- Flexibility for ‘Divcos’ In the C$ High Yield Market
- October 23, 2014 | Authors: Bill (William) G. Gilliland; William (Bill) K. Jenkins; Dan Shea
- Law Firm: Dentons Canada LLP - Calgary Office
The Canadian dollar high yield market continues to provide flexibility to public dividend-paying issuers to implement and maintain their distribution policies through specific and customized dividend baskets that are in addition to an issuer’s general restricted payment basket and other customary baskets and exceptions.1 This flexibility has also been available not only to the darlings of the high yield market (those with the highest of the high yield credit ratings) but to lower rated issuers, with growing examples of B-rated public issuers negotiating broad and flexible dividend baskets.
The dividend baskets are currently taking the following forms:
Cash flow-based basket: Permits the issuer to pay dividends based on a percentage (often 80 or 90 percent) of “excess cash” for the preceding four fiscal quarters, where excess cash is based on consolidated EBITDA less fixed charges, cash taxes and maintenance capex. The issuer is also required to satisfy a leverage ratio.
Dividend policy-based basket: Provides the issuer with flexibility to pay dividends at a level generally consistent with the issuer’s existing dividend policy on the issue date. For example, AutoCanada’s covenant pattern for its May 2014 issue permits payment of quarterly dividends in an amount up to $0.27 per share (at a time when AutoCanada was paying $0.23 per share and therefore also allowing for modest growth consistent with AutoCanada’s dividend policy).
Fixed cap basket: This type of basket permits dividends up to a specified amount in each fiscal year and may provide a carry-forward option for unused amounts subject to satisfaction of certain conditions. Generally the issuer would also be required to satisfy a leverage ratio or be permitted to incur $1 under its debt incurrence test.
The cash flow-based basket is the most prevalent and generally provides the most bondholder protection as it employs a focused financial test that evaluates the issuer’s overall financial health and ability to generate free cash flow, and although it provides the prospect for unlimited growth in distributions it also protects bondholders against deterioration in the issuer’s financial position.
To the extent the issuer intends to pay dividends in excess of the amount available in its dividend basket it will have the flexibility to “tap into” or allocate the excess (or any) portion of the dividend payment to its general restricted payment basket or to any other applicable basket or exception that has availability, permitting significant flexibility for dividend-paying issuers to increase their distributions in the future. Note as well that an issuer is not required to first allocate dividends to its dividend basket and has the flexibility to allocate and reallocate dividends to any available baskets/exceptions (and in some cases an issuer may have strategic reasons for doing so).
Issuers that negotiate a dividend basket will, of course, continue to be subject to any restrictions on distributions contained in their credit facilities and other debt instruments, but the added flexibility from including a dividend basket is nevertheless helpful given the relative hassle and lack of certainty associated with obtaining amendments to the indenture and the importance of dividends and dividend growth to these issuers.
1 Note on terminology: The term “dividend basket” is sometimes used to describe an issuer’s general restricted payment basket, but here we use the term to refer to a specific exception to the restricted payment covenant that relates specifically to payment of dividends on common equity.