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Alice Holian

Caitlin Carey

After a very busy June and July and the usual August slow-down, new issuance took a while to pick back up in September. We noticed a similar dip in our covenant data, with the more eye-watering baskets and documentation features seen earlier in the summer giving way to slightly more modest documentation in Q3 2021. Given what we have seen so far in Q4 2021, however, we expect this dip to prove temporary.

In this report, we highlight key covenant data and documentation trends seen in European high yield bonds in Q3 2021. In addition, for the first time, we also include certain data on European leveraged loans. Finally, we peer past Q3 2021 to preview the developments so far in Q4 2021, including a run-down of successful investor push-back in several recent deals.

Average Restricted Payments (RP) and Permitted Investment (PI) basket capacity (on a combined basis represented as turns of EBITDA, based on metrics at issue and excluding CNI and Available Amount capacity) decreased slightly in Q3 2021 as compared to Q2 2021. 


This average was affected by a couple of outliers in July 2021, Belden and Motor Oil, which had combined RP and PI capacity figures of 4.27x and 3.94x EBITDA, respectively. Both companies are publicly-listed corporate issuers with relatively low leverage. 


As described in our Legal QuickTake on the deal, Belden’s large RP capacity was largely the result of the $860m starter amount in its CNI builder basket, which we expect is sized to reflect historic build-up capacity (in the prior deal, the CNI builder basket was backdated to 2012). Motor Oil had over 1x EBITDA of leverage-based RP capacity and significant investments capacity, which is noteworthy given that it already has significant day one unrestricted subsidiaries. 

Excluding Belden and Motor Oil, average RP and PI capacity for Q3 2021 would have been 1.40x EBITDA (instead of 1.66x), which is lower than the average for the past several quarters. This lower average can be partly attributed to deals by repeat issuers with substantially identical covenants / minor updates to their prior deals (Paprec, Kantar, Parts Europe, United Group) and post-restructuring deals by McLaren and Pizza Express.

Out of the sponsor-backed deals in Q3 2021, Pasubio (PAI) and Nobian (Carlyle and GIC) had the highest RP and PI capacity, at 2.56x and 2.43x EBITDA, respectively. In Q2 2021, BUT (CD&R), Cedacri (ION Group / Andrea Pignataro) and Paysafe (Blackstone and CVC) were the sponsor/investor-backed deals with the highest combined RP and PI capacity, at 3.77x, 3.75x and 3.35x EBITDA, respectively.

Total debt baskets were also lower on average in Q3 2021 deals as compared to Q2 2021. Excluding Belden and Motor Oil, which are outliers in this category as well, the average of total debt baskets present in Q3 2021 deals would have been 2.28x EBITDA (rather than 2.62x EBITDA). 

In Q3 2021, Nobian and Titan (KPS) were the sponsor-backed deals with the highest total debt baskets, at 4.60x EBITDA and 4.11x EBITDA, respectively. In Q2 2021, the sponsor-backed deals with the highest total debt baskets were Birkenstock (Catterton) (5.7x EBITDA) and Paysafe (5.28x EBITDA).



Note: We calculate total debt baskets as the sum of all debt baskets, minus debt basket capacity deemed utilized by day one outstanding term debt. This calculation excludes any ratio-based debt capacity.

In addition to having lower overall basket capacity, on the whole we noticed that Q3 2021 deals seemed also more moderate in terms of other documentary features that we have been seeing in sponsor-backed deals earlier this year -- although aggressive documentation features have picked back up so far in Q4 2021, as we discuss later. 

Below is a table highlighting certain terms in Nobian and Titan against certain headline names from earlier this year (Ahlstrom-Munksjö, Birkenstock and Paysafe).


Comparison of selected data across loans and bonds


We frequently get asked the question: “Which has worse documentation - bonds or loans? ” The 9fin Legals team regularly reviews both types of documentation, and when it comes to the key incurrence covenants and related definitions, there’s not much daylight between the two. If you gave us a redacted Debt or Restricted Payments covenant and asked whether it belonged to a senior secured bond or a senior secured term loan B, we probably wouldn’t be able to tell (barring giveaway terminology like “Issuer”/ “Borrower”, “Indenture/Facilities Agreement” etc.).

Despite the similarities across bonds and loans, on average we’d give the nod to loans. For instance, when we compared overall RP and PI capacity across the two types of instruments for YTD 2021 deals, leveraged loans had on average greater capacity than bonds.


Note: Not all leveraged loans follow the same categorization as HY bonds. Where necessary we have approximated RP + PI capacity by aggregating capacity for dividends/share purchases, junior debt prepayments, JV investments, acquisitions of minority interests etc. 

In addition, when we look across the two instruments at the prevalence of certain types of covenant flexibility, we see some pronounced differences. We saw Available RP Capacity Amount (or “pick-your-poison”) debt baskets, which permit the issuer / borrower to convert RP capacity into debt capacity (on a 1:1 or, more aggressively, 2:1 basis), in almost 40% of Q1-Q3 2021 loan documents we reviewed. Over the same period, we saw the same provision in less than one-quarter of bond documents. The more aggressive 200% Available RP Capacity formulation was present in 7% of loan documents over the periods, as compared to only 2% of bonds.


Even more pronounced is the difference in frequency when it comes to "Available Amount” Restricted Payments and Permitted Investments baskets. 


In loan-land, the term "Available Amount” is used to refer to the typical “builder basket” for Restricted Payments, investments and junior debt prepayments. It may be based on retained excess cash flow or 50% CNI (or occasionally another metric or a “greater of” formulation) and may or may not be subject to a leverage or other ratio test.

In the context of this report, we are particularly concerned with deals where the “Available Amount” includes permitted debt, meaning that the issuer / borrower can make debt-funded dividends and/or investments subject only to (1) having debt incurrence capacity and (2) meeting any leverage/other conditions set out in the “Available Amount” basket (if any!). We saw this drafting in over one-third of leveraged loans deals in Q1-Q3 2021.

As mentioned in the Q2 trends report, we saw this concept make its way into the bonds for Lonza Specialty Ingredients, Ahlstrom-Munksjö and Birkenstock. The “Available Amount” concept has cropped up in two more HY bonds so far in Q4 2021, Modulaire Group and Arcaplanet. 

Similar to the basket in Birkenstock, the drafting in Modulaire Group does not have a maximum leverage or other ratio test limiting RPs and investments that are funded from the Available Amount. Arcaplanet has a leverage test on RPs funded from the Available Amount, but no such test applies for investments. 

Lonza Specialty Ingredients, Ahlstrom-Munksjö, Birkenstock and Modulaire Group each had TLBs in their capital structure as well as bonds, which perhaps helps to explain how this term has jumped from loans into bonds. Notably, however, Arcaplanet is a bond-only structure without a TLB; it is based in Italy, where local law rules make it difficult to structure financing as syndicated loans. 

As just described, Q1-Q3 2021 leveraged loan covenants are in some ways more flexible than bonds on average. However, the reverse is the case when it comes to EBITDA addbacks. It’s more common for EBITDA cost savings/synergies adjustments to be subject to a cap and a time limit in leveraged loans than in high yield bonds. 

In Q1-Q3 2021, just over a third of high yield bonds (36%) featured a cap on EBITDA cost savings/synergies adjustments, as compared to almost two-thirds of leveraged loans (62%). In Q1-Q3 2021 deals where cost savings/synergies adjustments were capped, this was most commonly capped at 25% EBITDA in both high yield bonds and leveraged loans.


In Q1-Q3 2021, approximately 9% of leveraged loans did not have any time limit applying to EBITDA cost savings / synergies adjustments, as opposed to 33% of HY bonds. For Q1-Q3 2021, a 24 month time limit was most common, occurring in 60% of leveraged loans and 38% of HY bonds. 


Caps and time limits on EBITDA addbacks, while helpful, are not always water-tight. For instance, adjustments made in calculating marketing EBITDA are often permitted under a separate clause that is not subject to (and will not count towards) the cap. The cap is often calculated as a percentage post-adjustment EBITDA, which would permit a greater amount of adjustments than investors might expect.


Time limits may also not be that protective. Ideally, the time limit should relate to when such cost savings / synergies are expected to be realised, but often these are drafted so that the issuer / borrower only has to expect to take the actions expected to result in the cost savings / synergies -- or “substantial steps” with respect to such actions -- within the time limit. Investors should keep an eye out to make sure, where added, the caps and time limits are meaningful.  We recently published an depth-report on EBITDA add backs which you can read here. 

Aggressive terms marketed in Q4 2021 bonds, but some investor pushback success

Coming off a relatively sedate Q3 2021, the first week in October brought an avalanche of LBO issuance into the market. Of the bonds that launched that week, Modulaire Group (Brookfield), Arcaplanet (Cinven and Fressnapf), Graanul Invest (Apollo), BIP (CVC) and EOLO (Partners Group) all featured above-average basket sizes and documentary flexibility.  

In particular, the Modulaire Group and Arcaplanet bonds seemed to be competing to set a new benchmark (or a new “low”, depending on your point of view) for covenant flexibility, brimming with the latest sponsor innovations. 

However, neither of those deals made it through the market unscathed. Investor push-back managed to get changes made to several of the most egregious terms in each. Both deals added EBITDA caps and time limits and reduced the 200% Available RP Capacity baskets. Arcaplanet reduced its portability leverage threshold, which had originally been set 1.5x above opening net leverage, to right around opening. Modulaire removed a provision that would have allowed it to distribute Specified Asset Sale proceeds, without meeting any leverage or other condition.

Iliad, another bond deal that launched the same week as Modulaire and Arcaplanet, also made documentary changes during marketing, as did Multiversity, which launched a couple of weeks later. 


Modulaire Group also featured never-before-seen drafting permitting the issuer to exclude debt outstanding under most debt baskets from all ratio calculations, other than for testing RP capacity. Typically, ratio calculations exclude Debt basket debt incurred on the determination date, in order to allow ratio debt and basket debt capacity to be used concurrently. The Modulaire Group drafting goes much further than this, running contrary to how investors would intuitively expect leverage ratios to operate. The Modulaire Group formulation was particularly egregious because it appears to permit the issuer to test its portability ratio, and arguably its Permitted Investment ratio basket, on this basis. Similar drafting was removed from Multiversity during marketing.


As described above, both Modulaire Group and Arcaplanet were marketed with aggressive “Available Amount” Restricted Payments and Permitted Investments baskets, which was not removed from either deal. In Modulaire Group, certain RP leverage thresholds were tweaked and an Event of Default blocker was added with respect to RPs funded with permitted debt. However, even after these changes, the issuer can still make uncapped debt-funded dividends and investments with no maximum leverage or other ratio test, so long as (1) it has capacity to incur the debt and (2) there is no Event of Default.


Modulaire Group’s CNI builder basket also featured new drafting, stating that the CNI component will build from 50% of “positive” CNI, without any deduction for “negative” CNI. While not entirely clear, this smells similar to an innovation we have been seeing in a few recent loans, which is to specify that the CNI “zero-floor” applies each quarter.

Taking a step back, the RP Builder Basket typically builds from 50% of the Consolidated Net Income along with various customary components such as a starter amount. It has become increasingly common in sponsor-backed deals to include a “zero-floor” on the 50% CNI Builder such that the CNI component of the basket cannot be negative. This means that any CNI deficit (cumulatively since the issue/closing date) will not deduct from the starter amount or other components. 

A quarterly “zero-floor” means that RP capacity will build by 50% CNI for each quarter in which CNI was positive, without this being offset by any quarters in which CNI was negative. In other words, rather than calculating cumulative CNI since the issue/closing date (including quarters where CNI was both positive and negative), and then taking 50% of the result, the borrower can disregard all quarters in which CNI was negative. We suspect that the Modulaire drafting was intended to accomplish the same purpose and that we may see similar drafting arise in future deals.

One other builder basket innovation that we have seen crop up in a few loans and bonds (US deals such as Ancestry, Medline Industries, as well as Paysafe, which had USD and EUR tranches) is the ability for the RP Builder Basket to build from the “greater” or “greatest” of several growth metrics. For instance, in Medline Industries, the RP Builder Basket builds from the greatest of (1) 50% Consolidated Net Income, (2) cumulative retained excess cash flow and (3) cumulative EBITDA less 1.5x cumulative fixed charges. Given the tendency of US innovations to float across the pond, we think it’s only a matter of time before we begin seeing this type of construct in more European bonds.

Note: We have based our data on final documentation / terms where these have been made available to us. For deals where we have not received final documentation / terms, our data is based on preliminary terms.

If you would like more information about 9fin's covenant data and analysis - including our new Covenant Capacity Tool - please get in touch team@9fin.com. 

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