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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?
Typically, Finnish high-yield debt is fixed rate with bullet maturity (ie, the principal matures on the final maturity date) whereas bank loans are typically divided into amortising term loan A and non-amortising term loan B. Most of the covenants in high-yield instruments are incurrence-based, meaning that they are only tested when the issuer takes affirmative action, such as incurring new debt. In bank financing, covenants are typically maintenance-based and automatically tested on agreed testing dates.
Therefore, with high-yield debt, the issuer typically has a higher degree of control over the covenants and when they are tested. In short, the benefits of a high-yield bond are bullet maturity and more issuer-friendly covenants. By contrast, the main disadvantage is that obtaining amendments and waivers from high-yield creditors is more difficult.
Are you seeing increased regulation regarding either high-yield debt securities or bank loans in your jurisdiction?
The liquidity and capital requirements of the Basel III and CRD IV packages are increasing the regulatory burden for banks and therefore make lending more challenging.
In addition, new legislation concerning the role of agents entered into force in September 2017. The purpose of the new legislation is to clarify the authority of the agent to act on behalf of the bondholders as well as how the agency actions are controlled. We believe that the development of regulation is likely to make high-yield bonds even more attractive in the future.
Current market activity
Describe the current market activity and trends in your jurisdiction relating to high-yield debt securities financings.
The energy, building and construction and real estate sectors in particular have been active during the past few years in various types of bond issuances (the high-yield market was quite active in 2017); however, we saw some acquisition-related high-yield issuances. Combinations of high-yield bonds and super senior working capital facilities sharing the same security package were seen in 2017 more frequently than before.
The high-yield (or non-investment grade) bond market from a Finnish corporate issuer’s perspective can be roughly divided into two separate markets: the European/international high-yield bond market and the domestic/Nordic high-yield bond market, of which the latter is significantly more active. In general, the total amount issued under any given bond issue in a European/international high-yield context is bigger, the documentation follows international standards and the governing law of the main finance documents is typically New York (or, in certain cases, English).
The high-yield issuances governed by Finnish law may vary from close to investment grade credit to junk bond with the majority of issuances in the higher end of the credit spectrum. Depending on the quality of the credit, it may be secured or guaranteed. On average, Finnish high-yield bonds are of higher credit quality compared with those issued in other Nordic markets. At the higher end of the credit spectrum, however, investment grade style documentation is frequently used.
There is growing interest in investing in bonds. Finnish pension funds have been active investors on both the loan and the bond side, but the investor base has expanded steadily over the past few years. In addition, the Finnish state-owned financing company Finnvera currently has a mandate to invest in bonds.
Identify the main participants in a high-yield debt financing in your jurisdiction and outline their roles and fees.
Bonds governed by Finnish law are usually arranged by a bank or financial adviser and are not underwritten. The arranger is responsible for arranging the bond, including pre-sounding of the investors, investor meetings and bookbuilding. The arrangement fee is typically based on the bond proceeds and there might be success fee elements based on the pricing. Generally, the fee varies from 0.5 per cent to 3.5 per cent of the bond proceeds, even though the highest credit quality high-yield issuers may pay fees below that range.
The notes are registered to Euroclear Finland and, typically, one of the arrangers also acts as issue agent and coordinates the registration of the notes into Euroclear. Out-of-pocket costs are paid by the issuer.
The bondholders are usually represented by the agent and in such case no bondholder is allowed to take any unilateral action against the issuer. There are two established participants in Finland providing agency services: Nordic Trustee and Intertrust. The fee is typically an annual fee and any additional actions, for example bondholders’ meeting arrangements, are invoiced separately.
Describe any new trends as they relate to the covenant package, structure, regulatory review or other aspects of high-yield debt securities.
We are likely to see more fallen-angel corporate issuers entering the high-yield space as they are likely to receive quite light covenant packages. Another interesting discussion topic is whether it remains necessary to have a proper red-herring listing prospectus of Nordic high-yield bonds or whether lighter documentation would be sufficient for marketing purposes. Many bankers and issuers think that the time it takes to access the markets is too long, because the bonds are usually sold by utilising a red-herring listing prospectus as an offering memorandum. The prevailing shortage in the demand for high-yield bonds has created the trend of covenant packages becoming less restrictive along with the wider European market, and the majority of Finnish issuances can be described as ‘covenant light’.
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?
The documentation prepared for the purposes of domestic/Nordic issues is usually governed by Finnish law and the bond terms are based on model bond documentation introduced in 2014 by the Confederation of Finnish Industries (EK) and the Advisory Board of Listed Companies (the EK Model Terms). The use of the EK Model Terms is standard in today’s domestic/Nordic market and, for the purposes of this type of bond issue, the main question from an issuer’s and investor’s perspective is whether the credit in question is strong enough to issue under investment grade documentation or whether the EK Model Terms will be required by the relevant investors. In general, strong ‘implied BB’ credits tend to issue bonds by using investment-grade style documentation, while ‘implied B’ and below credits tend to use the EK Model Terms. However, the practice among the weaker BB credits is more varied.
The EK Model Terms are used in a variety of different structures, including senior secured bonds, senior unsecured guaranteed bonds and senior unsecured and unguaranteed bonds. The terms included in the EK Model Terms are, in many ways, similar to bond terms in use in other Nordic countries (not least because other Nordic countries were benchmarked in connection with the preparation of the EK Model Terms).
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.
The typical maturity of a domestic/Nordic high-yield bond ranges from three to five years. The call structure is rather standardised in that a non-call period of 24 or 30 months is included, after which a prepayment premium, which decreases with time (eg, every six or 12 months), is applicable in the case of a redemption prior to maturity. However, the higher credit quality high-yield issuers using investment-grade style documentation generally do not have call option structures included in their bonds.
High-yield bonds are usually issued at par, although it is not entirely uncommon to see issues with an original issue discount. Other than the discussed call structure and other standard prepayment provisions (such as upon a change of control), no particular yield protection provisions are usually included.
How are high-yield debt securities offerings launched, priced and closed? How are coupons determined? Do you typically see fixed or floating rates?
It is common for domestic high-yield bonds to have fixed interest rates but a few transactions have included a floating rate interest (namely three-month EURIBOR plus margin) with zero floor.
Coupons are typically determined in a bookbuilding process where the arranger takes offers from the investors in respect of margin and amount.
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?
The main covenants restricting the operation of the debtor vary from transaction to transaction. In corporate issues at the higher end of the non-investment grade spectrum, the main covenants would typically include incurrence-based financial indebtedness and distribution covenants and relatively relaxed negative pledge and disposal restrictions. At the riskier end of the domestic high-yield bond market, the covenants can be extremely restrictive (similar to those included in a typical leveraged bank financing - for instance, prohibiting, in effect, all additional indebtedness other than possibly a tap issue and limited working capital financing required by the debtor).
As a main rule, the financial covenants included in a domestic high-yield bond issue are incurrence-based, although it is not unheard of to include maintenance covenants. This inclusion of incurrence-based financial covenants, as opposed to maintenance-based financial covenants, remains one of the main differentiating factors between the domestic high-yield bond market and the bank loan market (where, in the case of the latter, the financial covenants are always maintenance-based).
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?
The abundance of liquidity in the financing market has not affected high-yield bond terms, at least not at the lower end of the credit spectrum. One of the reasons for this could be that such debtors (or the reasons for procuring financing) may entail risk to such a degree that rather tight restraints are justifiable and also that such debtors lack an alternative source of funding (such as bank financing). As regards changes to covenants and other terms of the issue from launch to pricing, this happens from time to time, at least with respect to weaker credits.
For the stronger credits, this is not usually the case. In the current market, the higher-quality high-yield issuers get away with covenant-lite documentation and financial covenants are very rare.
Are there particular covenants that are looser or tighter, based on a particular industry sector?
Industry sector as such does not have a direct impact on covenant terms. Naturally, certain industry sectors may be more appealing to investors than others but this does not directly impact covenant terms. In general, covenant requirements tend to be greatest in the real estate sector bonds, where one would normally expect to see up to three financial covenants (eg, solvency ratio, secured solvency ratio and interest cover ratio) due to heavy dependence on funding.
Change of control
Do changes of control, asset sales or similar typically trigger any prepayment requirements?
As a general rule, a change of control always triggers the right of each investor to demand prepayment. Portability is a feature that is not usually included in domestic issues. As regards disposals, the position varies between strict restrictions on disposals on the one hand and, on the other, looser restrictions on disposals coupled with an obligation to discharge debt (whether the respective high-yield or some other debt) with the proceeds of disposal (which may be subject to a reinvestment right).
Do you see the inclusion of ‘double trigger’ change of control provisions tied to a ratings downgrade?
‘Double trigger’ change of control provisions tied to a ratings downgrade are not included in domestic high-yield bond documentation. In this context, it is good to bear in mind that neither domestic bonds, nor the issuers, are usually rated by an international rating agency.
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?
There is no established concept of a crossover covenant package for Finnish issuers who are on the verge of being investment grade. That said, as stated earlier, it is rare for domestic issuers to have a rating from an international ratings agency (or for any given bond issue to be rated). One could argue, however, that the larger, non-investment grade corporates that issue unsecured bonds under the EK Model Terms (or investment-grade documentation) have relatively relaxed covenant packages compared with the high-yield proper issuers at the lower end of the ratings spectrum.
From such perspective, one could take the view that although there is no concept of a crossover covenant package, these do exist and are in fact quite common. One of the main differences between the covenant packages of the high-yield issuers at the upper end of the credit spectrum compared with those at the lower end relates to the incurrence of additional debt, which, in the case of the issuers at the higher end, is tied to satisfaction of an incurrence test (if any); whereas in the case of the issuers at the lower end, incurring additional financial indebtedness may not be permitted at all.
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 Finnish Securities Markets Act (746/2012) as amended is essentially aligned with the relevant EU regulation and it applies to securities governed by Finnish law. Typically, domestic bonds are offered so that there is no need to publish a prospectus.
However, there is typically an information memorandum where the issuer and relevant risks are described and that information memorandum is quite often used as a template for the prospectus if the bond is listed at a later stage. In the event of a stock exchange listed issuer, the high-yield bonds are usually also listed and sold on the back of a red-herring listing prospectus.
The Finnish Financial Supervisory Authority must approve prospectuses.
Use of proceeds
Are there any limitations on the use of proceeds from an issuance of high-yield securities by an issuer?
The bond terms typically set out restrictions on the use of proceeds but otherwise there are no restrictions.
Restrictions on investment
On what grounds, if any, could an investor be precluded from investing in high-yield securities?
An investor could be precluded from investing mainly as a result of some internal regulations applicable to investors. In addition, there may be some requirements under the Markets in Financial Investments Directive (2004/39/EC (MiFID)) for the investors to which the arrangers may sell the bond. Obviously, international sales restrictions, such as exemptions from registration under the applicable US, European and UK legislation, will always need to be followed.
Are there any particular closing mechanics in your jurisdiction that an issuer of high-yield debt securities should be aware of?
The settlement mechanism follows the rules and decisions of Euroclear Finland. Certain practicalities can be agreed with the issue agent, Euroclear and the issuer.
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?
Depending on the credit in question and the corporate structure of the issuer, subsidiary guarantees are sometimes used in connection with high-yield deals. Usually, guarantees are given as directly enforceable guarantees under which the guarantor is liable for the principal debt in the same way as an obligor is personally liable for such debt.
A guarantee is typically issued in separate guarantee documentation and not as a part of the high-yield terms and conditions. However, it is usual that the terms and conditions address the need for additional guarantees from material companies in the future.
The upstream guarantees issued by Finnish subsidiaries are typically subject to applicable restrictions set out in the Finnish Companies Act (624/2006) regulating financial assistance and unlawful distribution of assets.
What is the typical collateral package for high-yield debt securities in your jurisdiction?
The typical security package depends on the credit, business and corporate structure of the issuer. Often the security package consists of a pledge over the shares in material subsidiaries of the issuer and in the issuer and certain intragroup receivables as well as business mortgages.
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?
There are no specific limitations on granting security for high-yield securities, although there are general restrictions set out in the Finnish Companies Act. Pursuant to the Act, any legal and other acts of a limited company should be taken for the corporate benefit of the company. The obligations of Finnish companies under the relevant agreements are subject to the requirement of receiving sufficient corporate and commercial benefit from the transactions. If the amount of financial benefit received from a transaction were considered to be insufficient compared with the obligations the company assumes, the transaction could be declared invalid or null and void by a competent court. Further, and without limiting the generality of the foregoing, the enforceability of obligations under any guarantee or security interest granted by a Finnish company could be limited up to the amount of financial benefit received.
In addition, the Finnish Companies Act stipulates that a Finnish limited company may not provide security for the purpose of a third party acquiring shares in the company or its parent company. In practice, this means in terms of acquisition financing that a target cannot provide a guarantee or grant security to any third-party lender to the extent the funds borrowed are used towards financing of the acquisition of the shares in the target company (or any direct or indirect parent company of the target).
If a company were to breach the aforementioned financial assistance rules, the transaction could be considered null and void or as constituting unlawful distribution of assets. In the latter instance, the recipient of the security could be obliged to return part or all of the assets. Further, criminal sanctions or compensation for damages could be awarded.
Due to these restrictions, subsidiary guarantees and security granted for the high-yield debt is typically subject to limitation language.
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?
If the bank debt and high-yield debt sit in the same structure with the same ranking or super senior arrangement, it is quite common that there is a shared security package meaning that the ranking and distribution of proceeds are typically agreed in the intercreditor agreement.
Who typically bears the costs of legal expenses related to security interests?
Typically, all costs relating to the security are paid by the issuer.
How are security interests recorded? Is there a public register?
Business mortgages and real estate mortgages as well as pledges over intellectual property rights are registered in public registers. As regards other types of security interests, no public register exists.
How are security interests typically enforced in the high-yield context?
We have not yet seen security interests being enforced in the high-yield context. However, enforcement is generally dependent on the type of security asset being enforced.
Debt seniority and intercreditor arrangements
Ranking of high-yield debt
How does high-yield debt rank in relation to other creditor interests?
There are different types of high-yield issuances. The riskier high-yield issuances are typically secured and therefore better positioned compared with other non-secured issuances.
Without any structural or contractual arrangement, the high-yield debt ranks as any other debt not preferred by law.
There have also been some Finnish high-yield issuers with super senior working capital facilities where the high-yield debt ranks behind the super senior debt in the payment waterfall.
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?
The international issuances follow international standards but there is no settled market position covering domestic issuances, and voting and control issues are typically heavily negotiated depending on the credit and the amount of bank debt in comparison with bond debt. If there is a considerably small amount of bank debt compared with the bond debt, the bond creditors usually control the enforcement process but the bank creditors (if they are in a super senior position) enjoy value protection.
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?
In general, interest expenses are tax-deductible for corporate tax purposes provided that the securities have been issued for business purposes. However, the deductibility of related-party interest expenses is limited.
Interest expenses may become non-deductible if the net interest expenses exceed 25 per cent of the company’s adjusted business profits (ie, taxable business profits adjusted with the aggregate amount of interest costs, depreciations, losses and change in value of financial assets and group contributions received, deducted with the amount of group contributions paid) and if the annual net interest expenses exceed €500,000.
Only related-party interest expenses are affected by the limitations. However, third-party loans may be deemed related-party loans if a related party pledges a receivable to an unrelated party as security for the loan and the unrelated party provides a loan to another related party, or the loan from an unrelated party is de facto a back-to-back loan from a related party.
Nevertheless, the interest expenses will remain fully deductible if the equity ratio of the company is equal to or higher than the consolidated equity ratio of the group. The regulation allows an indefinite carry forward of non-deductible interest expenses and deduction of such interest expenses, provided that the limitations are not exceeded.
There are no special tax considerations for the high-yield market in relation to deductibility of interest expenses.
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?
There is no general need for issuers to obtain a tax ruling in connection with the issuance of high-yield bonds. However, full certainty on, for example, deductibility of interest expenses in unconventional structures can only be obtained through an advance ruling issued by the tax authorities.