Striking a Balance: European High Yield April Wrap-Up by Covenant Review

The European high yield market enjoyed a much needed break over the Easter holidays, but by the end of the month volumes had accelerated to a breakneck pace. The increasing cost of debt brought to market a slew of opportunistic refinancing transactions as issuers sought to lock in lower rates. The month also featured much-awaited LBO financings, and the promise of future M&A activity in the months to come. The sheer volume of deals facilitated diligent resistance by European high yield investors against precedent-based flexibility, with deal teams now required to justify covenant flexibility with contextual credit stories. By the end of the month, the market seemed to be moving toward a more balanced approach to covenant flexibility as some issuers scaled back aggressive provisions in response to investor feedback, while others were willing to pay for extra flexibility.

On April 10th, debut issuer Aurum launched a Sterling-denominated offering of senior secured notes due 2023 with proceeds earmarked to repay a shareholder loan. The inclusion of an aggressive term that would allow the company to use declined excess proceeds from asset sales to be used for dividends incited a case of déjà vu for Covenant Review lawyers – as we noted in our report on the preliminary terms for Aurum’s bonds, the term had very recently been rejected by the market in Stark Group’s March offering.

We urged investors to resist the off-market dividend capacity and portability provision (which was set inside of opening leverage), and to insist that liberal EBITDA add-backs were capped at some modest amount or 5% - 10% of EBITDA. The final terms contained covenant changes that addressed these points, among others.

Several other issuers came to market the same week with refinancing transactions that ran the gamut from straightforward existing notes redemptions, in the case of Fives and Piaggio, to more complex credit stories like CGG’s refinancing of the first-lien slug of its recently restructured debt load. 

Proceeds of CGG’s $650 million-equivalent first-lien senior secured note offered in dollars and euros would refinance existing first liens that were issued in February as part of CGG’s financial restructuring. We noted in our report on CGG’s first-lien notes that flaws in the Restricted Payments covenant would badly disadvantage prospective first-lien noteholders. While not uncommon for European bonds, the flexibility for the issuer to make payments on existing second-lien notes ahead of first-lien noteholders was a key weakness in the context of the issuer’s new capital structure. The issuer conceded this point and made a number of covenant amendments that we summarized in our report, CGG: Covenant Changes Improve Position of First-Lien Noteholders. 

Fives’ €600 million of senior secured notes due 2025 refinanced the issuer’s existing fixed and floating rate notes, and the terms brought covenant flexibility largely in line with the market, increasing incremental capacity for debt, liens, and restricted payments, swapping total assets for consolidated EBITDA as a metric for growers. Notably, however, the issuer dropped the portability exception to the Change of Control covenant compared to its prior notes.

In contrast, the covenants for Vallourec’s €300 million senior notes refinancing was marketed with virtually identical covenants to its existing 2019s, and the terms of Drax’s $300 million of senior secured notes due 2025 incorporated only modest increases to incremental debt, liens, and restricted payments capacity.

Piaggio’s refinancing of its existing notes due 2021 with a €250 million seven-year maturity senior note comprised a three-part transaction involving the issue of new notes, an exchange offer for existing notes, and an optional redemption for any remaining bonds. Our report on the preliminary terms for Piaggio’s bonds noted a critical flaw in the “Permitted Investments” definition that would allow for uncapped investments in Unrestricted Subsidiaries, a la J. Crew’s infamous trapdoor. Though investors pushed back against the term, the exchange offer element of the transaction was a complicating factor, as incumbent flexibility is notoriously difficult to remove, and the deal priced with no documentary changes.

OCI executed a successful refinancing of its existing term debt and a shareholder loan with a $1 billion equivalent offering of dollar and euro denominated senior secured notes containing significant flexibility as to when it tests ratio and basket capacity in connection with virtually any transaction where there is a time lag between commitment and closing, a provision that has been appearing with greater frequency in this year’s deals.

Proceeds of Lycra’s cross-border offering of senior secured notes financed Shandong Rufi Technology Group’s acquisition of the business. Our report on the preliminary terms for Lycra’s bonds warned investors that, despite being separate series of bonds with different maturities, holders of the euro notes and the dollar notes would generally vote as a single class on amendments. This would allow, for example, the issuers to change or strip the covenants for the euro notes without the consent of any holders of the euro notes just by getting the consent of holders of the dollars. We noted that Virgin Media took exactly this kind of abusive action, which we described in a report published in February 2017.

Just as investors were catching their breath from the onslaught of deals, the week of April 18th brought yet another deluge of issuance across their desks. Gamenet came to market with €225 million of senior secured notes due 2023 to refinance the issuer’s existing 2021s with expanded financial calculation flexibility, significant dividend capacity on day one, and a portability exception that would be available even if the company levered up further from day one leverage. Gestamp and Grupo Antolin also launched refinancing transactions the same week.

Yell brought to market ￡225 million of senior secured notes to refinance existing cash-pay 2021s and partially redeem outstanding PIKs, essentially returning capital to shareholders. We noted in our report that Yell’s bespoke covenant terms, which reflected the post-restructuring posture of the issuer, would allow existing shareholders to increase their holding without triggering a Change of Control and included an unusual excess cash flow sweep as a sweetener to get the deal over the line. The company’s shareholders were wiped out in a debt-for-equity swap back in 2014, but the credit story appealed to some investors as Yell phases out its paper directories for subscription based income from its online presence.

Samsonite launched a debut offering of €300 million of senior notes due 2026 to refinance existing credit facilities. We described the BB+ issuer’s bespoke Restricted Payments flexibility in our report Samsonite Sponsor-Style Restricted Payments Provisions Reflect Varied Approach to BB+ Dividend Flexibility, which noted that covenant protections for BB+ issuers differs widely from deal to deal.

Toward the end of the month, the deals kept coming at a fever pitch, with LBO financings from debut issuer Fedrigoni and the much awaited subordinated bond pieces of the LBO financings for Refresco and Flora Food Group. Market participants following the recent trend of covenant amendments conceded by issuers on the road in response to investor feedback could be left scratching their heads on the outcome for these deals, as Fedrigoni was forced to tighten terms, but Flora Food Group and Refresco got deals away with exceptionally aggressive covenants. 

A key difference was that both Flora Food Group and Refresco allocated jumbo loans last year containing many identical aggressive flexibilities shopped in the bonds, creating a troubling negotiating dynamic for investors in these companies’ high yield bonds. It seems that once the loans process is wrapped, it is often very difficult for investors to dial back flexibility achieved by the issuers in those documents when the bond covenants are drafted to mirror the loans in many respects.

Fedrigoni’s offering of €455 million of senior secured FRNs due 2024 showed yet again that investors are unwilling to accept precedent justified flexibility. The bond covenants included a “Bain-special” provision that would allow the issuer to convert asset sale proceeds into dividend capacity, a concept rejected in several deals this year. We urged investors to query whether the flexibility contemplated specific asset disposals. The arrangers cited precedent – in this case, Bain portfolio company ICBPI’s PIK toggle notes.

Investors rejected the precedent justification and many made orders conditional on removal of the provision, in addition to citing serious concerns over the loosely drafted portability clause. Both terms were removed from the final covenants of Fedrigoni’s deal.

On the last day of the month, Nexi (ICBPI rebranded) launched a deal that will test investors’ mettle on precedent-justified changes – except in this case, the precedent comes from the PIK toggle notes being refinanced. As we've seen, incumbent flexibility is difficult to shift, but shouldn’t be intractable, and we published a Market Alert urging investors to resist the flexibility in that deal – which coincidentally features two very aggressive provisions that Fedrigoni was forced to ditch just last week.

Market dynamics are driving a more balanced negotiation over pricing and documentary terms. As a result, the precedent argument holds far less weight in the current market, and issuers considering launching deals in the coming weeks would be wise to avoid including flexibility that might seem “market” based on a data-driven precedent search, but don’t reflect genuine business needs. Investors are querying unreasonable, precedent-justified covenant provisions, and in several cases this month, have proven that they are willing to walk away from deals attempting to include covenants that bear no relation to the context of the credit.

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