August 7, 2019 - The headline above is slightly – but only slightly – tongue in cheek. With all the noise around leveraged loans (and general silence around high yield bonds), one might think that i) loans suddenly have migrated down the capital structure and ii) loan documentation is far worse than bond documentation. In fact, neither is true.

Our interest in this issue was first piqued by LevFinInsight’s quarterly review which observed that a number of borrowers issued both secured bonds and secured loans in the first half of 2019. Even though “the structures of a high yield secured bond are typically more permissive than that of a secured loan”, the bonds generally had thinner pricing than their pari passu loans. In the intervening month, Covenant Review drilled deeper, comparing characteristics of loans and bonds.

As it turns out, loans (other than second liens) remain at the top of leveraged companies’ capital structures and still command the lion’s share of collateral. That said, loan structures have weakened and there apparently have been a number of questions about how leveraged loans and high yield bonds differ. To that end, Covenant Review recently published a “Loans vs Bonds” series where they discussed differences in the two products. Bottom line: Even with their highly publicized loosening, loan documents and terms still tend to be more conservative than their high yield brethren.

Of particular interest was “A Comparison of Select Provisions in Recent LBO Deals”. Because these companies issued both loans and bonds, a nearly apples-to-apples comparison between loan and bond terms could be made.

First, Covenant Review notes that “lenders under the credit agreement are typically in the driver’s seat relative to the bonds, even if the credit agreement and high yield bonds are secured on a parity lien basis.” For one, the intercreditor agreement typically provides that the bank collateral agent will control enforcement proceedings with respect to collateral.  Second, if both instruments have liens on the same collateral, typically if a credit agreement releases liens securing collateral, the liens will automatically be released under the bond indenture. Third, if the loan credit agreement releases a guarantor, it will be released from the guarantee of the bonds as well.

More specifically, there are a number of discrete covenant provisions in loan agreements and bond indentures that can be compared on an “apples-to-apples” basis. Covenant Review analyzed eight LBO transactions since January 2018 where both loans and bonds were utilized, looking for places where the provisions were i) the same for both debt instruments, ii) looser for loans than the bonds or iii) looser for bonds than for loans. The categories included: i) debt covenants, ii) liens covenants, iii) restricted payments, and iv) investments.

To be fair, in the strong majority of cases, the provisions for the bonds and loans were essentially the same. However, where the provisions differed in the debt baskets, liens covenants and investments, the loans were tighter than the bonds. Where provisions differed in restricted payments, sometimes loans were looser and sometimes they were tighter.

Bottom line: While commentators seem confine their LevFin critiques to loans, the reality is that loan structures still tend to remain tighter than bond structures…even when bonds price more aggressively.