Over the past two years, Canada has witnessed the emergence and growth of a highyield debt market – a financing market historically limited to the United States. The growth of this new market can be primarily attributed to (i) Canadian investors seeking alternative high-yield investments to fill the void caused by the dissolution of the income trust market; (ii) Canadian investors’ increased appetite for risk in a lowinterest rate environment; and (iii) general receptiveness of the capital markets to known Canadian companies. A diverse range of issuers – in the logistics, transportation, food services, media, and oil and gas sectors – have recently completed offerings. These issuers include portfolio companies of private equity and pension funds.
To date, Canadian issuers have made use of the Canadian high-yield debt market primarily to refinance their existing debt and for dividend recaps. High-yield debt offerings can also be used to finance acquisitions (with a bank “bridge” backstop), and it will be interesting to see if this well-established U.S. practice is adopted in Canada.
From a Canadian issuer’s perspective, there are several advantages to issuing highyield debt in Canada compared with an equivalent offering in the United States. These advantages include (i) having Canadian dollar–denominated debt, which helps eliminate the cost and risks associated with having U.S. dollar debt (including currency hedging); (ii) the ability to do smaller offerings (with the current rule of thumb being a minimum offering size in Canada of approximately C$100 million, compared with US$200 million in the United States); and (iii) a Canadian offering being a comparatively simpler and less expensive process, both at the initial issuance stage and on an ongoing basis. For issuers also wanting to tap the U.S. market, a portion of a Canadian offering can be sold in the United States on a private placement basis in conjunction with the Canadian offering.
A Canadian high-yield offering can be completed in a relatively short period of time (as little as six to eight weeks). The debt is marketed to institutional investors on a private placement basis without the need for securities commission review. Unlike traditional U.S. high-yield debt offerings, the debt is not subject to a registration requirement. Instead, the agents or underwriters of the offering normally facilitate a secondary market among institutions. The steps involved in a typical Canadian high-yield offering include the following:
- preparing an offering memorandum (similar to a long form prospectus), including negotiating a detailed “Description of Notes” setting out the covenants;
- the underwriters or agents completing a due diligence review of the issuer;
- holding a road show to canvass institutional investors;
- pricing the issuance and negotiating an underwriting or agency agreement; and
- closing and funding (typically five business days after pricing).
The covenant pattern in the indentures for Canadian high-yield debt is very similar to that seen in the U.S. market. While more restrictive than investment-grade issuances, the covenants are much less onerous than traditional bank loan agreements. Unlike bank loans, which typically impose financial maintenance covenants and detailed restrictions on the operation of the issuer’s business, high-yield debt will contain only incurrence-based covenants and will not include operational restrictions. Key covenants in a highyield indenture are typically limited to restrictions on the incurrence of additional debt, restricted payments (i.e., payments to junior stakeholders, including shareholders), transactions with affiliates, dispositions of assets, the imposition of additional liens, new investments, and mergers and consolidations, in addition to financial reporting requirements.
One disadvantage to high-yield debt as a financing option is its limited flexibility once put into place. Unlike traditional loan transactions, in which an issuer typically deals with a single lender or a small syndicate of relationship lenders, high-yield debt is broadly distributed and institutionally held, so that obtaining bondholder consent for a waiver or an amendment can be challenging and costly. In addition, high-yield debt will include a “no call” period in the initial years (during which repayment is subject to a make-whole) and a declining prepayment premium thereafter, which can make early repayment very expensive. Finally, a change-of-control transaction will trigger a mandatory offer to prepay the bonds at 101% of par. Issuers and sponsors must, as a result, give considerable thought to long-term business and strategic plans before committing to a high-yield offering.
Set out below are representative key market terms for Canadian high-yield debt offerings.
|Transaction Size||C$100 million to C$200 million (with potential capacity for up to C$500 million)|
|Pricing||Fixed rate obligation; recent deals range from 6.3% to 12.25%|
|Guarantees/ Security||Typically guaranteed by material subsidiaries and unsecured (though can be secured on a “second lien” basis to improve the credit profile)|
|Ranking||Typically junior to bank credit facilities (by virtue of being unsecured or, if secured, by being second lien)|
|Maturity||Five to seven years, non-amortizing|
|Early Redemption||Subject to a make-whole or premium|
|Covenants||Less onerous than senior facilities, with incurrence-based covenants|
|Change of Control||Mandatory offer to repurchase requirement at 101%|
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