About three months after a controversial debt deal rewrote the rules of the leveraged-loan market, tilting the landscape in favor of distressed borrowers and pitting creditors against each other, another transaction has pushed the newly established precedent even further.
The deal last week -- a $120 million loan to cash-strapped restaurant supplier TriMark USA -- not only unilaterally placed the new lenders above everyone else in the repayment pecking order, but it also stripped some of the older creditors of safeguards they had written into the contracts to protect their investments, according to people with knowledge of the matter.
When word of the deal, which was driven by Howard Marks’ Oaktree Capital Management, first hit the market in mid-September, it sparked a panic. Investors dumped the old loans at such a frenetic pace that the price on one of them cratered 20 cents on the dollar in a matter of days.
The selloff revealed the scope of the problem facing money managers in the leveraged loan market. Desperate to generate higher returns during a decade of ultra-low interest rates, they have bargained away many of their legal rights. Now they find themselves with precious little protection for their investments just as the pandemic is causing a wave of corporate bankruptcies across the country. This is leaving them vulnerable to the kinds of hyper-aggressive moves witnessed over the past few months.
Marks has long been seen as one of the more staid voices in a distressed-debt world full of pugnacious vultures, and so the fact that Oaktree is behind the most recent deal to upend the market only further serves to drive home the point that anything goes in the world of leveraged loans today.
“It’s a civil war between lenders, and we’re going to see more of this,” said Thomas Majewski, managing partner and founder at Eagle Point Credit Management. “Nearly every company restructuring debt is looking at these possibilities.”
The TriMark transaction, similar to another loan that surf-clothing maker Boardriders Inc. entered recently, followed in the footsteps of a divisive financing by Serta Simmons Bedding earlier this year. The mattress maker got $200 million of fresh capital from existing lenders including Eaton Vance Corp. and Invesco Ltd. Those lenders jumped to the front of the line to be repaid if the company fell on hard times, pushing Serta Simmons’ other lenders further back, in a process known as priming.
There’s nothing new about priming, but the way lenders did it in the Serta Simmons deal resulted in litigation. The investor group led by Eaton Vance and Invesco didn’t give all other lenders the right to participate in the new loan, a move that is allowed by many deals’ documents, but hadn’t really been done before. Lenders who were left out, including Apollo Global Management, sued the company but a state court let the deal go ahead, effectively ushering in a new precedent in the market.
“Serta did open the floodgates in that regard,” said Tim Sullivan, an analyst at Xtract Research, “because it showed how provisions which are very common in agreements today can be used to incur priming debt.”
Aggressive maneuvers with creditors don’t always work. When Oaktree proposed such a deal for PSAV Inc., a company the investment firm had lent to, it wasn’t selected. Oaktree declined to comment through a representative.
A growing number of companies in the U.S. are going broke as the pandemic saps their revenues. Fitch Ratings projects 7% to 8% of leveraged loans will default by the end of 2021, compared with 1.8% in 2019. After years of the loan market growing rapidly, corporations that fail now increasingly have less in the way of income or assets to fork over to creditors, which is making fights among all parties more acrimonious.
In the case of Boardriders, Oaktree was one of the equity owners. The company negotiated a $135 million financing including a $45 million loan that has priority over all others. The debt came from Boardriders’ bigger lenders, a group that included Brigade Capital Management, Canyon Capital and MidOcean Credit Partners, according to people with knowledge of the situation.
The $45 million loan ranks ahead of investors that didn’t participate in the new financing. The minority lenders that were primed argue that was unfair because they weren’t given a chance to participate in the deal, the people said. The new loan is trading around 100 cents on the dollar, while the loan that was primed is trading around 35 cents.
For TriMark, the company saw its revenue falling and hired advisers to help it consider its options. It ultimately picked a transaction to raise $120 million from lenders including Oaktree and Ares Management Corp., people with knowledge of the matter said. Also in the group of existing lenders in the new deal were Blackstone Group Inc.’s credit arm GSO Capital Partners, Sculptor Capital Management, and BlackRock Inc. Their new loan is trading around face value, about 40 cents on the dollar higher than the loan that was primed. TriMark is owned by Centerbridge.
For both Boardriders and TriMark, minority lenders had covenants including limits on future company borrowings removed, the people familiar said. And the required schedule for repaying principal was slowed down, the people said.
The additional step of removing covenants is highly unusual in the loan world and is a big loss for investors, Xtract’s Sullivan said.
“It’s gone beyond Serta -- now it’s worse. By stripping it down to the ultra bare bones, all that leaves you with is just a promise to pay,” he said.
Representatives for Brigade, Canyon, MidOcean, Ares, GSO, Sculptor, BlackRock and Centerbridge declined to comment.
Lenders are fighting back, and some companies are deciding not to embrace these transactions. In May, debtholders rebelled against Elliott Management Corp. and Siris Capital Group, the owners of global travel reservation company Travelport, after those two firms tried to move assets out of the reach of creditors.
And when Oaktree proposed a priming transaction for PSAV Inc., a company that provides technology and staging services for events, the borrower elected to raise new capital through a loan that was in the same class as the existing facility.
“Priming transactions such as those executed by Serta and Boardriders are still the exception and the priming play is not the ‘new normal,’” said Judah Gross, a director at Fitch Ratings. “That being said, the higher degree of frequency with which such deals get done may indicate that priming transactions are not as taboo as once assumed.”