Aggressive Terms Spotlight: Leverage-Based Value Leakage Baskets Easier to Access in June US High-Yield Documentation

High-yield bond offerings reviewed by Americas Covenants by Reorg in June, suggest an increased frequency of deals providing access to leverage-based payments baskets at issuance. In 60% of June deals, leverage-based investments were accessible on day 1, compared with 53% in Q2 2024 overall and 43% in Q1 2024. Day 1 access to leverage-based restricted payments baskets was available in 38% of June deals compared with 35% in Q2 overall and 29% in Q1 2024.

In addition, in 23% of June deals, a leverage-based payments basket was subject to a first lien or secured leverage ratio test; not a total net leverage ratio, as is typical in the market. By contrast, only 6% of Q1 2024 deals reviewed included this provision.

Historically, leverage-based payments baskets offered an incentive to issuers for good financial performance, by providing unlimited restricted payments and/or investments for value leakage, conditioned on meeting a specified pro forma leverage test. To that end, the applicable leverage test should require meaningful deleveraging before the access becomes accessible. However, our data suggest that these baskets increasingly may require no deleveraging for access.
   
Deals reviewed by Americas Covenants in June also showed an increased use of change-of-control portability provisions relative to deals reviewed in the first quarter. Ratings-based portability was included in 54% of June deals, compared with 42% in Q2 deals overall and 33% in the first quarter. Ratio-based portability was included in 23% of June deals, compared with 12% in Q2 overall and 11% in Q1.

Portability is unfavorable to noteholders because it strips their right to put the notes at 101% after a change of control, if certain conditions are met. Generally, leverage-based portability means that the change-of-control put is not triggered if the company meets a specified leverage test, pro forma for the change-of-control transaction, and ratings-based portability means that the put is not triggered unless the notes are downgraded by one or more ratings agencies. One rationale for such portability provisions is that a change of control should not trigger a 101% put unless the company will be overleveraged post-transaction or risk to noteholders will otherwise be increased. However, this provision is seen as aggressive because it limits noteholders’ ability to exit their investment following a fundamental change with respect to the issuers’ leadership, and accordingly diminishes noteholders’ bargaining power.
 
A summary of the frequency of material aggressive terms present in U.S. high-yield documentation in deals reviewed by Americas Covenants in June is presented below. The data are based on the offering memoranda terms of deals announced in June, with certain exclusions, such as deals lacking full covenant packages. The data reflect amended terms where applicable, based on the most updated documentation received by Reorg.