High yield: junk or joy?
DACT Treasury Beurs
11 November 2011
High yield: junk or joy?
European high yield – a source of
liquidity and refinancing opportunities
for Dutch corporations
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High yield: junk or joy?
Introduction
Gregory Crookes
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High yield: junk or joy?
Introduction
Gregory Crookes Clifford Chance Amsterdam
Partner – Corporate M&A and private equity
Finding liquidity
Jelle Hofland Clifford Chance Amsterdam
Partner – Banking & finance and restructuring and insolvency
The high yield market
Michael Dakin Clifford Chance London
Partner – High yield and capital markets
Offering securities: high on regulation?
Tineke Kothe Clifford Chance Amsterdam
Senior Counsel – Banking and securities law and capital markets
High yield versus bank loans – discussion
Gregory Crookes (moderator), Michael Dakin, Jelle Hofland and Tineke Kothe
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High yield: junk or joy?
Finding liquidity
Jelle Hofland
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Current financial markets – traditional bank loans

Traditionally, the Dutch corporates generally finance themselves with traditional bank
loans in a variety of forms:




Bilateral facilities versus club deals versus syndicated loans
Term loans and revolvers
Guarantee facilities
Committed versus uncommitted versus until further notice.

With pressure on liquidity and the unstable economy, banks appear to have become more
picky and critical as to the level of debt they are willing to provide and generally require
more credit protection (in respect of the borrower group and versus other financiers).

The investment grade and other “high quality” borrowers (from a credit perspective and/or
from side business opportunities) will generally still not have much problems to continue
tapping the bank markets as they did before, although there may be some tightening of
freedom.

Other types of borrowers (because of sector issues, individual problems or other reasons)
encounter more problems to refinance at same levels or similar terms.

They may also have more trouble to generate appetite to provide event driven financing
at all or on short notice (eg to do strategic acquisitions).
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Current financial markets – alternative sources

Bank facilities will remain required as they provide for the largest range of products and
flexibility in financing options, but borrowers are wise to investigate other pockets of
liquidity.

Certain borrowers have always looked at these alternative sources to provide a level of
liquidity (such as securitisations, factoring, high yield, sale and leaseback structures and
private placements). Also, supply chain finance (with or without backing by a bank) can
ensure a diversification of financing sources.

A lot of corporates however dislike the idea of managing different debt layers (and
entering into complicated intercreditor arrangements), incurring the related costs and
entertaining the perceived never ending need of alternative financiers for more strict or
specific information requirements, administration systems and credit protection.

There is some merit in these contra arguments, but part of it is also because “unknown
makes unloved”. Once you get to know these products, the advantages can be multiple
and most of these can work perfectly together with the traditional bank loans.

Also, going through these processes can create a huge learning curve for an
organisation and individuals involved, and create more efficiency and risk awareness.
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Current financial markets – high yield bond alternative

In this workshop, we would like to focus on one of the alternative sources to bank funding:
(not surprisingly given the title) high yield bonds.

High yield bonds are not necessarily the product for everyone, but it may be a real
opportunity for more borrowers than you would expect.
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High yield: junk or joy?
The high yield market
Michael Dakin
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The European bank and high yield market
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The refinancing wall
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The refinancing wall
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Fallen Angels and cross over credits

Fallen Angels account for about 30% of total debt maturities of rated EMEA speculativegrade corporate.

Fallen Angels now account for the largest portion of annual refinancing needs in every
year until 2015.

Of the 34 biggest issuers in the speculative-grade universe, 13 of which are Fallen
Angels.

The outstanding debt of the Fallen Angels amongst the largest issuers continues to
represent around 20% of total debt for rated speculative-grade corporates.

The Netherlands has upwards of €7.25 billion bank/bond maturities between 2012 to
2015.

The Netherlands represents 4% of EMEA maturities between 2012 to 2015.
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Key features of high yield bonds

Traditionally two tiers of contractual ranking:
 Senior = has not agreed to be subordinated to other indebtedness in right of payment
(but may be effectively subordinated to secured debt)
 Senior subordinated = has agreed to be subordinated to some financial indebtedness,
but not other obligations, such as trade payables.

Many European deals traditionally feature structural subordination (eg the issuer of the
notes is the parent of the borrower of the bank debt).

Europe is increasingly seeing secured high yield note issuances.

Primary governing document = trust indenture/trust deed.

Passive relationship with noteholders via trustee means less intrusion into company
affairs, but also makes it difficult to cost-effectively modify terms.

No financial maintenance covenants - just a test at the time certain events occur (eg debt
incurrence or when restricted payments (like dividends) are being made).
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Key features of high yield bonds (continued)

Change of control requires a repurchase offer (usually at 101%).

Usually not prepayable (“non-callable”) for a few years, then with a premium
 Make whole premiums may be used to shorten non-call period
 Fixed rate notes typically are non-callable for half their tenor and thereafter callable at
fixed redemption premiums
 Floating rate notes allow redemption sooner and at lower premium
 IPO call of up to 35% of bonds at par plus coupon (“equity clawback”).

Bonds are a security, so securities law concerns come into play
 US private placement issues/10b-5 liability
 Listing issues.
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The pros and cons of high yield bonds

Attractive features of high yield bonds include:
 Incurrence only covenants
 Long tenors (7 to 10 years)
 Bullet payments
 Ability to incur more leverage
 Lower sensitivity to uses of proceeds (eg acquisitions, etc)
 Potential to do unsecured deals
 Ease of raising additional debt (eg tap issuances)
 Liability management transactions (eg open market purchases, tenders, etc).
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The pros and cons of high yield bonds (continued)

Less appealing features of high yield bonds include:
 Disclosure and due diligence
 The cost of disclosure and due diligence (but, it is a long term
investment – see above regarding ability to do tap deals, etc)
 Availability of financial statements
 Timing
 Difficulty in amending terms
 Limited redeemability/callability.
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Key milestones for typical high yield transactions
Corporate refinancings
Engagement/
Engagement
Letter (?)
Structuring
Kick-off
Meeting
Prospectus Drafting
and Due Diligence
Negotiation of
Description of
Notes
Launch
Transaction
Pricing
Closing
The high yield process is often run in parallel with a refinancing of an existing credit
agreement and certain aspects of the two processes can be run simultaneously for
purposes of efficiency.
* NB: the Rating Agency process has been omitted from the above, but is an essential part of the
underwriter’s role in a high yield issuance and typically runs simultaneously with the prospectus drafting and
due diligence.
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Sample due diligence and drafting timetable
 Typical offering process for a new issuer would take 8 to 12 weeks
 Kick off meeting
T
 Commence drafting of OM “wrap”
T+1
 Due diligence request list agreed
T+7
 Management due diligence meeting
T+14
 Commence drafting of Business/Risk Factors/MD&A
T+15
 Data room open
T+21
 First draft of OM circulated
T+28
 Documentary due diligence completion
T+28
 First drafting session on OM
T+30
 Second draft of OM circulated
T+35
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Sample due diligence and drafting timetable (continued)
 Second drafting session
T+37
 Third draft of OM circulated
T+42
 Third drafting session
T+44
 Fourth draft of OM circulated and sent to printer
T+49
 Drafting sessions at printer
T51-54
 Bring down diligence conference call
T+55
 Launch roadshow
T+55
 Print preliminary OM
T+55
 Drafting and negotiation of the Description of the Notes to occur throughout the process
 Ratings agency process to also run simultaneously and to be managed by banks
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Major differences between high yield and investment grade
bonds
Terms among various high yield, cross-over and investment grade bond deals vary
significantly within each such asset class, the below chart illustrates the significant differences
between generic standardised transactions of these types:
Covenant / Event of Default
Traditional
High Yield
HY w/Fall-Away
/ Suspension
Cross-Over
Credit
Investment
Grade
Debt incurrence
Yes
No
Varies
No
Restricted payments
Yes
No
Varies
No
Liens / negative pledge
Yes
Yes
Yes
Yes
Dividend blockers
Yes
No
Varies
No
Merger, consolidation and sale of
assets
Yes
Partial
Varies
Varies
Transaction with affiliates
Yes
No
Varies
No
Designation of restricted
/unrestricted subs
Yes
No
Varies
No
Guarantees of other indebtedness
Yes
Yes
Yes
No
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Major differences between high yield and investment grade
bonds (continued)
Covenant / Event of Default
Traditional High
Yield
HY w/FallAway /
Suspension
Cross-Over
Credit
Investment
Grade
Yes
No
Varies
No
Change of control
Offer @ 101
Offer @ 101
Offer @ 101
Varies
Asset sale
Offer @ Par
No
Varies
No
Non-payment
Yes
Yes
Yes
Yes
Covenant default
Yes
Yes
Yes
Yes
Cross acceleration
Above
threshold
Above
threshold
Above
threshold
Above
threshold
Judgment default
Above
threshold
Above
threshold
Above
threshold
Above
threshold
Bankruptcy
Yes
Yes
Yes
Yes
Illegality / unenforceability /
repudiation
Yes
Yes
Yes
Yes
Sale and leasebacks
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Major differences between credit agreements and high yield
bonds
Senior Credit Facilities:
 Term Loans
 Revolving Credit Facilities
High Yield Bonds:
 Senior = has not agreed to be contractually
subordinated to other indebtedness (but may be
effectively subordinated to secured debt)
 Senior subordinated = has agreed to be
subordinated to some financial indebtedness, but
not other obligations, such as trade payables
Governing Doc
Credit Agreement
Trust Indenture
Guarantees
and Security
Often (typically) secured by most or all of the assets
of the borrower.
Operating company notes usually have subsidiary guarantees.
Relationship
with Debtors
High yield: junk or joy?
May be supported by:
 Secured guarantees of the borrower’s
subsidiaries, and/or
 A guarantee by the borrower’s parent, if any
(secured by a pledge of the borrower’s stock).
Holding company notes usually do not have subsidiary
guarantees:
 Discount notes, PIK notes, etc, are common at the Holdco level
since Opco payments up for debt service will usually be
restricted
 May be partly or fully secured, on a first or second lien basis.
Active relationship with agent and lender group
means more intrusion into company affairs, but also
offers easiest method to modify the credit terms.
Passive relationship with noteholders via trustee means less
intrusion into company affairs, but also makes it difficult to cost
effectively modify terms.
Private communications possible, even for public
reporting borrowers.
Communications are assumed to have the potential to become
public.
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Major differences between credit agreements and high yield
bonds (continued)
Senior Credit Facilities:
High Yield Bonds:
Covenants
Almost always include financial maintenance
covenants.
Almost always involve an incurrence test at the time certain
events occur (eg debt incurrence or when restricted payments
(like dividends) are being made).
Ability to
prepay
Prepayable at any time, usually with no premium.
Usually not pre-payable (“non-callable”) for a few years, then with
a premium:
 Make whole premiums may be used for shorter non-call
period
 Generally a tender offer equal to the cash flows to the first call
discount at the sovereign rate plus 50 basis points will be
successful
 Floating rate notes allow redemption sooner and at lower
premium.
Change of
control
Change of control usually gives rise to an
immediate obligation to make a mandatory
prepayment in full.
Change of control requires a repurchase offer (usually at 101%).
Other
distinguishing
features
Representations and warranties repeated with each
borrowing.
Bonds are a security, so securities law concerns come into play:
 US private placement issues / 10b-5 liability
 Other securities laws and listing issues.
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High yield: junk or joy?
Offering securities:
high on regulation?
Tineke Kothe
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Bank lending versus capital markets

Higher capital requirements for banks under Basel III will result in less lending by banks,
forcing borrowers to look beyond bank financing to capital markets.

The capital markets are generally more regulated than bank lending transactions.

Issuers have disclosure obligations at time of issuance (prospectus), in particular when
offering securities to retail investors or listing securities on regulated markets…

… and issuers also have ongoing reporting obligations under transparency and market
abuse rules.

However, many exemptions are available in the EU for disclosure and reporting
obligations, for example, when offering highly denominated securities or when restricting
the offers to qualified investors.
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Bank lending versus capital markets (continued)

Depending on the investor base US and other securities regulations may apply.

Documentation includes prospectus / offering memorandum, subscription / purchase
agreement, agency agreement and trust deed / trust indenture…

… and generally more parties are involved than in bank lending transactions (paying
agents, trustee, regulators, stock exchanges, rating agencies and auditors).

Amendments to terms and conditions of the securities may require holders’ consent.
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This presentation is not intended or written to be used, and cannot be used by any person,
for the purpose of avoiding US federal tax penalties, or promoting, marketing or
recommending to another party any transaction or matter addressed herein. Each recipient
of this presentation that is not a client of Clifford Chance US LLP with respect to the matters
discussed herein should seek advice based on such recipient’s particular circumstances from
an independent tax adviser.
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