Thu 04/09/2020 12:33 PM
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Relevant Documents:
M&S 2037 Notes
M&S EMTN Base Prospectus (Nov. 14, 2018) for £250M 2027 Notes (July 8, 2019)
M&S EMTN Base (Nov 14, 2016) for £300M 2023 Notes (Dec. 6, 2016)
M&S EMTN Base (Nov. 9, 2012) for £400M 2025 Notes (Dec. 10, 2012)
M&S EMTN Base (Nov. 11, 2011) for £300M 2021 Notes (Dec. 2, 2011)

March has faced a record $90 billion of credit rating downgrades, according to the Bank of America, as reported in the Financial Times. The wave of rating downgrades of investment grade corporates to junk could gather even more momentum if the coronavirus pandemic continues. Fallen angels can change the composition of the market and finding buyers can be challenging. Amid all the serious consequences of investment grade being downgraded, there is one aspect to such downgrades that is often overlooked: the covenant package of fallen angels.

A company which previously was under a light touch investment grade covenant package could continue to enjoy its freedom under its limited negative covenants despite its credit rating being downgraded to high yield. High-yield covenant packages are typically much more restrictive than an investment grade covenant package.

The retail industry has been heavily affected by the coronavirus pandemic. On March 26, Moody’s and S&P downgraded Marks & Spencer to Ba1 and BB+ respectively, as the pandemic is expected to severely impact its clothing and home business, which will not be fully offset by its food and online sales. If the crisis drags on to the second half of 2020, there could be another rating downgrade. M&S’ notes only carry a narrow negative pledge and an investment grade-style change of control covenant. M&S’ 2037s also carry a limited reporting covenant.

Some high-grade bonds might seek to mitigate a rating downgrade by stepping up the coupon payable if such bond loses its coveted investment grade status. M&S’ ratings downgrade is accompanied by 1.25% per annum step-up in the interest rate for M&S’ notes issued under the EMTN programme.
Investment Grade Covenant Package

Investment grade bonds have limited covenant protection as the debt primarily focuses on the issuer’s credit profile. If rating downgrades do occur, as they have with M&S, companies no longer hold an investment grade credit rating with the related lower risk of default, but have only very limited restrictive covenants under their IG bond documentation.

An investment grade covenant package will typically not include restrictions on incurring unsecured debt, selling assets, making investments, making payments to shareholders or repaying junior debt.

The restrictive covenant package of investment grade bonds may include any (not necessarily all) of the following covenants:

  • Negative Pledge: Prohibits, in certain circumstances, the creation of security unless the same security is granted to the bonds on a pari passu basis. Often, the negative pledge only applies to capital markets or publicly traded debt.



  • Change of Control (IG style): Typically requires the issuer to offer to repurchase the notes at 101% or at 100%, often accompanied with the requirement of a rating downgrade.



  • Limitation on Merger: Prohibits the merger or consolidation of the issuer into another entity unless certain conditions are met.



  • Reporting: Ensures current information on the issuer’s financial position is regularly made available to the noteholders.



  • Sale and Leaseback: Prohibits issuers from selling assets (or removing them from the balance sheet for accounting purposes) and then leasing them back.


Under the limited restrictive covenant package for investment grade bonds, fallen angels, such as M&S, typically have the ability to, among other actions:

  • Incur uncapped unsecured debt;

  • Incur uncapped secured revolving credit facility and other loan facility debt;

  • Make dividends;

  • Make investments outside the group;

  • Freely sell assets; and

  • Enter into transactions with affiliates.


M&S’ bonds’ investment grade covenant package will permit it to incur an uncapped amount of private secured debt that could prime its notes, freely sell assets, and incur an uncapped amount of dilutive unsecured debt.

However, M&S may be constrained by financial covenants (if any) under their £1.1 billion revolving credit facility (which was not available for review).
M&S’ Bonds’ Covenant Package in Brief

 









































































































































































































































Marks & Spencer


09/28/2019

EBITDA Multiple

(GBP in Millions)

Amount

Price

Mkt. Val.

Maturity

Rate

Yield

Book

Market


£1.1B Revolving Credit Facility 1

-


-

Apr-15-2023



£300M Medium Term Unsecured Notes due 2021

300.0


300.0

Dec-06-2021

6.125%


£300M Medium Term Unsecured Notes due 2023

300.0


300.0

Dec-08-2023

3.000%


£400M Medium Term Unsecured Notes due 2025

400.0


400.0

Jun-12-2025

4.750%


£250M Medium Term Unsecured Notes due 2027

250.0


250.0

Jul-10-2027

3.250%


$300M Unsecured Notes due 2037 2

244.1


244.1

Dec-01-2037

7.125%


MTN's - Residual 3

397.1


397.1




Total Senior Unsecured Debt

1,891.2

1,891.2

1.9x

1.9x

Bank Loans and Overdrafts

43.9


43.9




Total Other Debt

43.9

43.9

1.9x

1.9x

Lease Liability

2,523.6


2,523.6




Total Lease Liabilities

2,523.6

2,523.6

4.5x

4.5x

Total Debt

4,458.7

4,458.7

4.5x

4.5x

Less: Cash and Equivalents

(351.4)

(351.4)

Net Debt

4,107.3

4,107.3

4.1x

4.1x

Plus: Market Capitalization

2,060.0

2,060.0

Enterprise Value

6,167.3

6,167.3

6.2x

6.2x

Operating Metrics

LTM Reorg EBITDA

998.8


Liquidity

RCF Commitments

1,100.0

Plus: Cash and Equivalents

351.4

Total Liquidity

1,451.4

Credit Metrics

Gross Leverage

4.5x

Net Leverage

4.1x

Notes:
LTM Reorg EBITDA is calculated as operating profit + depreciation, amortization, and write-offs before adjusting items. The company has a partnership liability to the Marks and Spencer U.K. scheme of £204M. The liability is valued at the NPV of future expected distributions from the partnership and is included as a liability due to it being a transferable financial instrument. Exact liquidity is unknown due to non-disclosure of amounts undrawn under credit lines.
1. Assumed to be undrawn.
2. Converted at a rate of GBP 0.8137 per USD.
3. Calculated as reported medium term notes (net of hedging derivatives) - the sum of known outstanding notes.



M&S’ senior unsecured bond documentation offers very limited covenant protection for noteholders. M&S’ 2027s, 2025s, 2023s and 2021s issued under M&S’ EMTN programme and their 2037s have a narrow negative pledge which does not apply to loans or non publicly traded debt such that private debt can be incurred and secured without any requirement to secure the noteholders. M&S’ notes include an IG-style change of control covenant and the 2037s carry a limited reporting covenant.

M&S’ 2037s, 2027s, 2025s, 2023s and 2021s do not carry any of the following standard high-yield restrictive covenants:

  • Limitation on indebtedness, which includes a prohibition on additional debt incurrence unless a ratio test is satisfied (ratio debt) or a carve-out is provided (permitted debt).

  • Limitation on restricted payments, which limits the making of dividends and certain other shareholder payments, the making of investments outside the restricted group (other than permitted investments) and the repaying subordinated debt.​​​​​​​

  • Limitation on asset sales, which regulates asset dispositions and the use of proceeds, typically requiring that proceeds be employed to repay debt or to make investments.​​​​​​​

  • Limitation on affiliate transactions, which regulates transactions that are not on an arm's length basis.​​​​​​​

  • Limitation on merger, consolidation and sale of substantially all assets, which prohibits the merger or consolidation of the issuer into another entity or the issuer’s transference of all or substantially all of the group’s assets unless certain conditions are met, including the £1 of additional ratio debt test so as to ensure any surviving entity is financially healthy.


 
Detailed Analysis of M&S’ Bonds’ Covenant Package

The 2027s, 2025s, 2023s and 2021s issued under M&S’s EMTN programme include a negative pledge and also carry a change of control put option.

  • Negative Pledge: Requires noteholder interests to be equally and ratably secured should other capital markets debt be secured on the group’s assets or revenues after the date of issue. The requirement to secure the notes only applies where security has been granted to other securities offered primarily to persons resident outside any country in the currency of which the securities are denominated or payable and for the time being quoted, listed or dealt in on any stock exchange. This is a narrow construction for capital markets debt and, in addition, the negative pledge does not apply to a revolving credit facility or any other type of loan facility.



  • Change of Control: Covenant requires the issuer to offer to repurchase the notes at its nominal amount plus accrued interest but only where there is a rating downgrade in conjunction with a CoC. This is weak (compared to high yield) in not requiring a put to the noteholders at 101%.


A CoC occurs where a person, other than a holding company whose shareholders are substantially similar to the pre-existing shareholders of the issuer, has in interest in more than 50% of the ordinary shares or the voting rights of the Marks & Spencer plc.

A rating downgrade occurs where the current rating of the notes (or if not the notes, of other rated senior unsecured debt of the issuer with a maturity of five years or more) is: either withdrawn and not replaced within 90 days of the change of control public announcement; or reduced from an investment grade rating to a non-investment grade rating and such downgrade is confirmed by the relevant rating agency (either Moody’s, S&P or Fitch), to be, in whole or in part, due to the change of control.

The M&S’ 2037s include a negative pledge, a change of control put option and a limited reporting covenant.

  • Negative Pledge: Requires noteholder interests to be equally and ratably secured should other capital markets debt be secured on the group’s assets or revenues after the date of issue, and, positively, as approved by holders with 75% of outstanding notes’ principal or of those constituting quorum in a meeting. Note that the negative pledge only applies where security has been granted to other notes, bonds or other securities offered primarily to persons resident outside any country in the currency of which they are denominated or payable and are quoted, listed or dealt in on any stock exchange. The Negative Pledge, therefore, would not apply to a revolving credit facility or any other loan facility.



  • Change of Control: Covenant requires the issuer to offer to repurchase the notes at 101% of the principal amount plus accrued interest where there is a rating downgrade in conjunction with a CoC.


The change of control in the 2037s has more triggers compared to the other M&S notes. A change of control in the 2037s can occur on the (1) the sale of all or substantially all of the properties or assets (other than by way of a merger or consolidation) of M&S to another person, (2) if any person becomes the beneficial owner of more than 50% of the voting shares of Marks & Spencer Group plc, or (3) where a majority change in directors occurs.

A rating downgrade occurs where a rating below investment grade by each of Moody’s and S&P, within a 60 day period of the change of control announcement, is issued and the downgrade is confirmed by the rating agencies to be, in whole or in part, due to the CoC.

Reporting: Provides that the most recent annual audited financial statements will be provided to noteholders upon their request. This is a limited reporting covenant in not requiring quarterly reports as well as the reporting of material events.

-- Jennifer Pence
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