A group of large high-yield investors, including representatives from Putnam Investments, has discussed organizing to push for stronger protections in new offerings. Steve Peacher, managing director at Putnam, says covenant packages and bond terms in high-yield deals are becoming increasingly issuer-friendly, in part because of the increased appetite for new issues spurred by new money coming into the sector. "In any hot market bankers push for [issuer-friendly] terms and you get a slow migration to the lowest common denominator," he says.
Another reason Peacher sees for the trend of terms that favor issuers is the proliferation of "fallen angels" in the high-yield market. Typically, investment-grade companies include very few covenants in the terms of their deals, so fallen angels are not accustomed to putting strict covenants in their deals, Peacher says. While the trend of looser covenants started with double-B companies, it has migrated to lower-rated companies, such as the recent $2.1 billion offering by Crown Cork & Seal (B1/B+).
Covenants could include restrictions on asset sales, or dictate circumstances under which proceeds have to be applied to reduce debt or to repay bonds, says Alyson Allen, an attorney at Ropes & Gray. They may also restrict the ability of a company to incur additional indebtedness, or restrict payments to groups such as subordinated debt or equity holders. They can also restrict affiliate transactions, or include change of control provisions, which trip an offer to redeem the bonds. Violations of a covenant could give rise to a right to accelerate the principal payments on the bonds, which is "Armageddon," Allen says. In most cases it would lead to a restructuring discussion or a consent fee payment.
Ropes & Gray, a Boston-based law firm, recently was invited by a group of more than 10 buy-side firms, representing "a substantial portion of the primary high-yield buyside community" to give a seminar on high-yield covenants and related issues, Allen says. She declined to name specific firms that attended or if any initiatives emerged.
Rich Zogheb, co-head of leveraged finance at Salomon Smith Barney, which was a joint-bookrunner on the Crown Cork deal, says he has not heard any investors complain that terms are becoming too issuer-friendly, and questions the seriousness of the investors' enterprise based on their choice of counsel. "Why would they go to Ropes & Gray? If you have issues with covenants you go to the main underwriters counsel--Cahill [Gordon & Reindel], Latham [& Watkins] or Cravath [Swain & Moore]."
Ropes & Gray's Allen, when told of those comments, shot back that such words are indicative of "typical New York parochialism."