That said, the high yield bond market has seen some loan-style terms crop up on occasion
Areas of Convergence
With the rising dominance of product-agnostic institutional investors focused more on yield than value investing, and traditional banks adopting more of an « originate and sell » model (with a correspondingly diminished role in on-going compliance monitoring) coupled with influential sponsors driving for more flexibility, the gradual shifting of loan terms towards a bond-style covenant package is has become the observed trend in the market.
As noted above, the « convergence » of bond and loan terms is arguably more of a unidirectional shift of loan terms towards a bond-style covenant package (i
Set forth below are some areas in which the leveraged loan market is currently seeing an increased penetration of bond-style terms:
- Yield/OID: original issue discount (or OID), a bond feature, has now become a standard component of TLB loan pricing. As a result, leveraged loan pricing is now thought of in terms of an overall “yield” (terminology originating with bonds), rather than a margin over LIBOR or EURIBOR. This is an important economic distinction for purposes of the “most favoured nation” (« MFN ») provision, and whether the term « interest rate » or « yield » is used therein is highly negotiated.
- Restricted/Unrestricted Subsidiaries: one of the first bond-like features that began appearing in term loan agreements was the concept of “restricted subsidiaries,” which limits the application of covenants and events of default to the borrower and only certain designated subsidiaries, whereas the « unrestricted subsidiaries » are excluded from covenants and EBITDA and other financial calculations.
- Restricted Payments – Unlimited Payments on Holdco Debt: an aggressive feature even in the high yield market but has started to appear in TLBs (e.g. Stada). This feature effectively allows a company to use its debt capacity to raise debt at the parent level for purposes of paying a dividend to shareholders without being constrained by the restricted payments covenant. 1
- Debt Incurrence – Ratio Debt: in high yield bonds, issuers are permitted to incur unlimited debt subject to meeting a pro forma FCCR test. Many TLBs/cov-lite loans in the large cap ount subject to a ratio-based test (often set at closing date leverage) plus an additional « free and clear » basket (based on a half-turn or a full turn of EBITDA).
- Debt Incurrence – Incremental Debt: MFN protection (which is not a feature in high yield bonds) is now becoming increasingly inapplicable to certain types of incremental debt.
- Debt Incurrence – Contribution Debt: a high yield bond concept which allows the borrower to incur debt equal to 100% (or occasionally up to 200% – more so in the U.S. market) of equity proceeds it receives from its investors. This concept is now appearing occasionally in TLBs, though it has not yet become mainstream.
- Events of Default: the extension of grace periods for interest payment defaults (to 30 calendar days) and covenant defaults (to 60 days), and the use of a « cross-acceleration » concept instead of a « cross-default » concept in leveraged loans are all the result of high yield bond influences. Additionally, a change of control or a breach of representation/warranty may no longer constitute an event of default, which is also a bond feature.
- General – EBITDA: EBITDA add-backs are becoming harmonized between bonds and loans and more borrower/issuer friendly, such as the inclusion of add-backs for extraordinary, unusual or non-recurring items, and project cost savings and synergies.
- General – Total Asset or EBITDA-Based Grower Baskets: a high yield bond feature which gives flexibility to issuer to increase dividend or debt capacity based on a growth metric without the need to seek bondholder consent personal payday loans Tazewell TN. EBITDA growers are more borrower/issuer friendly because it is subject to adjustments