high yield update - q1, 2019 21 Mar 2019 European High Yield Bond Market 2019 - Spotlight on Spain

In this article, we discuss the decade-old Spanish High Yield Market and its future prospects. We then analyse the structural features and terms of recent Spanish High Yield Bond Issuances, and how they differ from the broader European High Yield Market. Finally, we outline certain Spanish law considerations with respect to Spanish High Yield Bonds (as New York law-governed instruments issued by Spanish companies and marketed in the international capital markets).

A Decade of Spanish High Yield

This year marks the tenth anniversary of the first Spanish high yield deal (Abengoa's Senior Notes issued in November 2009).  Since that first issuance, the Spanish high yield market has significantly matured and has become a large, predictable source of funding for Spanish companies.  The main distinguishing features of this market are its stability and consistency, even in light of recent global and regional economic downturns.

More specifically, Spanish high yield volumes have been remarkably steady over the last decade despite fluctuations in the country’s economic outlook during this time, with six or seven Spanish public offerings of high yield debt consistently coming to market each year – with 2013 being a notable year that produced ten successful public high yield debt offerings. In each of 2018 and 2017, the total volume of public high yield issuances in Spain stood at almost EUR 4 billion (accounting for approximately 5.6% of all European high yield issuances).¹

We believe that the Spanish high yield market will continue to grow at a steady pace, and its share in the European high yield market will continue to increase. There are several factors informing this belief: Spain’s better economic outlook, improving returns from corporate bonds relative to government securities and the continuing pursuit for yield by investors. Moreover, we are seeing that the resurgent Spanish economy, a buoyant leveraged finance market, the imminent conclusion of several high-profile Spanish restructurings (namely, Abengoa and Codere), together with aggressive cost competition at Spanish banks in search for deals, are currently creating significant activity in the market.

From the perspective of investors, Spain’s relatively low credit rating can play to their advantage and boost their returns: many solid Spanish companies are categorically downgraded to sub-investment grade due to sovereign risk, resulting in higher-priced debt than they would other have been able to command had they been domiciled in a higher-rated jurisdiction such as France.

On the other hand, Spanish companies have become more active in the last decade, not only with respect to issuing high yield bonds, but with respect to fundraising in the capital markets in general. Taught a tough lesson on the scarcity of traditional sources of bank financing during the global financial crisis, Spanish companies have been focusing more on diversifying their sources of capital with high yield bonds emerging as an attractive and now familiar long-term component of their capital structures.

Spanish Bonds - Features and Terms 

Over a dozen high yield bonds were completed in the Spanish market in the 24-month period between the end of Q1 2017 and the first two months of 2019.  The following observations can be made about these transactions:

Market Conditions/Marketing Process

When comparing Spanish high yield bonds issued in 2017 to those issued in 2018, it is apparent that there are significant differences between their terms and their reception in the market. Such differences are not unique to Spain but rather reflective of the changes in the broader European and global market conditions over the course of 2017-18. 2017 had record levels of activity in the European high yield market (both in terms of volume and in issuances), characterized by tight pricing and covenant loosening. Exceptionally strong investor appetite in 2017 meant that virtually every deal brought to the market was oversubscribed with little investor push back on aggressive terms. As an example, in September 2017, the Spanish retailer Cortefiel (now Tendam) issued EUR 600 million of notes split between fixed and floating rate tranches, with both tranches receiving an enthusiastic reception in the market, pricing tighter than official price talk. The non-call period on the fixed rate tranche was reverse flexed by one year to non-call two. In contrast, the second half of 2018 saw a significant tapering in both the European high yield and leveraged loan markets in terms of volume and issuances, even though the year started off strongly. Increasing market scrutiny on deal quality led to longer marketing periods and tightening of the deal terms. One example of a Spanish deal that received strong investor pushback and which finally cleared the market on modified terms was Cirsa, priced in June 2018 with at least eight material documentary changes in between the preliminary offering memorandum and the final offering memorandum (some of which are described under Covenant terms below). Also, Aldesa's hope of capitalizing on a buoyant market to lower its cost of capital was dashed when market soundings unexpectedly indicated higher pricing than the company's outstanding bonds.

Active Local Players

Although international banks that are well-recognized in the high yield space (such as Morgan Stanley, Deutsche Bank, Goldman Sachs and J.P. Morgan) continue to lead the majority of high yield transactions in Spain, Spanish national banks such as BBVA, Santander, Banca March, Banco Sabadell, BANKIA, Bankinter, CaixaBank have generally been playing a more active role in the Spanish high yield market compared to other national banks in their local jurisdictions. In Spain, high yield bond investors are typically investment banks, pension funds, hedge funds, mutual funds, insurance companies and private wealth management accounts, while loan financing is still almost exclusively provided by the traditional banking sector. Direct lending by other players, such as investment managers and hedge funds, is still in the early stages of development, although consistently growing over the last 24 months. The consolidation in the Spanish banking sector during the downturn coupled with the strong relationships Spanish banks have with Spanish corporates have led to increased activity of the Spanish banks.

Issuer Characteristics 

More corporate than sponsor-backed
The majority of Spanish high yield issuers are family-owned (or otherwise closely held), such as Grupo Antolin, Naviera Armas and Aldesa, with only a handful of issuers being sponsor-backed (such as Cortefiel (CVC and PAI), Haya (Cerberus), Cirsa (Blackstone) and Allfunds (Hellman & Friedman)).

Wide range of sizes
Issuer size in terms of EBITDA varies from as low as EUR 56m EBITDA (Aldesa) to as high as EUR 1.3bn EBITDA (Grifols); with bond issue sizes varying from EUR 250 million (Grupo Antolin EUR 250 million 3.375% Senior Secured Notes due 2026 (May 2018)) to EUR 1 billion (Grifols EUR 1,000 million 3.200% Senior Notes due 2025 (April 2017)).

Modest leverage
The lowest reported opening leverage is 1.95x (Grupo Antolin), and the highest reported leverage is 6.3x (Empark).  The majority of issuers (with the sole exception of Empark) fall comfortably below the 5x threshold.

Diverse sectors/industries
Unlike some jurisdictions where one or two sectors dominate the high yield market, Spain's high yield market is fairly diverse in terms of sectors, including automotive, transportation, healthcare, construction, hotel, energy and gaming.  Over the last 24 months, Spanish issuances involved issuers from healthcare, retail, infrastructure, transportation, construction, with the most active sector being financial services (represented by three issuers: Allfunds, Haya and Wizink).

Structural Trends

FRNs
Over the last 24 months, 5 tranches of floating rate notes were issued in Spain (Cortefiel (n/k/a Tendam) EUR 325 million Floating Rate (EURIBOR +5.250%) Senior Secured Notes due 2024 (September 2017); Empark EUR 125 million Floating Rate (EURIBOR +2.750%) Notes due 2023; Naviera Armas EUR 300 million Floating Rate (EURIBOR +4.250%) Senior Secured Notes due 2024 (November 2017); Haya Finance EUR 225 million Floating Rate (EURIBOR +5.125%) Senior Secured Notes due 2022 (November 2017); Cirsa EUR 425 million Floating Rate (EURIBOR +5.750%) Senior Secured Notes due 2023 (June 2018)). We believe that this increasing trend of FRN issuances is linked to investor anticipation of interest rate rises (thereby driving demand) and increasing attractiveness to issuers of shorter non-call periods (typically one year) which offer more refinancing flexibility, as compared to the longer non-call periods of the fixed rate notes (which can be as long as half the tenor of the bonds and in any event not shorter than two years).

PIK Notes
Two PIK Toggle deals (Allfunds EUR 575 million 4.125% / 4.875% Senior Secured PIK Toggle Notes due 2024 (July 2017) and Wizink EUR 515 million 6.500% / 7.250% Senior Secured PIK Toggle Notes due 2023 (July 2018)) came to market in Spain in the last 24 months.  Holdco PIK note structures are generally considered to be more aggressive and less protective of the bondholders, as they are often not supported by guaranties/security from the operating entities, are structurally subordinated, and allow the issuer to avoid paying interest in cash (instead interest is added to the principal amount of the bonds, to be repaid at a later date).  That such deals attracted enough investor appetite is a testament to the strength and flexibility of the Spanish high yield market. 

Covenant Terms²

As a general observation, Spanish deals tend to have less permissive/more conservative terms as compared to the broader European high yield market (and to their Italian counterparts in particular). This may be due to the lower percentage of sponsor-backed deals (as private equity sponsors usually push for more aggressive terms), as well as the prevalence of single-B credits. Below is an overview of the prevalence of what one would typically consider to be aggressive terms in Spanish high yield bonds issued over the last 24 months:

10% at 103
Although this is becoming more common in the broader European high yield market, only about a third of recent Spanish deals have this partial redemption feature whereby the issuer can redeem up to 10% of the bonds at 103% each year.

Portability
While portability (an ability to consummate a change of control transaction without triggering a change of control put at 101% if certain conditions are met) is making a comeback in the rest of Europe, in Spain it is found in only some recent deals (in each case, in the form of a consolidated net leverage-based portability test rather than a ratings-based portability test). In at least one case (Cirsa EUR 425 million Floating Rate (EURIBOR +5.750%) Senior Secured Notes due 2023, EUR 663 million 6.250% Senior Secured Notes due 2023 and USD 550 million 7.875% Senior Secured Notes due 2023 (June 2018)), portability was removed during the marketing process. The main reason this feature is not often seen in Spanish deals is the prevalence of issuances by corporates or family-owned issuers compared to sponsor-backed issuances. Double-trigger change of control provisions are seen more often in European high-yield issuances for private equity transactions, because portability is more important for private equity sponsors focused on exit scenarios than for the non-sponsor-backed issuers.

2.5x FCCR
As a general rule, high yield bonds permit the issuer to incur unlimited "ratio" debt, so long as a pro forma fixed charge coverage ratio (FCCR) of at least 2.0x is met.  In some Spanish deals, the FCCR level for ratio debt is set at a tighter 2.5x (e.g., Grupo Antolin EUR 250 million 3.375% Senior Secured Notes due 2026 (May 2018), Gestamp EUR 400 million 3.250% Senior Secured Notes due 2026 (May 2018)), which is rare in other markets.

Basket size
The credit facilities basket in Spanish deals tends to be fairly small. In some cases, it is set as low as less than 20% of the issuer's EBITDA (e.g. Haya Finance EUR 225 million Floating Rate (EURIBOR +5.125%) Senior Secured Notes due 2022 and EUR 250 million 5.250% Senior Secured Notes due 2022 (November 2017); Aldesa EUR 300 million Senior Secured Notes due 2025 (deal marketed in April 2018 but pulled from the market)); and in most cases it is set at or below 100% of the issuer's EBITDA. The other major debt baskets such as cap leases and the general debt basket are also modestly sized (when calculated as a percentage of the issuer's EBITDA).

Grower baskets
Grower baskets are baskets that are set at the greater of a pre-set monetary threshold and the percentage of the issuer's EBITDA or total assets at the time of calculation (thus they "grow" as the issuer's business grows, but never fall below the minimum monetary threshold). In over half of the recent Spanish deals we reviewed, grower baskets are either entirely absent (e.g. El Corte Ingles EUR 600 million 3.000% Senior Notes due 2024 (September 2018) and Gestamp EUR 400 million 3.250% Senior Secured Notes due 2026 (May 2018)) or are based on a percentage of total assets (compared to the more permissive percentage of EBITDA grower construct seen in other markets) (e.g. Naviera Armas EUR 300 million Floating Rate (EURIBOR +4.250%) Senior Secured Notes due 2024 (November 2017) and Grifols EUR 1,000 million 3.200% Senior Notes due 2025 (April 2017)).

Acquisition debt
Acquisition debt (i.e. debt incurred to finance an acquisition) is not expressly permitted in at least a quarter of the recent Spanish deals we reviewed (though acquisition debt could still be incurred utilizing other baskets such as ratio debt and the general debt basket); whereas in the broader European high yield market, acquisition debt is now generally permitted (subject to the availability of at least EUR 1 of capacity under the ratio debt basket and pro forma FCCR being no worse than prior to the incurrence).

Contribution debt
Contribution debt (which is the ability to incur EUR 1 of debt for every Euro of equity contributed to the group after the bonds have been issued) is only permitted in about two-thirds of the Spanish deals that we reviewed, whereas it has become more prevalent in the broader European high yield market.

RP Builder basket 
The market convention is that the issuer is allowed to make restricted payments (RPs) (i.e. dividends, payments on subordinated debt and investments) utilizing the "builder basket" consisting primarily of 50% of the issuer's Consolidated Net Income (CNI) calculated on a rolling basis. An RP starter basket (a pre-set basket as an additional component of the 50% of CNI builder basket, and in addition to the general RP basket) is a relatively new feature seen in the more aggressive high yield deals. This feature is only found in one recent Spanish high yield deal (Cirsa EUR 425 million Floating Rate (EURIBOR +5.750%) Senior Secured Notes due 2023, EUR 663 million 6.250% Senior Secured Notes due 2023 and USD 550 million 7.875% Senior Secured Notes due 2023 (June 2018)).

Leverage-based RP basket
An RP basket that allows for restricted payments so long as a pre-determined pro forma leverage ratio is met is a relatively new (and aggressive) feature, but one that has now become almost standard in European high yield deals. While the majority of the Spanish deals that we reviewed do have this feature, the leverage level is typically set conservatively below the issuer's opening leverage, thus requiring some de-leveraging before the basket can be utilized. Investors have recently been scrutinizing this provision during the marketing process, as evidenced by the fact that in at least two recent Spanish deals the leverage level for the leverage-based RP basket was reduced during the marketing period (Cirsa EUR 425 million Floating Rate (EURIBOR +5.750%) Senior Secured Notes due 2023, EUR 663 million 6.250% Senior Secured Notes due 2023 and USD 550 million 7.875% Senior Secured Notes due 2023 (June 2018) and Haya Finance EUR 225 million Floating Rate (EURIBOR +5.125%) Senior Secured Notes due 2022 and EUR 250 million 5.250% Senior Secured Notes due 2022 (November 2017)).

Spanish High Yield – The Legal Framework 

Governing Law/Structure

The Spanish high yield market is dominated by bonds governed by New York law and issued under Rule 144A/Regulation S exemptions from registration with the SEC. The bond issuance is also typically structured in a way that it does not constitute a public offer of securities in Spain according to the Spanish Securities Market Law such that the issuer is not required to register the offering prospectus with the Spanish Securities and Exchange Commission or to comply with the minimum disclosure requirements under the Prospectus Directive.

In addition to high yield bonds, larger issuers also tend to have bank debt in their capital structure, typically represented by a senior facilities agreement (which may include an RCF and a term loan tranche) or, in the case of corporates, bilateral working capital facilities and/or guarantee lines. The senior facilities agreement, as well as the intercreditor agreement (for secured deals), tend to follow the Loan Market Association template, which is governed by English law. If the issuer is a Spanish-incorporated company (rather than an SPV incorporated in an alternative jurisdiction such as Luxembourg), in addition to the New York law bond documents, a Spanish public deed of issuance is typically also put in place. Additionally, the high yield bond indenture is sometimes notarized in Spain in order to guarantee access to a more expeditious enforcement process against the assets of a Spanish issuer or guarantor.

Security

The majority of Spanish high yield issuances are secured. A typical security package consists of pledges over the shares of the issuer, the parent company and certain of their subsidiaries, as well as over material bank accounts, receivables and insurance policies. Other security, such as non-possessory pledges over movable assets and real estate mortgages, is less common, mainly because of the associated registration fees and stamp duty. Spanish law does not provide for a "universal guarantee" over all the debtor’s assets; nor does it provide for the creation of a floating or adjustable lien or encumbrance. ³

Financial Assistance Rules

If the proceeds of high yield bonds are used to finance or refinance the acquisition of an issuer's shares or the shares of its parent (or, in the case of a Spanish SL or sociedad de responsabilidad liimitada, of companies within the same group), such obligations cannot be secured or guaranteed by a Spanish guarantor as it would breach the financial assistance prohibition. Therefore, such limitations would restrict the ability of Spanish guarantors to grant guarantees or provide security for financing used for such acquisition.

Under Spanish law, unlike in a number of other EU jurisdictions, there is no specific obligation for companies to justify that they are acting in the company’s benefit when granting a guarantee or security, although it is advisable to do so. It is worth noting though that upstream guarantees granted for no consideration are typically declared null and void in a subsequent insolvency if they fall within the two year hardening period.

This was enacted in the aftermath of the economic downturn and in the context of the Spanish companies experiencing difficulties accessing bank financing. The purpose of the law was to enhance flexibility of the legal regime applicable to bond issuances by Spanish companies, mainly catering for the following:

• Spanish SLs ("sociedades de responsabilidad limitada") are still not allowed to issue convertible securities (since due to their nature they are not entitled to issue securities and their own shares do not have the legal nature of securities), but may now issue and guarantee bonds and other securities.  This is however subject to a limit equal to 200% of their equity, unless the issuance is secured by a mortgage, a pledge of securities, a public guarantee or a joint and several guarantee from a credit institution.
• A much needed clarification in respect of the need for the bonds to establish a syndicate of holders and a commissioner of the bonds has been provided.  The previously applicable regime had been clearly thought of in the context of domestic markets and has not foreseen the difficulties it could cause in the context of interplays with other jurisdictions.  For example, under the previous regime non-Spanish law governed high yield bond issuances by Spanish companies that appointed a trustees as a bondholder representative could face challenges in Spanish courts because of not providing for the roles of a syndicate of bondholders or a commissioner.  In order to prevent this from happening, a syndicate of bondholders and a commissioner were sometimes appointed as well as the trustee, giving rise to duplicity of roles and conflicts.  This has now been clarified to provide that the governing law of the issuance (and not the jurisdiction of incorporation of the issuer) will dictate the requirements for the collective bondholder representation; thus for New York law governed bonds, having a trustee will suffice.

1. Based on our experience in this market, Spanish high yield debt is often placed privately in the form of private placements and not public offerings. The EUR 4bn figure, which reflects only public high yield debt offerings, would be significantly higher if private placements were also included in the calculation.
2. See Annex A  in the PDF below for a summary of the terms of the Spanish high yield bonds issued in 2017-2018.
3. Spanish law does not contemplate the concept of a security agent, and, although this by itself does not prohibit such agent from being appointed, the fact that there is a lack of regulation on the matter results in uncertainty as to how a Spanish court would recognize security granted only in favor of the security agent. This however does not impair the secured parties from entrusting the security agent with certain actions (such as enforcement) in the security documents.