LONDON, Feb 26 (IFR) - More issuers could loosen covenants and come to the European high-yield market with “high-yield-lite” documentation, following in the footsteps of recent deals from Elis and Faurecia.
Elis and Faurecia’s trades came with high-yield-lite documentation, after both previously issued deals with fully fledged high-yield covenants. Sources said it was rare for a high-yield issuer to drop its covenants.
High-yield-lite documentation excludes typical protections in the asset class, such as a restricted payments covenant, which limits an issuer from paying dividends and making other distributions out of the reach of creditors, and/or debt incurrence covenants, which limit the amount of debt an issuer can raise subject to leverage ratio tests.
“As issuers climb the rating curve into Double B ratings, we expect more to look to loosen their covenant protections and issue high-yield-lite bonds,” said Lisa Gundy, senior covenant officer at Moody’s.
“As their ratings improve, rising stars are looking to move towards investment-grade-style documentation. Cash leakage and debt covenants are suspended if bonds are upgraded to investment-grade. So in the meantime, issuers are seeing if there are any flexibilities they need before that happens,” Gundy said.
One banker confirmed several high-yield-lite trades are currently in the making.
“There are a lot of candidates and a few that have mandated deals, so I expect to see a stream of such issuers,” he said.
High-yield-lite documentation has become more common for Double B issuers in the European market in recent years as issuer-friendly conditions have allowed the sellside to push for aggressive terms.
Just over 33% of high-yield bonds came with high-yield-lite documentation in the first three quarters of 2017, compared to just over 10% in 2014, according to Moody’s data.
While an uptick is anticipated, the banker, who was on both Elis and Faurecia, stressed that the format was not for everyone, being above all a function of company performance and standing, before a trajectory towards an upgrade to investment-grade.
“Investors will only accept lite documentation for specific, recognised credits with size, scale, cashflow and transparency,” he said.
A strong domestic bid, which is often the case for French issuers such as Elis and Faurecia, is also seen as a factor permitting weaker documentation.
The changes come at an interesting time, when storied credits and challenged trades have seen considerable push-back on documentation this year. There is a growing understanding among investors that covenant risk should be assessed contextually, depending on the circumstances of the credit in question.
Sabrina Fox, head of European research at Covenant Review, sees these recent moves to high-yield-lite documentation and growing push-back as different sides of the same coin.
“I’m hopeful that this reflects a shift in approach to taking each credit in context,” she told IFR.
“I do expect that covenant packages for trickier trades will be tighter. But, if companies are better performing and close to achieving an investment-grade rating, investors have tolerance for a lighter covenant package because it’s reflective of the context of the credit.” (Reporting by Yoruk Bahceli, editing by Philip Wright, Julian Baker)