2017 saw the entrenchment of provisions that were deemed aggressive by the market at their initial introduction (e.g. “limited condition acquisition” flexibility being applied to the portability ratio test). These are now becoming commonplace in this precedent led market.
Given the ever-increasing prevalence of “standard aggressive terms” Debt Explained has introduced in 2018 the first ever data and market related scoring system for high yield bond covenants - Aggressive Covenant Terms Scoring (ACTS). For more details about ACTS please click here.
Flexible Ratio Calculations
In 2017, Debt Explained noted the following ways in which Issuers built in greater flexibility in calculating ratios:
- uncapped EBITDA add-backs;
- pro forma adjustments for cost savings and synergies;
- different application of those adjustments across ratios;
- expansion of the application of limited condition acquisition calculations; and
- carving out types of debt from the leverage test or secured debt in secured leverage ratio calculations.
Expansion of Flexibility Typically Allowed for “Limited Condition Acquisitions”
In 2017, the use of Limited Condition Acquisition (LCA) type flexibility in ratio calculations became almost standard fare in European high yield deals and, as noted in 2016, continued to expand beyond limited condition acquisitions (i.e. acquisitions for which financing has been secured and the acquisition documents would not allow the acquirer to exit the deal on the basis of “no financing” available”).
This flexibility allows ratio compliance, determination of basket availability and/or the “no default/event of default” condition to be tested on the date of the acquisition agreement, rather than the date the deal actually closes, allowing the Issuer to preserve covenant compliance at the date of documentation signing against any deterioration that may occur subsequent to signing (and exist at closing).
In addition, the transactions to which this flexibility applies now go beyond “acquisitions” to investments (even if financing has not been secured for such investment), any debt or lien incurrence, Restricted Payments and the portability test.
- 45% of 2017 deals contained LCA-type flexibility in any form compared to 16% of 2016 deals.
- 38% of 2017 deals that contained the LCA-type flexibility extended it beyond Limited Condition Acquisitions, compared to 13% of 2016 deals.
- 30% of 2017 deals that contained the LCA-type flexibility also extended it to portability ratio test, the compared to 13% of 2016 deals.
A Contribution Debt basket, where new “equity” permits incurrence of additional debt by reference to the amount of such new “equity”, has become standard in European high yield deals. The most protective formulation limits incurrence of such debt to the Issuer/Guarantors on a 1:1 basis for net cash proceeds received from equity or subordinated shareholder debt issuance. This is now being eroded by allowing Non-Guarantor Restricted Subsidiaries' incurrence of such debt. Very aggressive deals allow a 2:1 ratio that increases leverage risk.
These risks are further exacerbated by provisions that only prevent the new “equity cushion” which generates the new debt capacity for the debt’s incurrence from being extracted through a limited number of Restricted Payments baskets, including the CNI build-up basket.
- 38% of deals in 2017 with a Contribution Debt basket limited incurrence of such debt to the Issuer or Guarantors, compared to 49% in 2016.
- 5 deals in 2017 allowed such incurrence on a 2:1 basis, compared to only 2 deals in 2016. None of these deals in both 2017 and 2016 allowed NGRS to incur Contribution Debt.
- 62% of deals with the Contribution Debt basket allowed NGRS to incur Contribution Debt, five (9%) of which included some sort of cap. In 2016, 48% of deals with this basket allowed incurrence by NGRS, only four (16%) of which included some kind of a cap.
- Of the deals that had a Contribution Debt basket, 72% allowed such debt to be secured on the noteholders’ collateral on a pari passu basis, as compared to 55% in 2016. See below under “Subordination and Dilution” for increased dilution risk for this basket.
- 66% of 2017 senior secured deals allowed Contribution Debt to be secured pari passu on the noteholders’ collateral without being subject to a secured leverage test, compared with 39% in 2016.
Ratio Capped Restricted Payments Basket
The inclusion of a Restricted Payments basket allowing an Issuer to make payments from the restricted group if it can meet a leverage ratio has now become standard in the European high yield market.
There is a trend where payments made from the ratio-based basket do not reduce capacity under the CNI build-up basket, amounting to a “double dip” for Issuers; the CNI build-up basket can be used no matter the leverage at the time so long as the ratio debt basket (FCCR-based) would be available for incurrence pro forma, generally subject to no default or event of default. The more aggressive deals have set the leverage ratio above or close to the Issuer’s opening leverage so that this basket can be used at issuance or that substantive de-leveraging is not required before payments can be made to sponsors. In addition, 2017 saw a few deals dropping the “no default continuing” condition for the payment to be allowed, narrowing it to a “no event of default continuing” condition although this change can best be described as commercially immaterial.
About This Report
This report refers to data drawn from Debt Explained’s Market Maker database which tracks information from deals launched in the European high yield bond market.
The report is based on those deals which were in the market during 2017, and as indicated, and which were reviewed by Debt Explained during this period and no distinction is made between deals with different governing laws unless otherwise stated. All data was drawn from Debt Explained’s Market Maker or ACTS databases on 24 January, 2018.
Debt Explained’s Market Maker and Representative Loan Terms databases offer unique oversight of the European high yield bond and leveraged loan markets, each with an extensive number of searchable terms. The Aggressive Covenant Terms Scoring (ACTS) database shows individual scores for over 600 past high yield deals – all calculated using the same proprietary scoring system. A staple resource for all leveraged finance market participants – including capital markets bankers, legal advisors and asset managers – Debt Explained data reacts to the market in real time: subscribers receive ACTS scores followed by detailed deal snapshots on new issues as information is released to the market.
About Debt Explained
Debt Explained is a leveraged finance data firm and the only independent provider of High Yield Bond and Leverage Loan Legal Analysis in the European Market. In addition to storing data and analyses in custom, searchable databases, the company sends out timely and finely-tuned deal data and “snapshots” following the activity of the primary and secondary markets.
Debt Explained was founded in 2009 by Stephen Mostyn-Williams, previously a Senior Partner at four international law firms and the chair and co-founder of the European High Yield Association. It is staffed by experts in Capital Markets and Financial law with extensive experience in new issuance, corporate advisory work and restructurings. We pride ourselves on hiring extremely experienced professionals, as we know the level of expertise that is required to put deals together. As a consequence we only hire experts with at least 10 years legal experience in capital markets or financial law and with deep knowledge of our product areas.
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