Lenders to risky, debt-laden companies are increasingly demanding protection from financing maneuvers used to undercut creditors when times get tough.
A recent crop of leveraged loans demonstrates investors’ heightened concern with protecting their assets. In some recent deals money managers have successfully closed loopholes borrowers might have tried to exploit if higher-for-longer interest rates overwhelmed their finances.
The move is a response to years of controversial financial maneuvers — once called creditor-on-creditor violence, now more politely called liability management transactions — that leave some lenders out in the cold. And the resistance is spilling over to the world of private credit, too, which saw its veneer of safety shattered in May after a Vista Equity Partners-backed firm moved some assets out of reach of its private credit lenders.
“Because the market is so hot, investors are willing to consider lending to challenged companies, but in order to get those deals across the finish line, they want incremental protections,” said Robert Schwartz, a portfolio manager at AllianceBernstein.
The push for assurances on collateral is coming despite fierce competition for deals, and indicates borrowers face limits on their ability to change the standing of existing creditors to get the financing they need.
A key deal came last month, when health-transportation provider ModivCare Inc. had to amend documents on a $525 million financing to include measures like a ban on “double dip” moves, which give new lenders claims against collateral that has already been pledged elsewhere. The terms in some other recent transactions like Gray Television Inc., City Brewing Co. and Staples Inc. also offer investor protections that are better than the three-month average, according to data from Covenant Review, a research service that grades credit agreements.
Creditors’ current anxiety has its roots in the period of near-zero interest rates, when providers of syndicated loans were arranging deals that all but scrapped safeguards for collateral. The terms tended to be loose enough to leave borrowers a window to manipulate existing lenders’ claims on assets to obtain new financing.
That wasn’t such a problem when low borrowing costs gave firms breathing room to manage their debts amid a tough economic backdrop. But the recent bout of persistent high rates has driven companies to exploit loan loopholes with a seemingly endless variety of liability management transactions, and creditors are working hard to keep up.
“It’s a game of whack-a-mole,” said Derek Gluckman, vice president at Moody’s Ratings. “There are six different kind of liability management protections when a few years ago, we were only seeing two of them and rarely.”
The explosion of private credit into a $1.7 trillion force has stoked fierce competition among lenders — and prompted concerns about loan terms. While the upstart market has prided itself on shunning the fast-and-loose terms that have crept into Wall Street’s books, the turf war between the two camps have undercut the safety of borrowing contracts.
Vista-backed Pluralsight Inc.’s transfer of assets into a different subsidiary to obtain financing from its sponsor gave private credit a sharp reminder of the rules of engagement in the market. The company’s name has morphed into a battle cry, not least because its outcome echoes a 2016 deal for J. Crew Group that saw the clothing company use loopholes in credit documents to transfer intellectual property away from existing agreements to secure new financing.
“Right now, lenders are asking for a Pluralsight protection. It’s a twist on J. Crew that’s notable because it happened in direct lending,” said Patrick Walling, partner in the private credit group at Proskauer. “I definitely think there is a renewed focus on lender protections for liability management transactions.”
Pluralsight differed from J. Crew in some key ways — the assets were still tied to the covenants of the original loan, for example — but still came as a shock, and triggered a push among investors to review their own liabilities.
“When we see those precedents get set in large deals, we do make sure that possibility doesn’t exist in our deals,” Bill Sacher, partner and head of private credit at Adams Street Partners. “There is more attention being paid to make sure those liabilities aren’t there.”
To be sure, competition for new deals is steep and both the private and broadly syndicated markets are still eager to put dollars to work. That’s keeping up the pressure on private credit to sweeten terms to remain competitive against their broadly syndicated peers.
Audio-visual and event-services company Encore Group USA LLC, for example, just raised new private debt with a covenant-lite structure, according to a person with knowledge of the deal, who ask not to be named discussing a private matter. This is a flexible kind of lending structure that offers more favorable terms to companies and often will discard provisions that compel borrowers to periodically meet tests of financial fitness.
Still, lower-rated borrowers that need money will have to work with lenders to come up with deal terms everyone can accept — and that creates an opportunity for the latter to strengthen their position, said Brian Gelfand, co-head of global credit and head of credit trading at TCW Group.
“It comes down to whether lenders have negotiating leverage vis-a-vis borrowers at the time of refinancing,” he said. “The hope is that you start to see these terms make their way into regular deals.”
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