European High Yield Bond Market: Recent Trends in High Yield Bond Portability in Europe

High yield bonds have become a standard fixture in leveraged and acquisition financings for European sponsors and corporates alike.  Increased liquidity coupled with the undersupply of M&A opportunities have resulted in (among other things) the re-emergence and increased use of "portability" features in European high yield bonds, especially in the context of sponsor-led transactions.  For example, between 2015 and 2016, out of the 224 European high yield deals that we surveyed, 66 (or 29.5%) had portability. Whereas from January 2017 to date, out of the 248 European high yield transactions that we surveyed, 100 (or 40.0%) had portability. In particular, out of the 248 European high yield deals that we surveyed from January 2017 to date, 87 were sponsor-led, with 53 (or 61%) having portability, whereas out of the 161 corporate issuers, only 47 (29.0%) had portability.

See below statistics from January 2017 to date on the inclusion of portability in sponsor-led vs corporate transactions, and a breakdown of the types of portability formulation used (leverage- vs ratings-based).

What is portability

The change of control feature in high yield bonds (as well as other forms of financing) is there to provide investors with the opportunity to reassess their investment in the event new ownership takes control of the credit.  A typical high yield bond indenture would provide that, if an issuer consummates a transaction that triggers a change of control (which is a defined term that is often carefully negotiated especially in sponsor-led deals and family-owned corporates), the issuer is obliged to make an offer to buy back its bonds from investors at a purchase price of 101% of the face value of the bonds (known as the "change of control put option"). At that point, an investor can opt to exit the investment by putting its bonds back to the issuer at 101% or stay in the credit. A decision to "put" the bonds is therefore usually influenced by whether such bonds are trading at a discount or below 101% or not.

With portability, an issuer can be sold without triggering the change of control put option, and therefore the high yield bond can be "ported" over to the new equity owner, if certain criteria are met (for example, as will be discussed in more detail below, where the change of control will not cause a pre-agreed leverage ratio to be exceeded or the credit rating of the bond (or the issuer) to decline below the existing rating or a pre-set rating).  The benefit for the sponsor and/or corporate issuer in this circumstance is that it permits the seller to sell the asset without having to worry about the buyer having to refinance or pay back outstanding debt, thereby realizing the actual value of the asset.

Where did this come from

Ziggo was the first European issuer to include leverage-based portability in its debut high yield bond issuance in 2010. Pursuant to the Ziggo bond documentation, the issuer did not have to make an offer to buy back the bonds in the event of a change of control if, in connection with the change of control, the issuer's consolidated leverage ratio would not exceed 5.0x (or 4.5x after the first year; meaning that the issuer would have to de-lever at least 0.5x in order to use portability after the first year). The market accepted this feature and the success of Ziggo paved the way for other high yield issuers to also consider including portability in their bonds.

Based on European high yield transactions with portability that we surveyed, the leverage-based portability formulation historically has been more prevalent (representing approximately 60% ), with the remainder being a ratings-based formulation (which is more common in investment grade bonds). But recently, high yield issuers with better credit ratings are increasingly opting for a ratings-based formulation, while those issuers adopting a leverage-based formulation have begun setting the trigger level at or close to opening leverage (with therefore little to no requirement to first de-lever before portability can be used).

The two major types of portability formulations are discussed in more detail below.

Leverage-Based Portability

Leverage-based portability allows the issuer to undergo a change of control transaction without triggering the change of control put at 101%, as long as a certain leverage test is met after giving pro forma effect to the change of control transaction.  This is a feature that is particularly important for private-equity sponsored issuers, where an exit strategy during the lifetime of the bonds is often contemplated.

Once it is agreed that a deal will be marketed with leverage-based portability, negotiations around the provision focus primarily on the following points:

1. Leverage level: The main point of discussion is the appropriate level of leverage to be set for the portability test. In particular how close it will be set to the opening leverage (such that portability is essentially available out of the gate, versus requiring the issuer to de-lever before being able to exercise its portability feature). The general trend (with some exceptions) has been for the portability leverage level to edge closer and closer to the opening leverage. The most recent example for this is Wizink's €515 million senior secured PIK toggle notes (July 2018), where the portability leverage was set at 2.5x, i.e., at opening leverage, therefore making portability immediately available.

2. Leverage level step-down: This feature may be advocated by the underwriters if the issuer's overall credit story has a de-leveraging trajectory. The initial leverage level for the purposes of the portability test would be set at a certain level, which would decrease over time (usually within 12-24 months of closing, with one or two step-downs). This formulation is designed to permit the issuer to use the portability feature at a later date if it sufficiently de-levers. A recent example of this feature is found in Refresco's €445 million senior notes (April 2018).

3. One time use/multiple use: Historically leverage-based portability was limited to one time use only; however, more deals have been appearing in the last 18 months in which there is no limitation on the number of times portability can be used, as long as the pro forma leverage test is met. Some examples of deals which allow for multiple uses of portability can be found in ContourGlobal's €540 million senior secured notes and €300 million senior secured notes (July 2018) and Flora Food Group's €685 million senior notes and $525 million senior notes (April 2018).

Ratings-Based Portability

Ratings-based portability allows the issuer to consummate a change of control transaction without triggering the change of control put at 101%, provided the rating agency(ies) have not downgraded the bonds as a result of such change of control (or within a set period of time of such change of control). 

In contrast to the leverage-based portability, ratings-based portability is typically found in corporate (non-private equity sponsored) deals (with a recent exception of Neptune Energy's $550 million senior notes (May 2018), where the issuer is owned by a consortium consisting of CIC, Carlyle and CVC).

Historically, ratings-based portability was largely found in investment grade and emerging market deals for bigger corporations and in the US, but was very rarely seen in the European high yield transactions.  However, this trend seems to be changing, and the provision is quickly gaining ground in Europe.  Of all European deals with portability in 2018 (to date), almost half had ratings-based portability (whereas even last year this percentage was much lower, at less than 30%).

Below are the most important drafting variations around the ratings trigger that have been appearing in the market:

1. Ratings Decline Period: This is the reference period within which a ratings downgrade would have to occur in order for the change of control put to be triggered. It usually ranges between 30 days (e.g., Teekay Offshore's $700 million senior notes (June 2018)) and 6 months (e.g., Tata Steel's $300 million notes and $1,000 million notes (January 2018)) from the public announcement or consummation of the change of control transaction. Some deals also provide that the ratings decline period is to be extended for up to an additional 90 days if a rating agency is considering a downgrade (e.g., Nexans' €325 million senior notes (July 2018), Smurfit Kappa's €600 million senior notes (June 2018)).

2. Confirmation by the rating agency(ies) in writing that the downgrade resulted from a change of control (and not other factors): This is perhaps one of the more issuer-favorable formulations, as it removes the risk that a ratings downgrade is related to other, non-change of control related factors (e.g., sovereign rating downgrade) that occur during the applicable period. The language of this proviso is usually formulated along the following lines: "a downgrade by one or more gradations (including gradations within rating categories as well as between categories) or withdrawal of the rating of the Notes within the Ratings Decline Period by both Rating Agencies if each such Rating Agency shall have put forth a statement or publicly confirmed that such downgrade or withdrawal is attributable in whole or [to a significant degree][in part] to the applicable Change of Control." Such or similar language can be found, for example, in Darling Ingredients' €515 million senior notes (April 2018) and Hertz's €500 million senior notes (March 2018).

3. Downgrade by at least one rating agency/by both rating agencies: Most high yield bonds are rated by at least two major rating agencies. While the ratings decline trigger is usually tied to a downgrade or rating withdrawal by at least one/either of the rating agencies (see, e.g. InterXion's €1,000 million senior notes (June 2018)), sometimes the issuer is able to negotiate a more favorable formulation whereby the change of control is triggered only if there is a ratings downgrade or withdrawal by both of the rating agencies that have rated the bonds (see, e.g., Darling Ingredients' €515 million senior notes (April 2018)).

Thus far we have not seen investors expressing strong pushback on portability (as they once did when it first emerged), nor have any recent uses of portability by high yield issuers caused any major contention with bondholders. However, as with most relatively aggressive features in high yield bonds (such as 10%@103 redemptions, 40% equity claws, starter restricted payment baskets etc.), we believe the prevalence of portability will continue to ebb and flow in correlation with broader supply/demand dynamics in the market.