The covenants defining Europe’s HY surge

Author: Danielle Myles | Published: 15 Nov 2013
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  • Sponsors’ focus on borrower-friendly covenants has moved from portability to greater flexibility in incurring acquisition financing debt and paying dividends;
  • This month has seen some sponsors seek fully underwritten floating rate note bridges;
  • 2013’s record-break volumes, including the surge in payment-in-kind bonds, has sparked fears about releveraging;
  • Following last week’s 15-year deal by Germany’s Unitymedia, more longer-dated high-yield bonds are expected from crossover issuers.

European sponsors are looking beyond portability when negotiating borrower-friendly covenants into high-yield documentation, further bifurcating the private equity (PE) and corporate deal structures.

While the structural standardisation that has accompanied this year’s record-breaking high-yield volumes signals a maturing market, there are concerns about the combination of growing leverage and covenant lite lending.

The portability feature, which permits issuers to waive bondholders’ change of control rights, has become the hallmark of this year’s buoyant market. But deals over the last few weeks have seen PE-owned issuers’ focus shift to rights they are more likely to exercise.

"There are some more recent features that sponsors consider more important than portability," said Jeanette Cruz, partner at Allen & Overy, speaking at the Association for Financial Markets in Europe’s High Yield Conference on Wednesday.

Some financial sponsors are obtaining greater flexibility in incurring and securing acquisition financing debt, she said, as well as obtaining getting greater leeway in their ability to pay dividends.

"I think those are some of the more aggressive features we have seen in sponsor deals," said Cruz.

Further reading

High-yield portability becomes more aggressive

Are investor protections in European high-yield being eroded?

It’s in the post: bondholders seek greater rights against SCF

Sponsor interest in floating rate notes (FRNs), issuance of which surged earlier this year, has continued. The instruments’ shorter non-call periods and lack of maintenance covenants are a major draw.

Just this month sponsors have taken a more aggressive approach to these instruments. In the context of acquisition finance, Cruz said sponsors have wanted fully underwritten FRN bridges.

While there’s been considerable focus on covenants becoming more aggressive throughout the year, panellists stressed that the basic matrix of covenant packages does not substantially change from deal-to-deal.

While leverage levels and other measures are a point of differentiation, European deal structures have standardised compared to two years ago.

"What has changed is consistency. You see much more stability of terms now, which is a sign of a stronger and deeper market," said panellist Tim Peterson, partner at Milbank Tweed Hadley & McCloy.

A good example is bondholders’ stronger voting rights as against senior credit facilities, which the buyside community lobbied strongly for during 2011 and 2012.

Volume and risks

Year-to-date issuance has already made 2013 a record-breaking year for European high-yield, with volumes hitting €78 billion ($105 billion).

Investors’ global hunt for yield has been a primary driver.

"To the extent these instruments are coming from some of Europe’s good credit stories, it certainly makes a lot of sense – including because of the policy environment – that excess and fungible savings from around the world are trying to find assets and have made their way to Europe," said panellist Edward Eyerman, head of European leveraged finance at Fitch.

He said the greater riskiness seen in the 2013 market has really been on the instrument side, with a little migration on the issuer quality side.

But it’s the macro changes created by these structural shifts, along with the growing payment-in-kind bond issuances to fund dividend recapitalisations and repay shareholder loans, which are of greatest concern.

"The big disconnect, which we haven’t heard a lot about today, is that leverage is growing and terms are becoming more issuer friendly," said Eyerman. "It is as if these companies are generating a lot of cash and deleveraging – and we know that is not the case for most."

As competition among capital providers towards good credits becomes even more intense, more covenant lite and leveraged structures should be expected.

Longer tenors

This year’s more flexible and aggressive covenants have not, by and large, extended to corporate issuers. And another distinction between the two classes of issuer is tenor.

While sponsors have favoured the shorter call periods offered by FRNs, investors believe there ought to be more demand for long-term high-yield paper issued by crossover corporates.

Ten years is typically the longest tenor in high-yield markets. But last week’s 15-year high-yield bond issued by German cable company Unitymedia has sparked speculation that more longer-dated bonds might be in the pipeline.

"If anything, I’m surprised that we haven’t seen more of this sort of thing," said panellist Aengus McMahon, senior credit analyst at ING.

"If you are a corporate treasurer, you need money long-term and you need to try to ensure that you are not constantly relying on markets," he added. "Obviously rates are low and they won’t stay this low forever."

Michael Marsh, Goldman Sachs’s head of EMEA high yield, agreed the market could see a lengthening of tenors. "I’m not sure it is for every issuer… but there is no reason why companies rising into the investment grade world shouldn’t be enjoying longer tenors, to," he said.

He didn’t expect 15-year maturities to catch on so quickly, but said more deals in the 12-year and 15-year space by crossover companies are possible.

See also:

High-yield portability becomes more aggressive

Are investor protections in European high-yield being eroded?

It’s in the post: bondholders seek greater rights against SCF