Using the HYB Mind Map as a tool to make your high yield legal analysis more systematic, we review the guarantor and structural subordination analysis in this blog. You can also watch the mini-lesson that our founder, Sabrina Fox, recorded on our YouTube channel.
Understanding the Importance of Guarantees in High Yield Bonds
High yield bonds provisions are complex and present unique risks. One critical aspect that investors need to scrutinize is the level of guarantor coverage provided by the group. Guarantees are a promise to pay if the primary borrower does not. The level of guarantor coverage can significantly impact the bond's risk and return profile.
Key Areas of Focus: Guarantees and Guarantor Coverage
It's essential to focus on the security and guarantees analysis. Our last blog focused on the collateral analysis, and this one looks at guarantor coverage (measured by EBITDA, revenue, and total assets of guarantors) and jurisdictional issues. These elements are crucial for understanding the extent and quality of the guarantees backing your investment in high yield bonds.
- Guarantor vs. Non-Guarantor Entities: There is a lot ofvaluable information in the structure chart regarding entities that are guarantors and those that aren’t. The percentages indicate the portion of revenue, EBITDA, and total assets attributable to guarantors. For instance, in our Monkey Business Case Study, 66% of revenue, 72% of EBITDA, and 53% of total assets (excluding intercompany assets) are represented by post-closing guarantors.
- Practical Implications: These numbers reveal the substantive value behind the guarantees. The inverse percentages highlight the structural subordination risk, highlighting the need to analyze potential debt capacity ofnon-guarantors.
- Structural Subordination Risk: If there is significant non-guarantor debt capacity combined with low guarantor coverage, the investor faces a perfect storm of structural subordination risk. Keeping an eye on the debt covenant provisions thatrestrict non-guarantor debt incurrence is critical.
Risk Factors and Jurisdictional Issues
Risk factors are a treasure trove of information! Think of it like the borrower’s insurance policy against being sued for misrepresentation – if it’s in the Risk Factors, then lenders were warned.
This section contains valuable disclosure about the inherent risks linked to guarantees and the structural subordination of the notes. Unlike other parts laden with legal jargon, the risk factors are often presented in plain English, making them more accessible.
- Disclosure of Jurisdictional Issues: It's important to review the risk factors related to jurisdictional limitations. These could significantly impact the guarantee'senforceability, especially in certain European countries with complex local laws.
- Ensuring Comprehensive Guarantor Coverage: The goal is to maximize guarantor coverage to avoid structural subordination. Borrowers might have already structured the deal to include as many guarantors as permissible by local laws, but this isn’t always the case. Lenders should scrutinize the disclosure, and ask questions!
Conclusion
We trust you found this exploration of the guarantees and structural subordination analysis enlightening. Stay tuned for more insights to enhance your financial analysis skills using our HYB Mind Map – which will soonbe made available to the market for download!