Portability Trends in European HY
- Oliva Mantock
- +Brian Dearing
In this topical report, we take a close look at the trends weâve seen in portability terms across European High Yield since 2020.
Portability Briefly Explained
Before we dive in to portability, letâs quickly recap what it is. Following a change of control, portability allows an issuer to avoid triggering the put right that bondholders typically have to force an issuer to buy back bonds at 101%.
If portability is included in a transaction, it is typically only available when certain conditions are met, such as meeting a minimum ratings threshold or being below a stated leverage ratio. The concept is included in bonds because following a change of control, the argument goes, bondholders ought to have the flexibility to reconsider their investment, and if they want, get their money back early. But on the flip side, sponsors and issuers may argue that if the portability conditions are met (i.e., the business is meeting some metric that indicates it is successful or at least stable), this option should not be available, and the business should be allowed to keep its current capital structure and avoid refinancing.
To read more about the change of control put right, as well as portability, check out our 9fin Educational article âWhoâs in Control? A quick look at the Change of Control provision.â
Portability Trends Across European HY Bonds
Over the years we have seen the increased use of portability in European HY transactions, with it being consistently included in the majority of sponsor deals since 2016 (see chart below), in fact it has appeared in all sponsor deals so far in 2022.
The justification for leverage-based portability is that if the company is sufficiently strong (i.e., leverage is below set thresholds which act as a proxy for success or stability), there should be no reason to allow investors to exercise the put. The question is no longer whether to include portability (at least in sponsor deals), but what the appropriate threshold is for it to be available.
In the early days of portability, the leverage ratio was often set below opening net leverage, meaning the issuer had to de-lever (at least a bit) before portability was available. Nowadays, itâs common to see portability available at issuance, with 48% of sponsored deals since the beginning of 2020 having portability available day one, and 18% only requiring minimal de-levering to access it (i.e., up to a quarter turn of EBITDA). But still, as the chart below shows, 19% of sponsored deals still had to de-lever more than 0.75x EBITDA before accessing portability, so portability that actually requires de-leveraging isnât completely a relic of the past ... yet. This chart also shows the ratings breakdown of deals within each leverage range. For illustrative purposes, the CCCs and BBs are each presented on a combined basis, while the single Bs are broken down further.
Breaking this down further on a year-by-year basis, we see that over 2020 and 2021, the market standard for the availability of portability has stayed relatively stable, with most deals clustering around or slightly above opening leverage.
Across 2020, 2021 and YTD 2022, only 11 deals had portability set at 0.5x EBITDA or more above opening leverage â as displayed in the following graph (note that three of the 11 deals were United Group, but the chart below only shows the most recent deal (January 2022)).
The deal with the most portability headroom is BUT SA, with portability set 1.7x EBITDA above opening net leverage, perhaps unsurprising given the companyâs low opening net leverage of 2.3x. Coming in second and third, United Group and Cerved had 1.3x and 1.15x of portability headroom, respectively. Unlike BUT, both deals had relatively high opening leverage ratios, at 4.7x and 4.6x.
Portability step-downs: less in vogue but still around
When leverage-based portability first appeared, it was common to see step-down conditions attached, meaning that in order to access, the company was expected to de-leverage over time. While step-downs are becoming less common as time passes, itâs still a feature we saw throughout 2020 and 2021.
However, none of the portable deals weâve seen so far in 2022 had step-downs. In addition, we have seen deals with step-ups (i.e., the leverage at which portability is available increases over time). Apollo-sponsored plastics firm Kem One offers one example.
Our Covenant Capacity screener is a great way to keep track of which deals have step-downs over time, but the big picture for now is that approximately 15% of sponsored and portable deals in 2020 had step-downs against approximately 11% in 2021.
Once, twice or thrice: single-use or multiple-use portability?
Generally, portability clauses contain âone-time onlyâ wording that limits the feature to a single use over the lifetime of the bonds. This is a restriction on portability that protects bondholders since it avoids the issuer changing hands multiple times over the lifetime of the bond (even if that situation is unlikely). The share of portable deals with multiple use was fairly stable throughout 2020, 2021 and 2022 YTD, as the chart below shows.
All deals since 2020 with multiple use portability were sponsored deals:
- 2020: Empark (Macquarie), Synlab (Cinven), Lowell GFKL (Permira / Ontario Teachers' Pension Plan), IMA (BC Partners), Merlin Entertainments (Blackstone, CPPIB, KKB).
- 2021: Ahlstrom-Munksjö (Bain Capital / Ahlstrom Invest B.V. / Viknum AB), Cedacri (ION), Nobian (Carlyle / GIC), Modulaire Group (TDR Capital), Keepmoat (Aermont).
- 2022 YTD: Cerved (ION), Ceramtec (CPPIB / BC Partners).
Leverage-based portability risks: a closer look at how leverage is calculated
Gross v. net calculations and round-tripping
Given leverage-based portability is (as the name implies) contingent on the issuer meeting a certain leverage ratio, it is important for bondholders to pay close attention to how this leverage figure is calculated. Most deals will use net, rather than gross leverage ratios for covenant purposes. Net leverage deducts cash and cash equivalents from debt, since any cash could theoretically be used to pay down debt anyway.
Practically, that creates a risk of âround-trippingâ: the issuer could inject cash without paying down debt to temporarily reduce the net leverage ratio. That temporary reduction in net leverage can then be used to access portability before sending the cash back to the sponsors/owners as a restricted payment (this is also a bit worrisome when connected with the fact that there is significant flexibility in the timing of when the issuer calculates leverage for purposes of accessing portability).
The chart below illustrates how round-tripping works:
Usually, the covenants will include some form of round-tripping protection, for example, by resetting the builder-basket upon a change of control (note this doesnât protect against other Restricted Payments), or by utilising the âExcluded Amountsâ concept, which blocks round-tripping by preventing cash injected for the purpose of avoiding a Change of Control from being distributed back out via the builder-basket or contribution RP basket.
But round-tripping protection can be deficient (and often is), for example, in Kem One, Worldwide Flight Services, Zenith Leasedrive (and others) where the âExcluded Amountsâ concept, only applies to the builder basket. This means that any amounts contributed to achieve portability donât build the RP builder basket, but they could be designated as âExcluded Contributionsâ simultaneously, and then the issuer could simply utilise the separate RP basket that allows for the distribution of all Excluded Contributions. Deals protect against this, for example, by including a line in the definition of âExcluded Contributionsâ that excludes from the calculation all âExcluded Amountsâ.
Excluding key baskets from the leverage ratio
Another interesting development occurred in Modulaire Groupâs covenants where the leverage calculations exclude most debt outstanding under the Debt covenant (other than for purposes of calculating Restricted Payments capacity). So far, we havenât seen these expansive exclusions make it past marketing in any other deals in the bond universe (for example, Multiversity had similar drafting which was removed during marketing). But we have seen similar flexibility in at least one loan in 2022. This type of flexible drafting creates a serious discrepancy between the financial leverage ratios and the covenant leverage ratios, meaning the issuer could access portability when the financial leverage ratios are well-above the portability threshold (which would be calculated utilising covenant leverage).
The Modulaire Group drafting has implications beyond the portability feature as well, which we noted in our Q3 2021 Covenant Trends report.
Whatâs going on across the pond - is it âno worseâ?
One final point to discuss in the portability realm, is the rise of âno worseâ portability â which has been seen in two recent US deals, Medline Industries (Sept. 2021) and Athenaheath (Jan. 2022).
No worse portability means that portability is always accessible to the issuer no matter how leveraged they are so long as the change of control does not increase (or âworsenâ) their leverage ratio. The portability feature is drafted such that it is not considered a Change of Control if the leverage ratio, on a pro forma basis, is ânot greater thanâ the leverage ratio âimmediately priorâ to the Change of Control.
This is notable because what happens across the pond tends to be imported to European HY eventually, so this is a trend weâll be keeping an eye on here at 9fin. It may be worth saving the âno worseâ search link to our Description of the Notes search tool so that you can keep an eye on whether new deals have this feature.
If you have enjoyed our summary of portability trends, you may be interested in more of our covenant analysis. 9fin has recently launched 9fin Educational - a series of articles which shine a light on specific topics in the leveraged finance market.
Down and Dirty with the âAvailable Amount"
Asset Sale - or is it?