The trend of more issuer-friendly covenants in European High Yield Bonds (HYBs) has continued, particularly over the past six months. Here is a quick summary of the key changes to the covenant package we have noticed.
Change of Control: Portability
At the end of 2015 and into early 2016, investors pushed back against portability in change of control provisions, particularly in non-sponsored deals. Since the referendum on Brexit, owing in part to exit considerations for owners of issuers and general uncertainty, issuers have inserted leverage-based portability back into most issues of HYBs (e.g. SISAL, Lecta, and IDH). To make the leverage test easier to satisfy, portability is sometimes being tested on the commitment date, rather than on the closing date, of the acquisition (e.g. IDH). BB/Cross-over type issuers continue to align themselves with investment grade issuers and base portability on ratings rather than on leverage (e.g. Rexel).
Optional Redemption: Equity claw back
The specified percentage of HYBs that issuers can redeem during the non-call period using proceeds from 'Equity Offerings' has continued to increase from 35% to more frequently 40%, and even recently 45% (e.g. Loxam). The definition of 'Equity Offerings' has also been drafted more broadly to include 'other securities offering', including potentially debt offerings. These two developments make it easier for issuers to be in a position to re-finance during the non-call period a large portion of their debt at lower interest rates.
Transactions with Affiliates
To protect bondholders against value-leakage from the issuer's group due to transactions with non-affiliates, issuers have traditionally needed to satisfy two requirements: first, pass a board resolution stating that in the directors' bona fide belief the transaction is at arm's length; and second, if the transaction is over a certain value, obtain a fairness opinion from an independent third party, usually a bank. In Europe recently, following the US market and particularly in sponsor led transactions, this second requirement has started to disappear from the covenants. However, we noticed some push back from investors in a few recent corporate transactions.
Soft-capped baskets / growers
Soft-capped baskets and asset growers are becoming increasingly common place throughout the terms and conditions. A reference to total assets is favoured by investors, whilst EBITDA is preferred by issuers. These growers are now fairly common in general debt baskets (they also appear in general permitted payment baskets and in certain definitions such as asset sales).
Cost savings / synergies / add-backs in EBITDA definition
Projected costs savings and add-backs have, in some cases recently, been allowed up to a cap of 15% of consolidated EBITDA for the 12 month period (less so 18 months but, in the case of FNAC the cap was not limited to a time period) following an acquisition or implementation of a restructuring initiative (e.g. Swissport), as determined in good faith by a relevant accounting or financial officer.
Asset Sale Covenant
This covenant has been subjected to increasingly aggressive carve-outs. Excluded assets are being more widely defined and include in some cases the inventory of significant subsidiaries. The de minimis baskets have also continued to grow.
Leverage-based payment baskets
Leverage-based payment carve outs have become prevalent with them ranging from 0.5x to 6x net debt to EBITDA, with an average of 3.5x. Furthermore, in a few instances, as part of the build-up basket, the date at which the consolidated net income basket is set has crept back to dates before the HYBs were actually issued so that this basket was already sizeable at the date of issuance.
In a few instances, sponsors' management fees are excluded from the ambit of restricted payments but are still subject to restrictions/scrutiny under the Transactions with Affiliates covenant.
Market Abuse Regulation (MAR)
Issuers are choosing the Channel Islands (being outside the reach of MAR) for listing their HYBs over Ireland and Luxembourg to avoid MAR's increased disclosure and compliance obligations (including insider lists and related training, closed trading periods for Persons Discharging Managerial Responsibilities, and specified procedures for market soundings, to name a few).