Junk Bondholders Make Limited Progress in Europe's Covenant War

  • Companies are adding `aggressive' terms to bond documents
  • Investors are struggling to push back against provisions

Junk bondholders are struggling in a battle to protect their investments in Europe.

While investors have made some progress reducing punitive provisions such as portability, which can erase their redemption rights when an issuer is acquired, companies are increasing the use of clauses that allow them to pay dividends to shareholders, according to independent credit research company DebtXplained.

“Deals can easily come to market with 10 to 15 aggressive terms in them and when investors push back, they normally only manage to remove about three,” said Stephen Mostyn-Williams, founder and chairman of DebtXplained. “That limits the impact of any push-back, since whatever they manage to remove is just a small portion of the terms that might later threaten their investment.”

Better Disclosure

Creditors are campaigning for better disclosure of clauses that diminish their safeguards and some are asking for issuers’ lawyers to summarize and explain key covenants in the first few pages of sale documents, which can run into hundreds of pages, according to people familiar with the matter. The Association for Financial Markets in Europe is aware of investors’ concerns and plans to discuss the matter within its high-yield division, according to Gary Simmons, director of the group.

“Most investors face a covenant package now with a look of despair,” Martin Reeves, head of global high yield at Legal & General Investment Management and co-vice chair of AFME’s division, said at the industry group’s high-yield conference in London last week. “The trust needs to get rebuilt.”

The balance of power may be shifting to bondholders as demand for risky assets wanes amid concerns about slumping commodity prices and rising rates. Average yields reached a more than two-year high of 5.73 percent this month, according to Bank of America Merrill Lynch index data, and junk bond sales fell 19 percent to 55 billion euros from a year earlier, data compiled by Bloomberg show.

Credit Conditions

“We’ve seen, overall, more favorable covenants for issuers,” said Apostolos Gkoutzinis, partner and head of European capital markets at Shearman & Sterling. “As credit conditions change, as the cycle changes, we may see movement of covenant terms in the opposite direction.”

Portability provisions featured in 26 percent of deals analyzed by DebtXplained this year, down from 40 percent in 2014. Interoute Communications Ltd., the owner and operator of a European fiber network, removed the term from a 590 million-euro bond sale last month after investors objected, Chief Financial Officer Catherine Birkett said at AFME’s conference. More than 20 asset managers including AllianceBernstein LP and Schroders Plc complained about the clauses in an open letter in February.

“There are provisions that have become widely used in Europe merely because they’ve been included before and investors should be more aware of them,” said Jane Gray, co-head of European research at Covenant Review in London. “They should take a more critical view.”

Leverage Tests

Companies are giving themselves greater flexibility to pay shareholder dividends even when a net-income test wouldn’t allow it. About 54 percent of deals analyzed by DebtXplained this year allow use of less-stringent leverage-ratio tests instead of net-income limits, compared with 38 percent in 2013. Average testing levels on debt to earnings in the deals also weakened to 3.6 times from 2.9 times.

Companies are also including provisions that make it easier for them to tap existing notes using the same collateral they’ve already pledged, thereby reducing creditors’ claims in a default, according to Covenant Review.

French cargo handler WFS Global Holding SAS included both the collateral and leverage provisions in bonds to fund its purchase by Platinum Equity, according to Covenant Review. Glassmaker Verallia SA sold bonds containing the collateral feature for its buyout by Apollo Global Management LLC and Spanish sausage maker Campofrio Food Group SA included the leverage test in an offering in March, the research firm said.

Officials at WFS and Verallia didn’t respond to requests for comment on their bond terms. Luis Montesinos, treasurer of Campofrio, declined to comment on the deal terms.

Bondholder protections are also being eroded in the U.S., according to Moody’s Investors Service. The rating company’s covenant-quality gauge weakened to 4.29 for dollar-denominated high-yield bonds issued in September from 4.17 a year earlier, on a scale of one to five.

“We are in the midst of a miniature standoff between issuers and investors,” said Evan Friedman, a Moody’s analyst in New York. “It’s going to take a little time for covenants to get better.”

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