Germany: New levels of sophistication

Author: | Published: 1 Jun 2011
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Over the last year, the debt markets in Germany have benefited from the overall market recovery. Activity has picked up significantly compared to the depth of the financial crisis in 2008 and 2009. There have been some significant recent developments in leveraged loan and bond deals which are discussed below along with a comparison of current deal structures with pre-crisis structures.

Interestingly enough, this short time span of increasing activity has already witnessed the plethora of the commercial and structural parameters shifting towards a borrower-friendly environment. This applies both to interest rates offered in competitive bidding situations as well as to equity ratios requested from private equity sponsors. From a structural perspective, the most important change is that the markets for leveraged loans, high yield bonds and equity issues are no longer distinct: cutting edge deals combine these products in innovative ways and thereby create a new level of product sophistication in the debt markets.

Leveraged loans

The bidding processes for private equity targets remain highly competitive. Pre-emptive bids, or at least efforts to that effect, seem to be the rule rather than the exception. Lenders are typically required to provide commitments on certain funds terms including an executed interim loan agreement with full satisfaction of conditions precedent. Very few banks are prepared to perform a sole underwriting, and so more often than not a syndicate of underwriters comprising three or four lenders is formed.

The loan documentation usually only provides for two facilities, A and B, thereby increasing the amortising element and an early reduction of lending risk. Equity ratios started off with a solid 50% but have been seen to come down already. Lenders continue to place high importance on the financial covenant package. The practicability of business cases, headrooms and equity cures are subject to intense negotiations and - in contrast to recent developments in the US and London markets - the introduction of covenant light structures to the German market is not on the horizon.

A further interesting structural element is the discussion around the so-called double LuxCo structure. The recent restructuring phase has shown that there are certain legal hurdles to overcome in a successful enforcement of a share pledge agreement governed by German law. Firstly, the enforcement of the pledge can only be commenced after the secured claim has become due and payable. However, an acceleration of the secured claim arguably triggers the 21-day period within which management must file for insolvency, likely resulting in a destruction in value. Secondly, an enforcement can only be implemented by way of a public auction and not, as in Luxembourg for example, a private sale.

Therefore, there was a train of thought amongst advisers that new deals would likely be set up with Luxembourg holding companies in order to improve the enforcement options for lenders. This has, however, not become the general rule. Perhaps market participants take sufficient comfort from recent enforcement cases such as Tele Columbus, primacom and Walter Services where the public auction route was initiated. This resulted in sufficient pressure on the owners/pledgors to hand over the keys for more or less symbolic amounts.

Finally, the choice of which law should govern the financial documentation and place of jurisdiction seems to be of ever-growing importance. In the days of Schefenacker, the shift of centre of main interest (COMI) was the secret ingredient required to change jurisdiction from Germany to England so as to benefit from legal instruments such as schemes of arrangement afforded under English law. Recently, in cases such as Tele Columbus and Rodenstock (both being companies incorporated and operating in Germany), the English courts exercised their jurisdiction to sanction schemes of arrangement primarily on the basis of English law-governed finance documentation expressed to be subject to the exclusive jurisdiction of the English courts. However, it remains to be seen whether such schemes of arrangement without the merits of COMI will be recognised in the non-English jurisdictions. A case on this question is pending at the German Supreme Court.

Combined bank/bond structures

The high-yield bond market has been very active in Germany over the last months. Companies are making use of the large investor appetite in the debt capital markets and the reduced volatility of interest expenses. This has led to at least two innovative features for bonds which, in times past, were used as an unsecured and structurally subordinated debt instrument in addition to existing secured bank facilities. Recently, however, bonds have been used as a take-out mechanism to replace the secured bank loans. This resulted in a structure combining a senior secured bond and a remaining revolving credit facility which sometimes ranks pari passu with the bonds or, with respect to distribution of proceeds on enforcement of collateral, even super-senior. This structure entails intense negotiations of intercreditor issues such as control over enforcement and consultation rights of bondholders.

Another, even more sophisticated, structure has evolved by invoking the clause on structural adjustments which is contained in most standard leveraged buyout transaction documents. This clause provides that by a super-majority senior lender decision (usually 85 or 90%) an additional senior secured facility can be implemented into the existing structure. When the clause was invented, the rationale was that either existing members of the syndicate or new bank lenders would be the lenders providing the commitments for the new facility. In today's world with its propitious debt capital markets, corporates such as Kion, Ziggo and Xella came up with a slightly different concept.

The debt volumes allowed for by the structural adjustment clause were not provided by bank loans but rather by special purpose vehicles which acted as issuers of high yield bonds. The proceeds that were raised by the bond issuance were used to fund respective new facilities under the existing financial documentation. Again, this has led to innovative provisions governing the intercreditor relationship between bondholders (as indirect members of the syndicate through the interposed special purpose vehicle) and the syndicate banks.

About the author

Tom Oliver Schorling is a partner at White & Case and advises banks, corporations and investment funds on international finance transactions.

He specialises in the restructuring of complex finance transactions with a particular focus on insolvency-related matters for financially distressed companies.

He has broad experience in all levels of capital structure, the securitisation of receivables and other structured finance transactions, non-performing loan trading, banking regulatory and capital market law issues.
Contact information

Dr Tom Oliver Schorling

White & Case LLP
Bockenheimer Landstraße 20
60323 Frankfurt am Main

t: +49 69 29994 1569