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HIGH YIELD DEBT OFFERINGSLes Journées de l'AFTE - 2015

November 2015

General

• High-yield bonds is a term used to describe non-investment grade bonds issued in private placements to institutional investors (i.e., not in a public offering), but it is more appropriate to categorize them as “quasi-public” securities which are traded.

• Timetable: 8 to 15 weeks, depending on availability of publicly available information on the company (e.g., prospectus, annual report, etc.).

• The market is volatile and the pricing can be sensitive, with variations of 10 to 100 basis points in a given week. Therefore, there can be an “urgency” to “hit” the market in a given week.

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Key Placement Issue

• Will the offering involve a U.S. placement (Rule 144A tranche), or will it be an entirely European placement?

– Most of the tasks will be the same, but there are differences:» Scope of due diligence» Extent of disclosure in offering memorandum» Governing law» Certain of the terms of the bonds

– Rule 144A tranche: offer and sale of bonds in the U.S. only to “qualified institutional buyers” (QIBs), and strict restrictions on “publicity” in the United States before and during the offering period

– Current reality: This has become a trans-Atlantic market

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Key Tasks

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Key Tasks

• Preparation of an offering memorandum, the most time-consuming task

– Form and substance dictated principally by market practice and expectations of the investors. When the European company is listed, its existing disclosure will be a key factor in the preparation of the offering memorandum.

– Similar to a prospectus for an IPO, although the “marketing story” is aimed at debt investors

– The “marketing story” (4 to 6 pages in total): summary business description; strategy; key strengths and key financial data

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Key Tasks (cont’d)

– Key sections: audited and interim financial statements; pro forma capitalisation; use of proceeds; risk factors; detailed description of business; “MD&A” (operating and financial review); description of other indebtedness (e.g., the credit agreements, including their covenants); management; shareholders; and tax consequences to investors

– In addition to the financial statements, the most time-consuming sections to prepare are the risk factors, the business description and the MD&A. See Appendix I

– The terms and conditions of the bonds are also in the offering memorandum

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• Due diligence – Business, legal, financial, accounting, etc. – If there is a Rule 144A tranche, due diligence by the banks and

their counsel will be more extensive. Among other things, banks generally require a Rule 10b-5 letter from counsel to the company and the banks

• Review of other credit arrangements (if any)

• Road shows– Group meetings, as well as one-on-ones– “Pre-deal” road shows

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• Terms and conditions of the high-yield bonds– Complexity of covenant package often depends on expected

rating of the bonds, as well as on market conditions– Market practice is for the bonds to be governed by New York or

English law, but generally New York law. If a Rule 144A tranche, almost certainly New York law. Issuances under laws of Continental European countries are rare

– Heavily negotiated between the company and the banks. Market practice and precedents have an important impact on such negotiations

– Covenants in high-yield bonds are generally less numerous and less restrictive than covenants in credit agreements although their terms are converging

– Subsidiary guarantees and security package (collateral)

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• Rating agency presentations– The anticipated rating of the bonds will impact the covenants that will

be necessary

• Stock exchange listing– Generally Ireland or Luxembourg

• Transaction agreement/documents– Mandate letter (engagement letter)– Indenture or Deed of Trust– Documents for security package (collateral)– Purchase agreement (underwriting agreement)– Comfort letter– Opinions of counsel– Corporate authorizations

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Typical Provisions in High-Yield Notes*

* Generally referred to as “notes” if governed by U.S. (NY) law (and issued pursuant to an indenture) and “bonds” if governed by English law (and issued pursuant to a Deed of Trust).

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Voluntary Prepayments/Redemptions

• The notes are commonly not callable until midpoint of term (generally 3 to 4 years), then they are callable at declining premiums that typically begin at half the interest rate.

• However, the notes may be callable prior to the midpoint of term at a “make-whole” premium based on the present value of the interest payments to, and the redemption price payable at, the first scheduled call date.

• The notes are typically callable in part (typically 35% or, recently, 40%) from proceeds of equity sales (sometimes only public offerings). The call premium generally equals the interest rate.

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Mandatory Prepayments/Holders’ Put Rights

• Change of control put: In the event of a change of control of the issuer, each bondholder has the right to require the company to repurchase some or all of the holder’s bonds, at a price of 101% of principal amount.

• Asset sales: In the event of asset sales by the issuer, save for specified exceptions, net proceeds of asset sales must be applied to prepay certain debt or reinvest in the business generally within six months to a year. If the proceeds are not so applied, they must be used to offer to repurchase the bonds at par. Usually also require that 75% of consideration for asset sales be in cash or cash equivalents.

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Covenants

• The terms of high-yield notes do not require the company to maintain certain financial covenants. They do have a financial ratio, which the company needs to meet on a pro forma basis if it wants to incur material amounts of debt or make material restricted payments (dividends, share repurchases) or take certain other actions, subject to certain exceptions, as described below. The financial ratio in high-yield notes is often a coverage ratio test (EBITDA to interest expense), except that notes issued by “TMT companies” (technology, media and telecom companies) generally have a leverage ratio test (debt to EBITDA) instead.

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Covenants (cont’d)

• Debt – Incurrence of debt is permitted so long as the financial ratio is met on a pro forma basis. Exceptions are negotiated for debt that can be incurred even if the financial ratio is not met.

• Liens – Grant of liens and other security interests on assets is prohibited if liens are being granted to secure pari passu or subordinated debt unless the notes are also secured. There are typically various exceptions to this covenant.

• Guarantees – Guarantees of debt by a subsidiary prohibited unless notes are also guaranteed, sometimes with exceptions.

• Generally, limitations on prohibitions on ability of subsidiaries to upstream cash or other assets to the issuer. Therefore, consensual restrictions on ability of a subsidiary to pay dividends, repay loans or transfer assets to company are prohibited, with exceptions.

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• Dividends, purchases of equity securities and other restricted payments to subordinated debt and equity holders – They are permitted so long as the financial ratio is met and total restricted payments are less than total equity additions and returns on restricted investments plus half of net income (or minus net losses). Exceptions are negotiated for restricted payments that can be made even if the financial ratio is not met or the “basket” is otherwise unavailable.

• Loans, advances and other investments – Typically treated as restricted payments under the covenant discussed above, with exceptions for permitted investments, which include acquisitions of businesses or subsidiaries.

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• Prepayments of certain other debt – Typically no restrictions on prepayment of senior or pari passu debt. For prepayments of subordinated debt, often no restrictions beyond the restricted payments covenant.

• Asset sales – Subject to certain exceptions, asset sales can take place only for fair value, largely for cash or equivalent, and if net proceeds are applied to prepay debt, reinvest in the business or offer to purchase notes. Fair value and cash requirements are often the most meaningful.

• Mergers, consolidations, liquidations, and transfers of substantially all assets – Prohibited for the company and often also for guarantors (but often not for individual subsidiaries), unless a financial ratio is met on a pro forma basis and any third-party successor assumes or guarantees the notes.

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• Transactions with affiliates – Generally must take place on an arm’s-length basis, with exceptions. Often requires transactions above certain monetary thresholds to be approved by a majority of disinterested directors or addressed by a fairness opinion, unless falling within the list of specified exceptions. Occasionally includes a “safe harbor” for transactions approved by a majority of disinterested directors.

• Acquisitions – Generally no explicit restriction on acquiring assets or subsidiaries.

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Reporting Obligations

• Typically, annual audited financial statements and unaudited semi-annual financial statements together with an operating and financial review. U.S. GAAP reconciliation is generally not provided.

• Bondholders and trustee typically do not have any right of access to other, non-public information.

• If the notes are listed on an exchange, the exchange will also have reporting requirements, which generally are not materially more onerous than the negotiated terms.

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Events of Default

• The events of defaults for high-yield notes are less numerous and less restrictive than for “bank” debt. They typically include cross-acceleration and cross-payment default to other debt. Change of control is not a default, but gives rise to a noteholder put right.

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Amendments and Waivers

• Requires approval of holders of a majority or two-thirds of the notes outstanding (or 90%, with some examples of 75% or unanimity, for amendments or waivers of key commercial terms).

• Since covenants are often less restrictive than those of bank debt, amendments or waivers are not often needed. If they do become necessary, they can be difficult (i.e., expensive and time consuming) to obtain.

• In NY law-governed notes, amendments are done by consent solicitation, as compared to bondholder meetings for English law or other European law governed bonds.

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Recent Developments & Trends

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Recent Developments & Trends

• Two key trends: – The U.S. and European markets are increasingly integrated.– Covenant packages and terms of the notes are becoming even

more issuer-friendly.

• Until 2014, European companies were increasingly accessing the US market and sold dollar and/or euro denominated notes to US investors. In the last few months, the reverse has happened; a large number of US companies have taken advantage of the current macro-economic climate which has led to the cost of borrowing in euros reaching a record low as against the dollar.

– In essence, in the current low interest-rate climate, investor demand is huge. European and US companies sell their bonds in the market that offers them the best terms; the geographic boundaries have become largely irrelevant.

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Recent Developments & Trends (cont’d)

• The weaker U.S. terms have encroached into European bonds. We find covenant packages and other terms are structurally similar, but differences remain. In all cases, however, companies have been taking advantage of favorable market conditions to negotiate (much) more flexible terms. Some examples:

– We are seeing more bonds with a tenor longer than the customary 6 or 7 year period. More interestingly, the standard for the no-call period, even for 8 year bonds, has become 3 years.

– The market standard for notice period for redemption has been at least 30 days. This period is now being shortened to 10 days.

– In some deals, companies have the right to redeem up to 10% of the issue at a 3% premium, even during the no-call period. This had been seen in senior secured notes; now it has encroached in a couple of senior unsecured notes.

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– The definition of EBITDA (actually, adjusted EBITDA) is becoming more issuer-friendly, with the company able to add back various items (some quite subjective) to its EBITDA.

– In the last two years, restricted payments have been allowed for so long as the company meets a pro forma leverage ratio, even if it did not have accumulated net income or contribution to capital.

– In the U.S., companies maintain flexibility to layer secured debt ahead of HY notes, without any special restrictions. This is still rare in Europe.

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– It has become customary for most covenants to become suspended once the company become investment grade (other than the negative pledge covenant and the change of control put). We are seeing a permanent fall away (as opposed to a mere suspension) more frequently in the U.S. than in European deals. In the U.S., we are seeing notes being issued with a fairly substantial “starter” restricted payments, which allows the company to make a significant dividend from the outset. This has not yet been seen in Europe.

– “Portability” is becoming common in European issuances, but not in the US. This feature allows, in certain circumstances (if a leverage test is met or provided the change of control does not cause a ratings downgrade, for example), for a change of control of the issuer without requiring a change of control offer to be made to the noteholders.

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Outline of Key Sections ofOffering Memorandum*

* Offering memoranda are tailored to the business and the industry. This appendix notes some typical sections.

Appendix I

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Summary

• The key marketing section of the Offering Memorandum

• Often set in, and described as, a “box”

• Generally includes– summary business description– strategy– competitive strengths– summary of terms of offering and Ts & Cs of the notes– summary financial statements

• About 8 to 15 pages long

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Risk Factors

• Risk factors relating to the notes

• Risk factors relating to the capital structure (e.g., high leverage)

• Risk factors relating to the industry and the business

• Risk factors specific to the company (e.g., specific litigation or IT concerns, controlling shareholders, etc.)

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Business Description

• General market/industry description and (if available and relevant) data

• Detailed description of each division or line of business, including its products, services, customers and suppliers

• Competition

• Sales and marketing structure

• Information technology

• Intellectual property

• Research and development

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Business Description (cont’d)

• Regulation

• Insurance

• Litigation

• Environmental matters

• Material joint ventures, partnerships, contracts, etc.

• Plants and “real estate”

• Management and governance structure and principal shareholders

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MD&A (Operating and Financial Review)

• Summary overview of financial performance and the key factors driving performance

• Review of each key line item of income statement, and analysis of variations from period-to-period

• Review of each key line item of cash flow statement, and analysis of variations from period-to-period

• Review of each key balance sheet item

• Liquidity and description of financing sources

• Review of capital expenditure (historical and projected)

• Qualitative and quantitative disclosures about market risks (review of any hedging or other derivative arrangements)

• Projections (highly tailored)

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About Debevoise & Plimpton LLP

Debevoise & Plimpton LLP is a premier law firm with market-leading practices, a global perspective and strong New York roots. We deliver effective solutions to our clients’ most important legal challenges, applying clear commercial judgment and a distinctively collaborative approach.

We have extensive experience in all aspects of domestic and international leveraged finance, including syndicated bank loans, high-yield debt offerings, second lien financings and mezzanine capital investments. Our European Finance Group includes specialists qualified in English, French, German, Russian and New York law, who are able to offer clients first-rate pan-European and US financing advice.

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Debevoise Team – European Leveraged Finance

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