation S-K, which governs what needs to be included regarding the description of the business, risks and trends, among others; and Regulation S-X, which governs what needs to be included in terms of financial statements. While a 144A deal with back-end exchange rights or a 144A for-life deal requires no SEC filing or approval at the time of issuing, in practice, the disclosure requirements are substantially similar, with certain caveats.
For example, a registered deal requires executive compensation information, which is burdensome and costly to put together. Most people take the position in a 144A deal that such information is not material to debt investors and, as a result, it is rarely included in the offering document.
Overall, however, the disclosure requirements applicable to a 144A deal as compared with a registered deal are the same. The key difference is execution and timing. Since a 144A deal is not subject to SEC review, it enables issuers to access the market more quickly and efficiently.
Use of proceeds
Are there any limitations on the use of proceeds from an issuance of high-yield securities by an issuer?
None, other than in violation of any anti-terrorism, anti-money laundering or similar laws.
Restrictions on investment
On what grounds, if any, could an investor be precluded from investing in high-yield securities?
As noted in question 15, most high-yield debt securities are issued on a 144A basis. Rule 144A under the Securities Act of 1933 allows private resales to qualified institutional buyers. Such securities are also often concurrently sold to non-US investors pursuant to Regulation S under the Securities Act of 1933. As a result, the type of distribution used for selling the securities will dictate the types of investors permitted to participate in the offering.
Are there any particular closing mechanics in your jurisdiction that an issuer of high-yield debt securities should be aware of?
Closing mechanics in the United States are fairly uniform but can be complicated. In addition, in cross-border transactions or if securities are issued in a non-US dollar denomination, settlement will be increasingly more complicated. For a typical high-yield issuance, as noted earlier, once the securities are priced, they are actively trading and then they typically settle in three business days.
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?
The most common high-yield structure is to have an issuer with upstream guarantees from its subsidiaries. In certain instances where the issuer may not be the topco entity, there may be a downstream guarantee too. Most often, the guarantee structure will mimic the bank finance structure.
In general, unsecured guarantees are limited only by fraudulent conveyance issues. Under US federal bankruptcy law, the incurrence of indebtedness, the guarantee thereof or the grant of a security interest in collateral could be avoided as a fraudulent transfer or conveyance if the issuer or guarantor (i) incurred the indebtedness or guarantees with the intent of hindering, delaying or defrauding creditors; or (ii) received less than the reasonably equivalent value or fair consideration in return and, in the case of (ii) only, one of the following is also true at the time thereof:
- the issuer or any guarantor was insolvent or rendered insolvent by reason of the incurrence of the indebtedness or the guarantee;
- the incurrence of the indebtedness or the guarantee left the issuer or the guarantor with an unreasonably small amount of capital or assets to carry on its business;
- the issuer or guarantor intended to, or believed that it would, incur debts beyond its ability to pay as they mature; or
- the issuer or guarantor was a defendant in an action for money damages, or had a judgment for money damages docketed against it if, in either case, the judgment is unsatisfied after final judgment.
In addition, there are limitations associated with foreign guarantees. First, the provision of a guarantee by a foreign entity of the obligations of a US issuer can have serious economic consequences for the issuer. Under the US tax code, income earned abroad by companies that are organised abroad is generally not taxed by the US. If, however, the assets of such company provide credit support for obligations of a US affiliate, then the undistributed earnings and profits of the foreign entity may be deemed repatriated to the United States and become subject to US taxation as a dividend.
As a result, in the US market, issuers are typically not expected to take such a risk and guarantees from foreign subsidiaries are not commonly required. While the 2017 tax reform bill allows companies to repatriate foreign earnings back into the United States, there are still certain limitations in place that would encourage domestic issuers not to obtain guarantees from foreign subsidiaries. That may change in the future but, at this point in 2018, the structures have remained the same.
What is the typical collateral package for high-yield debt securities in your jurisdiction?
Collateral that is typically used as security falls into two general categories: real property and personal property. Real property is governed by the law of the state in which the property is located and a security interest in real property can be granted pursuant to a mortgage or similar agreement. The creation of security interests in most types of personal property are governed by the Uniform Commercial Code (UCC), a form of which has been enacted in each state. Security interests in such personal property governed by the UCC can be granted pursuant to a single security agreement and perfected, subject to certain exceptions, by the filing of financial statements describing the collateral in the jurisdiction of organisation of the party granting the security interest.
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?
See question 20.
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?
There is no single typical collateral structure in the US. It is certainly common to see crossing lien deals between high-yield debt securities and bank agreements, but that is not the only structure. Typically, lenders take a first lien in the hard assets and the bonds get a first lien on personal property. Then the lenders would take a second lien on the personal property and the bonds would get a second lien on the hard assets. It is also possible for secured bonds to rank pari passu with the bank debt. In addition, while uncommon, there are deals where the bonds obtain a second lien on all of the collateral.
Who typically bears the costs of legal expenses related to security interests?
While the underwriters generally pay underwriters’ counsel for their legal expenses, the costs of legal expenses related to security interests are generally paid by the issuer. In the United States, borrowers typically pay the legal expenses associated with counsel to the lenders and, since the work related to security interests is really more akin to a credit agreement, it is customary for issuers to pay for the legal expenses of counsel to the underwriters for such work.
How are security interests recorded? Is there a public register?
Similar to the creation of the security interest, the UCC governs the perfection of a security interest in most types of personal property. Perfection occurs through:
- the filing of UCC financing statements with the relevant state office;
- the filing of intellectual property security agreements with the relevant federal office;
- the execution of control agreements with respect to cash and cash equivalents held in a depositary bank, or in certain circumstances, with a securities intermediary;
- the possession or delivery of certain personal property;
- the recording of mortgages with the relevant state office; and
- other filings or actions in the case of other special category assets.
How are security interests typically enforced in the high-yield context?
There is no real distinction between high-yield debt securities and other debt in terms of enforcing security interests. A secured noteholder that forecloses on collateral outside the bankruptcy process generally takes that collateral subject to any other potential liabilities against which the collateral is subject.
Typically, on the filing of a petition for bankruptcy reorganisation (a Chapter 11 proceeding) or liquidation (a Chapter 7 proceeding) under Title 11 of the US Bankruptcy Code, an automatic stay arises, which prohibits all collection and enforcement efforts, subject to certain exceptions for the right to close out most securities and financial contracts, criminal proceedings and the exercise of regulatory powers.
Generally, all interest accruals stop as of the petition date, unless a debtor is solvent and covenants are not enforceable once a petition is filed. Under certain circumstances, a secured noteholder may be able to obtain relief from the automatic stay to enforce remedies against collateral.
Debt seniority and intercreditor arrangements
Ranking of high-yield debt
How does high-yield debt rank in relation to other creditor interests?
There is no distinction between high-yield debt securities and other debt in terms of ranking, and it depends on the capital structure of the company. In general, the high-yield debt securities rank equally in right of payment with any existing and future senior debt, are effectively subordinated to all secured debt to the extent of the value of the collateral and are senior in right of payment to any existing and future subordinated debt.
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?
This depends on the structure and the answer to question 22. In general, each tranche of debt has its representative. For example, noteholders are represented by a trustee, which will sign the intercreditor agreement; and the bank lenders are represented by the administrative agent, which will sign the intercreditor agreement.
Typically, control resides with the party that holds the most senior piece of debt or, if the different tranches of debt rank pari passu, then, typically, voting and control will reside with the biggest tranche of debt.
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?
Generally, in the United States, interest should be deductible in accordance with the issuer’s method of accounting. Interest expense on indebtedness issued with original issue discount is deductible on a constant yield to maturity basis, even if the issuer is on a cash method of accounting.
There are many interest deduction rules with which a US issuer may require guidance. In addition, one special consideration for the high-yield market is the application of the high-yield discount obligations (AHYDO) rules. If a debt obligation is issued with original issue discount and the AHYDO rules apply, a portion of the interest expense may be deductible only when paid in cash and, as a result, a portion may be permanently non-deductible.
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?
No, a typical high-yield transaction does not require issuers to obtain a tax ruling in connection with the issuance. In certain circumstances, however, relating to tax-free spin-offs and the issuance of high-yield debt securities in connection therewith, a tax ruling may be required or desired by the issuer.
Update and trends
Update and trends
Updates and trends
The emerging trend in the high-yield market is the return of volatility into the markets. Investors have become spooked by the looming recession, rising interest rates, worries about inflation, among others. We have also seen the market retreat after President Trump imposed tariffs on steel and aluminum. As a result, issuers will have to be mindful that if a window opens up, they should get in because otherwise they might be shut out for a while because of the volatile market.