Lexology recently published an article by Baker Botts Partners Justin Hoffman, Douglas Getten, Andrew Thomison, and special counsel Chuck Campbell.

A version of this piece can be read on Lexology, here.

Global Overview

Introduction

Since the 1980s, high-yield debt has been a staple of the capital structure for both public and private companies, and it has been especially prevalent in connection with Large Leveraged buyout financing packages for public companies. High-yield notes are typically structured as a senior unsecured layer of debt that sits beneath the issuer's secured bank financing. Many non-public companies also offer high-yield notes as their first securities offering, often as a prelude to an initial public equity offering.

High-yield notes are characterised by several hallmark features. These include:

• incurrence-based covenants that are generally more flexible than corresponding bank loan covenants, featuring limited affirmative obligations and an absence of financial maintenance covenants;
• an initial period when the bonds are 'non-call', meaning they can be redeemed by the issuer only by paying a premium that includes a net present value of the interest payments for the non-call period, followed by premiums that decline to par for some period prior to maturity;
• a senior ranking; and
• where applicable, guarantees by the ultimate parent company and/ or all or certain of its restricted subsidiaries (generally the same entities that guarantee the issuer's credit facility).

Current market activity

Current activity levels remain robust despite broader market volatility, driven largely by the historically low interest rates that have characterised US fiscal policy in recent years. High-yield issuances totalled roughly US$486 billion in 2021, up from roughly US$467 billion the year before and more than double the amount issued in 2018 (source: Deal Point Data - High Yield Debt Issuances by Year) Source: Deal Point Data - High Yield Debt Issuances by Year). Moreover, high-yield debt makes up a substantial portion of the broader 144A market, with $1.36 trillion and US$1.15 trillion of total 144A issuances in 2021 and 2020, respectively according to SIFMA (source: SIFMA — Background Briefer on Rule 144A + Rule 15c2-11). Energy, materials and utilities, consumer discretionary and communications have generally comprised the lion's share of the corporate high yield debt market. In recent years, traditional energy producers and services companies have had more limited access to the market due to investor fatigue from the most recent commodity downturn, which drove a significant number of companies into bankruptcy and/or consolidation. Environmental., social and governance (ESG) concerns have also driven investors away from all but the most highly rated and Lowest Leveraged of these traditional energy credits. ESG concerns have also driven bond offerings that are rated as 'sustainable' by a third party in connection with the issuer's adoption of green bond principles that will govern the use of proceeds from the bonds.

Issuance process

The main participants in a high-yield debt financing include company management, investment bankers, issuer's counsel, initial purchasers' or underwriters' counsel., as well as auditors, rating agencies, the trustee, the Depositary Trust Company and the collateral. agent (in the case of secured bonds).

The launch, pricing and closing of high-yield debt securities is coordinated by the investment bank in consultation with the issuer. Although high-yield securities are typically issued in unregistered offerings, high-yield offerings are typically conducted with a prospectus and registration statement or an offering memorandum that meets all material disclosure requirements of the U.S. federal. securities laws applicable to a registered offering of debt securities, incLuding audited financial. statements. In particular, the underwriters will engage in extensive due diligence reviews to take advantage of the legal Liability due diligence defences under sections 11 and 12(a)(2) of the Securities Act of 1933 (the Securities Act). This process entails an extensive review of the issuer's business and financial condition, which is supported by a robust document review conducted by the underwriters' counsel.

Prior to pricing, the investment bank's counsel will tie out the factual non-financial information in the offering document and negotiate the comfort letter covering the financial. information. At pricing, the auditors will deliver their signed comfort letter.

Concurrently with the diligence and comfort process, the issuer, the investment bank and both of their counsels will draft the offering documents. Prior to launch, the teams will finalise the offering memorandum or prospectus, incLuding a description of notes, which is then sent to investors. Many deals are 'pre-marketed' where a 'non-deal roadshow' is initially conducted using company information (excluding any discussion of the actual note terms), and following investor feedback, the offering is officially launched. The underwriters will complete their due diligence efforts prior to launch to ensure that the documents are accurate and the negative assurance letters of the counsel can be delivered without qualification. At pricing, the issuer and the initial purchasers or underwriters will execute the purchase or underwriting agreement, and investors will confirm their purchases of the securities upon receipt of the final term sheet.

Closings for high-yield debt securities sold under the Rule 144A exemption are almost always conducted through the Depository Trust Company. Closing typically occurs two to 10 business days after the date of pricing, although the SEC has recently proposed shortening the standard settlement cycle to one business day (source: SEC.gov | Statement on Proposal. to Shorten the Standard Settlement Cycle). In acquisition transactions or transactions where there is a contingency to the ultimate use of proceeds, the proceeds from the issuance may be funded into escrow, and the bonds will be subject to mandatory redemption by the issuer if the acquisition or other contingency does not occur by a specified date. If the acquisition does not close within a specified period of time, the issuer is required to redeem the bonds.

Structuring considerations and common features

Maturity and call protection

The maturity of high-yield notes generally ranges from five to 10 years, but longer and shorter terms are sometimes seen. High-yield bonds will generally be 'non-callable' for the first two to four years, depending on maturity.

The most common structures seen today are a five-year term, with a non-call period for the first two years, and a seven- or eight-year term, with a non-call period of the first three years. The yield protection is generally a premium set at either 75 per cent or 50 per cent of the initial coupon following the non-call period. 'Non-call' is a bit of a misnomer as most bonds are redeemable at all times. However, any redemption by the issuer in the non-call period will involve both the payment of the call premium plus the net present value of the interest payments due through the non-call date, usually discounted at a reference US treasury rate plus 50 basis points. Other redemption features include an equity claw which applies during the non-call period and allows the issuer to use proceeds of certain equity offerings to call 35-40 per cent of the bonds at a price of par plus the coupon.

Covenant package

The general covenant package for high-yield debt securities is fairly consistent across industries. At a high level, high-yield covenant protections are largely focused on cash and value leakage out of the 'restricted group' (ie, the issuer and its restricted subsidiaries) and debt that is priming from a seniority perspective Lie, secured debt, as high-yield deals are most commonly unsecured). To prevent cash leakage upstream to the equity holders or downstream into entities that are not subsidiaries Leg, joint ventures) or unrestricted subsidiaries, there is a restricted payments covenant, which regulates both types of payments (dividends and investments). The debt covenant will limit the amount of additional debt that can be incurred, most notably for unsecured notes by imposing hard caps on secured debt in conjunction with the liens covenant. To further prevent value leakage, the asset sale covenant requires that sales of assets be made for at least 75 per cent cash consideration and that cash from asset sales be reinvested into the business or used to repay other senior debt. Other covenants include a limitation on dividend blockers and other payment restrictions affecting subsidiaries, future guarantor obligations, limitations on transactions with affiliates, limitations on a change of control, limitations on mergers, consolidations or sale of substantially all of the assets, and affirmative obligations related to reporting.

Despite the common features noted above, each industry has devised baskets and exceptions to the general covenant package due to the specific needs of companies within that industry which have become generally acceptable for issuers within those industries. Additionally, these covenants are more likely to be negotiated based on the issuer's specific business and near-term business objectives, as well as by reference to bond terms of competitor companies in the issuer's space.

Credit support and collateral.

Subsidiary guarantees are very common in high-yield debt security issuances and if the issuer has an existing credit agreement with subsidiary guarantors, generally the same entities would also guarantee the bonds to ensure no additional credit support leakage. Guarantees by the ultimate parent company of the issuer, although less ubiquitous than subsidiary guarantees, are also relatively common in high-yield offerings. As mentioned above, high-yield notes are most commonly issued as senior unsecured debt, but generally there are three common structures with respect to secured bonds: (1) high-yield debt securities and bank agreements share pari passu in the same collateral pool, (2) crossing liens, where bank agreements are secured by a first lien on the same collateral pool that high-yield debt securities have a second lien on or (3) bank agreements and high-yield debt securities are each secured by separate collateral. In the case of first-lien bonds, the collateral package will frequently include substantially all of the issuer's assets, subject to certain customary and negotiated exceptions. Asset-based credit facilities may be secured by a separate current asset collateral package, and the bonds may not have a lien on that colateral, although occasionally the bonds may be secured by that collateral on a second lien basis.

Intercreditor agreements are often entered into between the trustee for high-yield debt securities and the administrative agent for bank agreements, for the benefit of the holders and lenders respectively. Intercreditor agreements set out the rights of each group in relation to the shared collateral in the event the issuer or borrower defaults on its obligations under the debt documents. In a transaction structure where the bank agreement is secured with a first lien and the high-yield debt securities are secured by a second lien on the same collateral, the inter-creditor agreement will also include subordination provisions whereby the securities holders' right to receive proceeds from the collateral is subordinated to the right of the lenders under the bank agreement. The bank agreement administrative agent will typically have control over the collateral, and the trustee will only have voting or objection rights on a limited number of matters.

Practical considerations

Private companies wishing to access the high-yield securities market should treat the process similar to an initial public offering, without the SEC review process. In particular, issuers should confer with bankers as well as experienced counsel about expectations for the offering process well in advance of launch of a transaction. Public companies also need to be mindful of equity reporting issues Leg, earnings guidance) and other communications issues that can arise during the pendency of a private offering (such as a previously scheduled conference or media appearance).

To read the full article, click here.

ABOUT BAKER BOTTS L.L.P.
Baker Botts is an international law firm whose lawyers practice throughout a network of offices around the globe. Based on our experience and knowledge of our clients' industries, we are recognized as a leading firm in the energy, technology and life sciences sectors. Since 1840, we have provided creative and effective legal solutions for our clients while demonstrating an unrelenting commitment to excellence. For more information, please visit bakerbotts.com.