Civil war of lenders pierces credit euphoria
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The writer is a former investment banker and author who is currently working on a book on the rise and fall of General Electric.
In the past, it would have been unthinkable – if not professional suicide – for lenders to grant risky loans without what are called “covenants”. These are contractual protections that, among other things, served as an early warning of a company’s growing financial distress or prevented it from borrowing additional money without the approval of an existing lender.
But these days, so-called “cov-lite” leveraged loans are all the rage among borrowers and lenders and, according to some, account for nearly 90% of all riskiest loans issued in the United States in 2019.
In our environment of consistently low interest rates, largely driven by central banks around the world, lenders have traded less contractual protections and more risk for more rewards in the form of higher interest rates. students. Now the price is paid for such recklessness. Lenders face the inevitable unintended consequences of their senseless risk-taking and greedy behavior.
Some of their loans are rapidly losing value as companies that have issued cov-lite loans are in financial difficulty in the face of the economic stress associated with the pandemic. Another sign of how some lenders are more widely exposed to a general easing of credit discipline are several recent fierce battles over fundraising.
As companies seek additional sources of capital, some are finding that new investors are willing to lend them money by exploiting weak covenants from old lenders.
Take, for example, what happened in October at TriMark USA, a distributor of restaurant equipment and supplies. The private equity firm Centerbridge Partners purchased TriMark in 2017 for around $ 1.2 billion. He charged the company with $ 795 million in bank debt which was then sold by the banks that underwent him to investors.
When TriMark ran into financial trouble this year due to the Covid-19 pandemic, it secured a new $ 120 million loan from a hedge fund group led by Howard Marks, the savvy founder of Oaktree Capital, and by Ares Management, another smart Los Angeles. – speculative funds.
By making the new loan to TriMark, Oaktree and Ares were able to “prime” existing lenders, placing the new loan higher for them in the capital structure and providing the new loan protections that the old lenders had previously negotiated.
It was a brilliant tactical move by Mr Marks, who has long criticized the US Federal Reserve’s willingness to lower short- and long-term interest rates through its quantitative easing program. . Mr Marks was also skeptical of the Fed’s massive interventions in March and April to provide much-needed liquidity as pandemic concerns hit markets. Mr. Marks wanted companies to meet the outcome the markets had in store for them, not be bailed out by the Fed.
“Capitalism without bankruptcy is like Catholicism without hell”, he said. wrote in an April blog post. “Markets work best when participants have a healthy fear of loss. “
But rather than trying to fight the Fed, it’s clear in the TriMark case at least, that Marks has decided to teach cov-lite lenders a lesson. As news of the new $ 120 million TriMark loan hit the market, the value of TriMark’s existing debt plummeted; one of the existing loans was would trade at about 20 cents on the dollar, a loss of 80% in a matter of days. It hurts.
TriMark is not the only example where the value of cov-lite loans has been decimated as a result of seed by new lenders. A similar dynamic occurred with a recent $ 200 million loan for mattress maker Serta Simmons, owned by Advent, another buyout company.
Eaton Vance and Invesco mutual funds provided new financing and agreed to restructure their existing debt to Serta Simmons, effectively preparing other holders of the same cov-lite loans. The hedge funds filed a lawsuit to stop the seeding but lost in court because Serta Simmons’ “cov-lite” terms permitted such a possibility.
The same has happened with Boardriders, a surf clothing company owned in part by Oaktree. Boardriders recently negotiated $ 135 million in new financing, some of which took precedence over other company lenders who did not participate in the new loan.
Some have described these battles as a “civil war” between lenders. But what is really happening is a correction in the credit market after years of perverting the well-established rules of credit analysis. It’s a long-awaited puncture of another credit-related euphoria. What remains unfathomable is why lessons never seem to be learned until it’s too late.