Junk Debt Investors Win Few Breaks on ‘Worst Ever’ Covenants

(Bloomberg) -- They’re not the “worst ever” lender protections anymore, but they’re still pretty bad.

The $10 billion financing backing the buyout of a Johnson Controls International unit is being offered with some improvements to covenants in the debt agreement, according to people familiar with the matter. In exchange for the tougher documents that govern the borrower, investors are surrendering some yield, the people said, asking not to be identified discussing a private matter.

The bonds and loans, which back the buyout of the Power Solutions unit by Brookfield Asset Management Inc. and Caisse de Depot et Placements, garnered criticism from analysts for granting the borrower and its sponsor too much leeway. After investors complained, a slew of lender-friendly changes were made, including the addition of a quarterly earnings call and limits on dividends for the first year, said the people. Still, they don’t broadly improve the credit accord, with some investors upgrading the analyst categorization from the worst ever, to one of the worst ever. Analysts at high-yield research firm Lucror said the documents remain weak for bondholders.

Despite the covenant concerns, demand for the financing has been overwhelming because investors have limited options in the high-yield bond and leveraged loan markets. That allows borrowers like Power Solutions to get more favorable terms. The loan got $9 billion of orders alone, demand that enabled the acquirers to boost it by $1 billion to $4.2 billion, while cutting a portion of bonds by the same amount. The entire debt package netted nearly $30 billion in orders overall, the people familiar with the matter said.

Lower Yields

Investors also agreed, for a second time, to accept a lower yield on the loan, now offered at 350 basis points above the benchmark interest rate. The original range tabled was 400 basis points to 425 basis points. The original issue discount was also narrowed to 99.5 cents from 98.5 cents initially.

Yields on the bonds were also reduced, with the $1 billion portion of secured notes offered at 6.25 percent from an initial range of 7 percent to 7.25 percent. The $750 million of equivalent euro bonds were offered at 4.375 percent, down from an original range of low 5 percent. Another $1.95 billion unsecured-bond offering is being discussed at a price of 225 basis points above the secured bonds, making further pricing shifts likely.

Buyers are now likening the debt to other aggressive deals like Blackstone Group’s purchase of Refinitiv from Thomson Reuters Corp. late last year. Terms were deemed flawed but investors still piled into a known name that they’d be able to trade in and out of. That loan has generally traded down since it was sold, and is quoted now at 97 cents on the dollar, according to data compiled by Bloomberg.

Other changes made to the loan documents include:

  • Most favored nation provision that sunsets at 24 months rather than 18 months
  • 101 soft call protection extended to 12 months from 6 months
  • Restricted payment amount reduced to $600m from $700m and 37.5% of consolidated Ebitda from 42.5% of Ebitda

Other changes made to the bond documents include:

  • Limitation on indebtedness covenant:
    • Permitted non-guarantor restricted subsidiaries’ indebtedness reduced to the greater of $1.25b and 75% of Ebitda (previously $1.66b and 100% of Ebitda)
    • All non-guarantor debt baskets have been tied to the incurrence covenant, thereby limiting debt that can be incurred by non-guarantor restricted subsidiaries. This was absent earlier
  • Limitation on restricted payments covenant:
    • Existing build-up and general basket reduced
    • After one year from issue date, restricted payments allowed as long as pro-forma net consolidated leverage does not exceed 5.35x (previously payments allowed within that leverage even in the first year)

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