RP and PI Capacity Trends

Our data shows a steady rise in average RP + PI capacity over FY2020 and through to Q1 2021 (represented as turns of EBITDA, all calculations are based on metrics at issue). Ahlstrom-Munksjö, Novelis and Foncia boosted the overall Q1 2021 average, with combined RP and PI capacity figures of 6.5x, 3.8x and 2.9x EBITDA respectively.

In particular, Ahlstrom-Munksjö is a significant outlier—our 6.5x RP + PI capacity figure takes account of the company’s capacity under its off-market ‘Available Amount’-based RP and PI baskets. As described in our Legals QuickTake, the ‘Available Amount’, a broad concept that is defined in that deal to include any Permitted Indebtedness, can be used to make RPs subject only to a 2x Fixed Charge Coverage Ratio test (after certain pref instruments are repaid) and can be used to make PIs without meeting any ratio test. As a result, we have added Ahlstrom-Munksjö’s significant capacity for incremental Permitted Indebtedness to the RP and PI capacity it would have otherwise had, absent the Available Amount concept.

Excluding the Available Amount baskets, Ahlstrom-Munksjö’s RP + PI capacity would have been only 2.03x EBITDA and the Q1 2021 average would have dropped to 1.4x.

Next we dive into the key RP and PI baskets that make up these combined figures. The graph below shows how the average sizes of the RP General Basket and Starter Amount have developed in FY2020 and Q1 2021. The average size of the RP General Basket has remained stable over the period at roughly 30% of EBITDA. The average size of the RP Starter Amount has also remained relatively consistent, with the unusually high average in Q4 2020 attributable to two outliers (Primo Water and INEOS, whose 2.99x and 0.79x EBITDA Starter Amounts reflected built-up RP capacity from prior deals).

Without these outliers, the average Starter Amount basket for Q4 2020 would have been 0.08x EBITDA, squarely in line with the other periods presented.

Whereas the average size of key RP baskets have remained relatively stable, the average size of several key PI baskets has increased markedly during FY2020 and Q1 2021. In particular, the average size of the PI general basket has increased from 0.28x EBITDA in Q1 2020 to 0.42x EBITDA in Q1 2021, and the average size of the PI basket for Unrestricted Subsidiary investments has nearly doubled from 0.09x in Q1 2020 to 0.17x in Q1 2021.

And the Prize Goes to...

Moving on from general market trends, we shine a spotlight on the FY2020 and Q1 2021 deals with the largest combined RP and PI Capacity. The three March 2021 deals we called out above (Ahlstrom-Musksjö, Novelis and Foncia) all placed in the top seven and were in fact the top three sponsor-backed deals during the period, handily beating out notable contenders from 2020 such as Merlin Entertainments, IMA, Masmovil Ibercom and Gamenet. Even without considering the ‘Available Amount’ capacity described above, Ahlstrom-Musksjö’s day one RP and PI capacity would have been on par with Gamenet.

For our next category, we turn to the leverage tests for making uncapped RPs and where these tests have been set relative to the issuer’s day one net leverage. The chart below shows the FY2020 and Q1 2021 European HY deals that have set the RP leverage tests above opening leverage, meaning that these issuers had day one capacity to make uncapped dividends and other RPs so long as their leverage did not fall below the test level.

According to our Covenant Capacity data, B&M Retail takes the gold in this category. Its bonds give it flexibility to make uncapped dividends and share buybacks subject to a 3x net leverage test and uncapped investments and sub debt prepayments subject to a 3.25x net leverage test, both tests set well above B&M’s opening net leverage of 1.5x.

Noteworthy ‘also-rans’ include Novelis, whose recent green bond deal had an uncapped RP leverage test set more than 0.7x EBITDA above opening leverage; Q-Park and Empark, which each had an uncapped RP test set 0.6x above opening leverage (but whose current leverage levels now far exceed their RP leverage tests); and Verisure, which recently topped up its leverage with a dividend recap.

And we could not cover the topic of leverage-based capacity without making special mention of an innovation seen in recent sponsor deals: uncapped PI capacity subject to a ‘no worse’ leverage test. Such a provision essentially allows issuers to make an uncapped amount of leverage-neutral/leverage-improving investments, no matter what its current leverage is. For example, this could enable an issuer to invest businesses that are currently EBITDA negative into an Unrestricted Subsidiary, even though these businesses might contain valuable assets or represent strong growth potential.

Last July, Thyssenkrupp Elevator removed a provision that would have allowed unlimited PIs subject to meeting either a leverage or FCCR test, or either test being ‘no worse’ pro forma (replaced with a tighter leverage-based PI provision without a ‘no worse’ prong). Subsequently a ‘no worse’ leverage-based PI provision cleared the market in Kloeckner Pentaplast in January 2021. Two further variants have been spotted in March 2021: Advanz Pharma included a provision along the same lines as the Thyssenkrupp Elevator provision, except that investments Unrestricted Subsidiaries were not permitted under the FCCR test or FCCR ‘no worse’ prongs of the provision. Ahlstrom-Munksjö also included a ‘no worse’ leverage-based PI provision and in addition can make uncapped PIs from the ‘Available Amount’ without meeting any ratio test. Investors should keep an eye out for these types of provisions in future deals.

More Than Just Baskets: Other Key RP Provisions To Consider

Typically, access to the RP builder basket is subject to two conditions: (i) no Default or Event of Default and (ii) meeting the Ratio Debt test in the Debt covenant, which together serve as a proxy for the financial health of the issuer. If either condition is not satisfied, then the issuer cannot use the builder basket to make RPs.

However, recent deals have been chipping away at these cornerstone protections, with these conditions weakening in some deals and disappearing altogether from others. For instance, the Default blocker has given way to an Event of Default blocker in deals such as Kloeckner Pentaplast, Adevinta and Pure Gym, which means that the issuer could continue to use the builder basket during a Default, as long as it has not ripened into an Event of Default. In some instances, such as Foncia, access to the RP builder basket is only blocked during a payment or insolvency Event of Default. In other deals, such as Asda and Gamenet, investments can be made using the RP builder basket without being subject to no Default / Event of Default or a Ratio Debt test.

We’ve also been tracking provisions that explicitly permit Unrestricted Subsidiaries to transfer value invested by the credit group to the shareholders, without this being deemed an indirect RP. This provision could undermine investors’ arguments to dispute a spin-off of an Unrestricted Subsidiary to shareholders, similar to what Neiman Marcus did with its myTheresa business in 2018.

Essentially, Permitted Investments capacity to invest value into Unrestricted Subsidiaries becomes unlocked as additional dividend capacity, removing the distinction between RPs and PIs. In FY2020 and Q1 2021, we saw this language included in deals by 10 issuers: ThyssenKrupp Elevator, Primo Water Corporation, Maxeda, Bite, Merlin Entertainments, United Group, Kloeckner Pentaplast, Ahlstrom-Musksjö, Foncia and Advanz Pharma. Unsurprisingly, these issuers had some of the most aggressive covenant packages we reviewed during the period.

Have You Adjusted Your EBITDA Today?

The capacity metrics we’ve used in this report are based on disclosed opening EBITDA and leverage figures. However, European HY deals typically provide issuers with flexibility to include various add-backs and adjustments in calculating these metrics for covenant purposes, meaning that the figures used for covenant purposes could differ significantly from the issuer’s reported EBITDA and leverage ratios.

In particular, it has become customary to allow pro forma cost savings and synergies to be added to EBITDA, even if these effects may be some way away from being realised. These provisions vary significantly across deals, with the more aggressive deals permitting synergies adjustments to be applied on a ‘run-rate’ basis, to include revenue/top-line synergies, to include synergies unrelated to acquisitions/similar transactions (e.g., those related to broadly defined ‘group initiatives’, including new/revised contract terms) and not to be subject to any cap, time limit or any due diligence, certification or reporting requirement. An issuer’s covenanted EBITDA could therefore be much higher, and its leverage ratios correspondingly lower, than its financials would suggest.

In FY2020 and Q1 2021, over two-thirds of European HY deals (~70%) featured uncapped EBITDA adjustments for cost savings/synergies, and almost half of deals did not include any time limit on when the cost savings/synergies added back are expected to be actioned or realized.

To give a few specific examples of European HY issuers using creative EBITDA adjustments, Kloeckner Pentaplast, global manufacturer of plastic packaging products, included ‘strategy’, ‘restructuring’ and ‘other non-recurring costs’ in its marketing EBITDA despite having recurred in the Adjusted EBITDA in 2018, 2019 and 2020. Any adjustments used in calculating marketing EBITDA in the OM can also be included for covenant purposes.

PureGym’s 2025 SSNs include a run-rating of EBITDA based on three-year forward estimated earnings of new facilities. Douglas’ recent deal included no fewer than five different measures of EBITDA, with 4-5 pages of reconciliations and footnotes explaining the various adjustments. The marketing figure is ‘Management Adjusted EBITDA’ of €395m, compared to the Pre-IFRS 16 reported EBITDA of just €111.9m. Furthermore, Douglas has pre-set its quarterly covenant EBITDA figures for the next several quarters, maintaining €395m as its covenant EBITDA baseline through June-21.

Final Remarks

Over FY2020 and Q1 2021, our data shows an uptick in average day one RP and PI basket capacity and an increase in other sponsor-friendly RP and PI provisions. The most recent batch of Q1 sponsor deals really exemplify these trends, so to put these deals into context, here’s a chart showing how they stack up against a few of the headline deals from 2020.

Graphs and data sourced from 9fin. Capacity calculations presented are estimates of covenant capacity based on the documentation available to us (which in some cases is limited to preliminary terms) and are not substitutes for consultation with legal counsel or a full documentation review. Total RP + PI Capacity is calculated as the sum of all Restricted Payments and Permitted Investments baskets (excluding the CNI build-up basket, other than disclosed backdated build-up capacity). For purposes of calculating capacity under the relevant net leverage tests, we have assumed that any Restricted Payments/Permitted Investments would be made in cash (and would therefore increase net leverage).

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