European High Yield Bond Market: Spotlight on Sectors 

HY Bonds – Spotlight on Sectors

Given Ashurst's particularly strong industry teams, we wanted to focus this issue of our quarterly update on certain sectors that have been prolific in the European high yield bond market in H1 2017 and to highlight certain discerning features of the high yield bonds in such industries. The sectors discussed in this issue are TMT, Oil & Gas and Financial Services.

TMT

TMT historically has been one of the early adopters of the high yield bonds as a source of funding, and this industry remains one of the largest issuers by volume, with many repeat issuers regularly (sometimes several times a year) tapping the high yield market for their financing needs. This is the field dominated by such behemoth issuers as Virgin Media and Liberty Global just to name a few. As the industry continues growing and consolidating, and given the telecoms' long and proven record of bond issuances, the TMT issuers generally enjoy favourable terms and wide covenant flexibility, as compared to the issuers in other industries. This is true even for the smaller players in the market, and even for lower-rated (Salt (Matterhorn), Caa1/CCC+; Play, Caa1/B-) and distressed issuers (Avanti Communications, Ca), whereas issuers with such ratings in other sectors typically would have a hard time placing their bonds on even very conservative terms. Another example is VimpelCom, which enjoys an investment grade covenant package (i.e. no covenants other than a negative pledge) despite its B1 rating.

Some of the recent (H1 2017) TMT high yield deals include: Avanti Communications Group plc $292.8 million 10%/15% senior secured PIK notes and $481.6 million 12%/17.5% senior secured PIK notes (EMEA); Helios Towers Africa $600 million 9.125% senior notes (Africa); SALT (Matterhorn Telecom S.A.) €525 million floating rate senior secured notes and €117 million 4.875% senior notes (Switzerland); Play Topco S.A. €500 million 5 3/8%/ 6 1/8% senior PIK toggle notes (Poland); VEON (VimpelCom Holdings B.V.) $600 million 3.95% senior notes and $900 million 4.95% senior notes (global); UPC Holding B.V. €635 million 3 7⁄8% senior notes (Europe); Intelsat Jackson Holdings S.A. $1,500 million 9.750% senior notes (global).

A few highlights of the terms of the recent TMT deals include:

• CLR debt test: perhaps the single most distinctive feature of the TMT high yield deals is that the ability to incur "ratio debt" in the TMT industry historically is measured by reference to the consolidated leverage ratio (or consolidated net leverage ratio) (i.e., debt divided by cash flow or EBITDA) in the range of 4.5x-5.5x. Note that a standard for all other high yield bonds is a 2x fixed charge coverage ratio (i.e., EBITDA divided by fixed charges) test. The CLR test became customary in TMT as it is a highly capitalized industry, and it may be difficult for the issuers to meet the FCCR test in the earlier stages of their development.
• Very large baskets: One of the most dramatic examples is Intelsat Jackson's $1,500 million 9.750% senior notes, where the size of the credit facility basket is 1000% of opening EBITDA, and each of the capital lease basket and the general debt basket is at 110% of opening EBITDA.
• Guarantees: A large percentage of the high yield bonds in the TMT sector are not guaranteed by opcos (for example, Play, VimpelCom, UPC and Intelsat Jackson).
• Equity clawback: Equity clawback percentage for the industry is firmly at 40%.

Oil & Gas

The Oil & Gas industry presents an array of perhaps the most geographically diverse issuers, and has probably the highest percentage of the emerging markets issuers (often from the Middle East, North Africa, Nigeria and the CIS). Because of the variety of jurisdictions involved, the terms of the bonds tend to vary quite a bit as well, and certain very bespoke terms can be found in this market. Nevertheless, some trends emerge. As a general matter, the issuers tend to have higher EBITDA(X) and Total Assets than issuers in other industries, and tend to be less levered (the long-term oil price dip notwithstanding). Despite that, the covenants in the O&G deals are generally more conservative than average, probably due to the oil price volatility and geopolitical risks faced by some of the issuers.

Some of the representative recent oil & gas high yield deals include Corral Petroleum Holdings AB (Preem AB) €570 million 11.75%/13.250% senior PIK toggle notes and SEK500 million 12.255%/13.750% senior PIK toggle notes (Sweden); DEA Finance SA €400 million 7.5% senior notes (Germany); KCA Deutag UK Finance plc $535 million 9.875% senior secured notes (Scotland) and Motor Oil (Hellas) €350 million 3.250% senior notes (Greece).

A few peculiarities of the O&G high yield deals to highlight:

• The use of EBITDAX as a metric of performance: Earnings Before Interest, Taxes, Depreciation, Amortizations and Exploration Expenses - this is a variant of EBITDA commonly used in the oil and gas industry to measure performance.
• Grower baskets: These tend to be based on a percentage of Total Assets. While grower baskets based on a percentage of EBITDA are generally considered more issuer-friendly, for this industry baskets based on a percentage of Total Assets make more sense because these issuers tend to be asset-heavy and the value of the assets tend to be rather stable, while their EBITDA depends heavily on the oil prices, which may be volatile.
• Maturity, non-call periods: The oil & gas issuers tend to be fairly disciplined in this respect, with the average tenor for the bonds hovering around five years, and the non-call period at around half of the tenor.
• Portability: While this concept is making a comeback in 2017 in the European high yield space, it is yet to make much headway in this industry. Leverage-based portability is unheard of, though several of the larger public issues do have the ratings decline trigger in the
  definition of the "Change of Control".
• Ratio debt test: The standard test for incurrence of ratio debt in the high yield bonds is 2x FCCR (though see an exception for the TMT bonds described above). In this area, the oil & gas issuers tend to be subject to a more conservative 2.25x FCCR test (and an additional senior secured leverage ratio test, if such ratio debt is to be secured).
• Contribution debt: There is still no contribution debt basket in the majority of the oil & gas deals (though it is making an appearance in the most recent deals), while this basket has become almost a norm in some other sectors.
• Sponsor management fees: There is no addback and no restricted payment carve-out for sponsor management fees (primarily a reflection of a small number of private equity sponsor-backed deals in this sector).
• Sector-specific permitted investments: Often uncapped business investments (JVs) in oil & gas businesses are permitted, as well as investments in community development projects and economic development activities.

Financial Services

This industry is a relatively recent entrant into the European high yield markets, but has been getting increasingly visible over the last several years, probably due to the consolidation of the industry and corresponding concentration of market share. Note for instance the amalgamation of GFKL (the German receivables management business) with Lowell (the UK debt purchasing and collections business) and the acquisition of Marlin by Cabot (both UK-based). Other significant financial services high yield market players are Arrow Global (UK) and Lindorff (Norway). One of the surprising trends in this sector is the strength and the number of recent financial services issuers from the UK. There has been half a dozen of financial services high yield bonds issued out of the UK since the beginning of 2017.

Some of the recent (H1 2017) financial services deals include AMIGO Luxembourg S.A. £275 million 7.625% senior secured notes (UK); New Day (Nemean Bondco plc) £275 million 7 3⁄8% senior secured notes and £150 million senior secured floating rate notes (UK); ICBPI (Mercury Bondco plc) €600 million 7.125% senior secured fixed rate PIK toggle notes (Italy); Together (Jerrold FinCo plc) £200 million 6.125% senior secured notes (UK); Arrow Global €400 million senior secured floating rate notes (EURIBOR + 2.875%) (UK); Travelex Financing plc €360 million 8% senior secured notes (UK); KIRS Group (KIRS Midco 3 plc) £400 million 8.375% senior secured notes and $520 million 8.625% senior secured notes (UK).

Some of the peculiarities of the high yield deals in the financial services sector worth highlighting include:

• Guarantees: Bonds in the financial services sector tend to have high guarantor coverage (in terms of the proportion of total assets and consolidated EBITDA represented by subsidiary guarantors), and the guarantors tend to be incorporated in jurisdictions with minimal thin cap and financial assistance concerns. The Lindorff notes even contain a guarantor coverage maintenance requirement (not to fall below 80% of EBITDA and gross assets), which is unusual for high bonds which are meant to only have incurrence based covenants (not maintenance).
• Consolidated Senior Secured Gearing Ratio: This is a ratio sometimes used in the industry instead of the senior secured leverage ratio test (for the ratio debt permitted to be secured), and it is calculated as a ratio of secured, non-securitization financial indebtedness to the non-securitization secured property loans held by the group.
• Grower baskets: Grower baskets are sometimes calculated as a percentage of ERC ("estimated remaining gross" collections), rather than as a percentage of Total Assets or EBITDA, as is customary in other industries. ERC represents an estimate of the anticipated future cash collections on the group’s purchased debt portfolios and other overdue receivables at any point in time and is considered to be a key metric reflecting the cash generation capacity of the assets backing the relevant business.
• Sector-specific permitted debt basket: Indebtedness represented by the unpaid purchase price for underlying portfolio assets and indebtedness incurred by a Permitted Purchase Obligations SPV to finance or refinance the acquisition of portfolio assets is often permitted (included on a secured basis). Permitted Purchase Obligations are defined as debt of the Permitted Purchase Obligations SPVs that meet certain criteria, including that the SPVs must be wholly owned restricted subsidiaries set up to finance the purchase of debt portfolios and that the Permitted Purchase Obligations are non-recourse to the issuer and the rest of the restricted group.

HY Bonds – Documentary Update: Expansion of the “Limited Condition Acquisition”

The previous issue of our newsletter focused on the recent developments in the European high yield covenant terms. The trends described in that issue still held in Q2.

The one additional trend worth noting separately is the continuing expansion of the "Limited Condition Acquisition" concept, which allows the issuer, in connection with acquisitions that are not conditioned upon the availability of third-party financing (the "Limited Condition Acquisitions"), to determine availability under baskets and ratios at the time of signing of the purchase agreement (giving pro forma effect to the acquisition and including the target's EBITDA in all subsequent calculations) rather than at the time the acquisition is consummated. This flexibility was initially introduced so that a buyer in an acquisition could bolster its position by stating its offer to buy is not conditional on obtaining third party debt. While the use of such optionality for the Limited Condition Acquisitions has become relatively common, the new frontier has now become allowing such election to be made in pro forma calculations for any acquisition (even if conditional on obtaining third party finance) or any Investment, and even in the portability ratio test (the latter so far being found in only two deals, Prestigebidco (Schustermann & Borenstein) €260 million 6.250% senior secured notes and New Day (Nemean Bondco plc) £275 million 7 3⁄8% senior secured notes and £150 million senior secured floating rate notes). This is a trend to watch.