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Private Credit 

Oliva Mantock

Brian Dearing

In 2021, 76 European High Yield sponsored deals priced, and 16 (~21%) of those deals were subject to covenant changes before pricing. In this trends piece, we take a closer look at the key covenant battlegrounds where investors had success pushing for change.

In addition, if you want to see the full landscape of changes made during marketing on recent deals, be sure to check out the latest addition to our suite of legal tools, Covenant Pushback. The tool sets out every change that happened in sponsored deals in 2021 and 2022, and provides you with quick links to 9fin’s Covenant Explorer tool so you can view the actual changes in context.

Out of the 16 sponsored deals with doc changes, five added both a synergy cap and time horizon for calculation. To place this in context, 62% of sponsored European HY deals in 2021 had uncapped synergies. The most common combination of synergy caps and synergy time limits, which were found together in 30% of deals, was a 25% cap and subject to a 24-month limit. Notably, 27% of deals had neither a cap or time limit on synergies.

The five deals with changes to synergies during marketing were: Arxada, Marcolin, Modulaire Group, Multiversity, and Arcaplanet. All of these deals moved from no cap on synergies to a 25% cap and no time horizon to 24-months (except Marcolin, which added an 18-month cap). From the chart above, we can see that more than 60% of deals do not have a synergies cap, while conversely more than 60% of deals have some form of a time limit.

While it’s clear that having a time horizon for the calculation of synergies is likely better than not, we do query whether there is actually much of a value add when it’s set at 24 months. Synergies typically need to be at least “reasonably anticipated” (or similar), meaning they can’t be completely made up, and it’s probably difficult for companies to reasonably anticipate synergies more than two years out anyway.

In addition, the typical drafting of time limits on EBITDA add-backs does not impose a limit on the issuer actually realising these synergies. The time limit only specifies the period during which the issuer expects to take the actions expected to result in (or in some cases, just “substantial steps” toward) the anticipated synergies. As a result, it’s quite possible that the issuer won’t even begin to see the benefit of their actions until well after the 24-month time limit has elapsed (if it ever does!).

The potentially more pressing question lies in the large proportion of deals that lack any cap. While the most likely outcome for a deal that has pushback is to simply add a time horizon, the inclusion of a cap may be more impactful. The caps are typically set as a specified percentage to the company’s EBITDA, which at least gives investors some ability to calculate an upper limit on EBITDA adjustments (although, admittedly even this is still quite difficult - particularly if only certain EBITDA adjustments are subject to the cap). But, given that caps place a more meaningful limit on EBITDA adjustments, one can deduce rather quickly why sponsors may be more willing to agree to time horizon limits than caps!

Delever to Deliver: Ratio-based RPs and PIs

Ratio-based Restricted Payments (RPs) and Permitted Investment (PIs) baskets saw significant changes during marketing in 2021.

The inclusion of a ratio-based RP basket is very much market standard these days, with Lottomatica being the only sponsored issuance of 2021 that did not have one (you can see 9fin’s data using our Covenant Capacity tool, note that if we broaden this search to all deals, and not just sponsored, there are still only approximately 10 deals without it). Ratio-based PI baskets, on the other hand, are much less common appearing in only 38% of 2021 sponsor deals.

Based on 9fin research, we have found that for sponsored European HY deals in 2021 ratio-based RP baskets were set, on average, 0.86x below opening leverage, while ratio-based PI baskets are set, on average, ~0.5x below opening leverage. It’s possible to rationalise this greater flexibility for investments (from which the Restricted Group could in theory derive some residual benefit) as compared to general RPs (which permit direct distributions to shareholders). However, as described in our primer on Unrestricted Subsidiaries, there are various ways that companies can structure value leakage transactions using investments capacity — so the more prudent approach is to consider investments capacity as potential dividend capacity.

No matter your view on ratio-based RPs vs ratio-based PIs, one thing’s for sure: the deleveraging required to access ratio-based RP / PI baskets is an area where we saw lots of successful investor pushback in 2021. Six sponsored deals saw their RP leverage baskets tightened during marketing, and four of those deals also saw their PI/investment leverage baskets tightened. The chart below shows the changes in these baskets for our six issuers:

Note: Vertical axis indicates where basket leverage is set relative to opening leverage (x EBITDA). Note also that some of these deals have separate limbs for RPs funded from the ‘Available Amount’, we have looked exclusively at the non-Available Amount limbs for the purpose of our analysis.

As illustrated above, Advanz Pharma, Birkenstock and Modulaire Group each saw the dividend limb of their RP-leverage baskets tightened to ~1.0x below opening leverage, while PDA was tightened to 0.6x below opening leverage. Notably, all four of these deals already would have been required to de-lever (at least a little bit) post-issuance, but following the doc changes they ended up around the market standard.

Aggreko actually saw their ratio-based dividend capacity loosened, as they moved from two RP limbs to a single test for all RPs consisting of TNL < 3.6x. Originally, Aggreko had two limbs in their RP-leverage basket: (1) one for subordinated debt / investments (TNL < 3.75x), and (2) another for any other RPs (TNL < 3.5x).

In the prelim OM, all six of these deals had ratio-based investments capacity set at or above opening leverage — in three of the deals it got changed to below opening (Advanz Pharma (0.7x below), Aggreko (0.1x below) and Birkenstock (0.6x below)), in one deal it got reduced to just above opening (Arxada (Lonza Specialty Ingredients) (0.1x above)) and in two deals it remained the same (Modulaire Group and PDA).

We also note that each of Advanz Pharma, Arxada and Birkenstock’s ratio-based PI baskets also included the ability to make investments so long as the leverage ratio would be ‘no worse’ on a pro forma basis. So even though the leverage thresholds for these baskets were tightened, they kept that flexibility.

As a final note, the preliminary OMs of Advanz Pharma and Arxada (Lonza Specialty Ingredients) also included an FCCR no worse limb (i.e., PIs so long as there is no deterioration in the FCCR), but it was removed in both deals.

Five deals saw their Available RP Capacity Amount baskets reduced or removed in 2021. The five deals are shown below (Arcaplanet, Arxada, Birkenstock, Modulaire Group, and Multiversity):

Typically, the Available RP Capacity Amount basket gives issuers the flexibility to convert RP capacity to debt, usually on a 1:1 basis but sometimes permitting RP capacity to be converted to a higher (up to 2x) amount of debt capacity. The logic being that sponsors could, in any event, issue dividends to themselves via the RP covenant then re-inject cash into the business to increase their debt capacity via the contribution debt basket.

In 2021, 37% of European HY sponsor deals had an Available RP Capacity Amount basket, compared to just 13% in 2020. Clearly the trend is towards more deals including it, however, it’s not an automatic win, for example, Birkenstock and Arxada each had the Available RP Capacity Amount concept removed.

Three deals (Arcaplanet, Modulaire and Multiversity) managed to keep their Available RP Capacity Amount, but only by modifying it. We compared the day one debt incurrence capacity under the Available RP Capacity Amount basket based on the final terms of these three deals relative to other 2021 sponsor deals with this concept (where there were no doc changes). Note our calculation assumes that all of the specific RP baskets are fully converted into debt capacity under this basket. Based on 9fin data, the average Available RP Capacity Amount basket for deals with no doc changes in 2021 was ~0.7x EBITDA. Arcaplanet, Modulaire and Multiversity came to market with Available RP Capacity Amount baskets representing ~2.0x EBITDA on average and saw their baskets reduced significantly, but ultimately their average final Available RP Capacity Amount baskets still landed above the average among deals with no doc changes at ~1.0x EBITDA.

See our 9fin Educational on the Available RP Capacity Amount for further detail on how the provision works.

Modulaire and Multiversity’s Available RP Capacity Amount baskets take certain RP baskets and create debt capacity on a 1:1 basis (scaled down from 1:2), which matches their contribution debt baskets which were also reduced from 200% to 100% during marketing (see Modulaire and Multiversity changes). We’ve not seen any transaction have the Available RP Capacity Amount convert debt at a higher rate than the contribution debt basket (this would undercut the logic of the basket).

But Arcaplanet actually saw their Available RP Capacity Amount basket scaled down to 1:1.5 from 1:2, even though their contribution basket remained at 200%. In other words, they incur a 0.5 conversion “penalty” on every dollar of RP capacity converted to debt capacity via the Available RP Capacity Amount basket versus using the contribution basket on a 1:2 basis. In our view, this reduced conversion rate makes some sense considering the Available RP Capacity Amount converts theoretical RP capacity into debt capacity (i.e., the issuer may not actually have cash to distribute, but they have capacity), unlike the actual cash needed to create debt capacity via the Contribution Basket.

There are a few other areas that saw successful investor pushback, below we highlight some that may not have had the level of success as those above, but are still worth mentioning.

Two deals had their “super growers” removed (this is the concept where EBITDA remains at its highest level for purposes of grower basket calculation): Advanz Pharma and Modulaire Group. Generally, 18% of sponsor deals had a super grower in 2021.

Portability was removed from two deals (Golden Goose and Ideal Standard) and tightened in another two deals (Arcaplanet and Multiversity).

Approximately 70% of sponsored European HY deals in 2021 included portability, with portability set at ~0.25x below opening leverage on average. Meaning most deals allow the issuer to increase leverage slightly, and still maintain access to portability.

Arcaplanet’s initial portability clause was set at 6.55x, or 1.50x above opening leverage of 5.05x, significantly more generous than the average. It was tightened to 5.0x during marketing, just below opening leverage.

Multiversity’s prelim portability was set at 4.0x (0.6x below opening leverage of 4.6x), and subsequently tightened to 3.5x, or 1.1x below opening leverage.

For a further discussion of Portability clauses, see our 9fin Educational.

Some debt is not like the others…(for ratio calculations anyway)

Two deals had changes to ratio calculations: Multiversity and Golden Goose.

Golden Goose excluded the RCF drawings from ratio calculations in their initial docs, a bit of financial alchemy that didn’t survive marketing.

Multiversity’s initial drafting went much further and excluded almost all debt incurred under the debt covenant baskets from ratio calculations. That language was completely removed from in Final OM, even though it made it through marketing in Modulaire Group two weeks prior.

See more information about our Covenant Pushback Tracker.

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Restless Investors Covenant Pushback in European HY 2021

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