Portability provisions are now commonplace in European high yield documentation and showing up more in loans, as sponsors seek to maximise flexibility amid a backlog of unsold portfolio companies. For some this situation is yet another example of weakening investor protections amid a white-hot new issue market, but some loan investors are determined to push back.
Private equity firms are increasingly refinancing portfolio companies with flexible debt that makes them more attractive to prospective buyers. According to PitchBook data through Sept. 30, private equity sponsors are sitting on a record 12,578 of European-headquartered companies, while the medium hold period is six years — down only slightly from 2023’s record 6.3-year hold time.
Portability allows a sponsor to sell their portfolio company without triggering a change-of-control put on its debt. The provision — usually linked to a leverage threshold — first emerged in 2010 for a bond deal from Ziggo, then backed by Cinven and Warburg Pincus. So far this year it has featured on over 65% of high yield bonds for sponsor-owned businesses, according to analysis by LCD News (for deals where the information was disclosed). Portability is also a common feature in the private credit sector, although in direct lending the provision typically has a pre-agreed white list of eligible owners, and comes with a consent fee to lenders.
Unlike private credit or high yield debt — which both come with varying degrees of hard call protection — loans typically feature no more than six months of soft-call protection that makes them flexible and prepayable at par. This inherent flexibility means lenders have in general been less willing to give up on change-of-control protection, especially for an asset class that can be repriced at will.
Repricing waves
Loan repricings, which tend to cluster in waves, will invariably take margins on a performing credit to the bottom in terms of market yield, with no opportunity for lenders to adjust upwards when pricing dynamics shift. “Portability extends spread-duration risk for loans and an ownership change gives us as lenders an opportunity to reset the credit,” said one manager.
The fear is particularly relevant for lenders today, given Europe is in the midst of the third repricing wave of the year that is taking decent B2 margins down to around E+375, with little to no OID. In this context lenders say the ability to revisit a credit on an ownership change is important, as loans are typically repaid, extended or otherwise amended by four years and are not expected to remain outstanding for their full term. “Ordinarily you would expect to see repayment on a loan well ahead of the seven-year maturity date,” said the same manager.
The reticence helps explains why portability has been included in the bond portions of buyout packages this year for deals including Evri and Innomotics, but not on the loans. “Loans are the outlier as portability is standard in high yield and more common in private credit, but they both come with stronger non-call protection,” said a manager, adding that portability provisions have been removed from at least one deal in pre-marketing recently.
Even so, while lenders have been successful in keeping portability out of buyout loans this year, that has not been enough to stop it creeping into refinancings and extensions. This includes deals such as those for Partner in Pet Food, B&B Hotels, Stada, Mehilainen, Belron and Nobian, according to market sources. In the case of Partner in Pet Food, closing of a €750 million term loan recap on June 25 was followed by an agreement announced three days later from Cinven to sell the Hungarian maker of private and own-label food for cats and dogs to CVC. “In this case the sale was agreed and, from what we understand, based on the portable financing,” said one manager.
For a deal such as Partner in Pet Food, lenders admit they would struggle to object to a swift sale to a top-tier sponsor such as CVC. “It makes sense for sponsors that are at the end of their fund lifecycle to help a sale,” said one manager. More recently, an amendment to waive change-of-control provisions on Techem’s €1.85 billion term loan that priced in February passed in October following the group’s sale to TPG.
Credit work
That said, lenders note that moves to include portability on deals are giving more flexibility to the issuer, and do not include a white list of permitted new owners nor a minimum equity contribution. For some, the removal of white lists is especially egregious given sponsors' insistence on the same limits for loan trading. In these cases, managers argue that ownership is an essential part of their credit work — especially for borrowers with more involved stories where lenders want certainty that sponsors will stay committed.
“It’s on a deal by deal or situation by situation basis, but it is a lot more problematic with a more routine credit,” said one manager, adding that it is important to understand factors such as the capacity for further leverage under new owners. “It has to be structured well in the right deal,” he added.
Even those generally against the move say they can understand sponsors’ rationale. The best conditions for deal origination across both the bond and loan markets in nearly three years also mean sponsors are actively refinancing businesses that are in either early or advanced sales processes — thereby giving greater flexibility to prospective new owners.
Stada, for example, priced a €1.25 billion two-part secured bond offering which featured more flexible terms than its existing bonds, with a “zero floor” provision for calculating restricted payments and the market-standard leveraged-based portability. The deal came amid reports that sponsors Bain and Cinven are close to agreeing a sale of the German pharmaceutical group to GTCR for up to €10 billion.
“Everyone knows Stada is up for sale and has been for a while,” said an investor involved in October's bond deal from the borrower. “In order to get a better valuation it totally makes sense for the sponsors to term-out the capital structure.” For loan buyers, the sheer size of a deal like Stada means they are — perhaps counter-intuitively — less concerned on portability given only a small number of top-tier sponsors could absorb a deal of that quantum.
Chicago-based PE firm GTCR is however not exactly a well-known sponsor for euro-focused investors, having only sponsored two sterling high yield bonds in Europe, according to LCD. “I understand healthcare is one of their pillars but I’ve never seen GTCR in Europe before,” said one bond investor.
The erosion of change-of-control rights for lenders is just one aspect of a trend where lender protections have been weakened this year. This is especially relevant for documentation, which gives borrowers a greater capacity for dividend payments.
“The trend on new deals for the past few months has been that docs are as bad as they have ever been because it’s such a hot market,” said a loan investor. “Even deals that aren’t from a tier-one sponsor start with super-aggressive documentation.”
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