How do any of these deals make sense?
Just looked over a credit agreement on a recent (like last month) LBO and saw there was uncapped ability to move collateral to unrestricted subsidiaries. It wasn't like there was a blocker or some tricky language, I mean it was like section 1 and section 34 under permitted investments. And checking the deal site it seemed like the credit agreement was posted relatively early in the syndication so it wasn't something particularly hidden that the syndication team posted last minute. I mean genuinely I don't understand how you could possibly think the debt of any of these companies is remotely safe when you can have all collateral stripped. It genuinely makes me feel burnt out because I know barring a collapse in credit, this asset class will continue to degrade with every deal brought to market. And it's not like you are getting compensated! Bank prefs and ABS offer way better risk weighted return to some S+300 shitco.
It sounds like you're frustrated with the erosion of creditor protections in recent LBO deals, and you're not alone. Based on the most helpful WSO content, this trend of "covenant-lite" or "cov-lite" agreements has been a growing concern in the private credit and leveraged finance space. These agreements often lack the traditional safeguards that would protect creditors, such as restrictions on moving collateral to unrestricted subsidiaries or other mechanisms that could dilute the value of the collateral backing the debt.
Here are some key points to consider:
Uncapped Collateral Transfers: The ability to move collateral to unrestricted subsidiaries without blockers or limitations is a glaring risk. It essentially allows the borrower to strip assets from the entity backing the debt, leaving creditors with less security. This practice has become more common as borrowers and sponsors push for more flexibility, and lenders, in a competitive market, have been willing to accept these terms.
Degradation of Credit Quality: As you noted, the lack of protections means that the debt of these companies is inherently riskier. Without proper safeguards, creditors are exposed to significant downside risk, especially in the event of a default or restructuring.
Market Dynamics: The private credit market has seen a surge in demand, with alternative lenders and direct lending funds competing aggressively for deals. This competition has led to a "race to the bottom" in terms of covenant quality, as lenders accept weaker terms to win mandates.
Risk-Reward Imbalance: Your point about compensation is spot on. Many of these deals do not offer sufficient yield to justify the risks, especially when compared to other asset classes like bank preferreds or ABS, which may provide better risk-adjusted returns.
Potential Fallout: If credit markets tighten or defaults increase, the lack of protections in these agreements could lead to significant losses for creditors. As highlighted in WSO discussions, the private credit market is particularly vulnerable due to the prevalence of cov-lite deals and the limited ability of lenders to step in and recover value.
Your concerns are valid, and they reflect broader industry frustrations with the current state of the leveraged finance market. While the market may continue to degrade in the short term, a credit event or broader market correction could force a reevaluation of these practices. Until then, it’s crucial to be selective and focus on deals with stronger protections and better risk-adjusted returns.
Sources: Safe leverage / coverage ratio for LBOs during holding period?, Alternative Lenders & the End of Risk Taking for Banks - Opportunity or Risk?, State of Credit markets now and in the future?, Debt for LBO?, Overview of Leveraged Finance
'tis the cycle brother. Only saving grace is once the collateral is stripped the docs will be tightened (for the new money lmao)
I used to work at a BB…I was told the worst of the excesses pre-08 was funding a TV network at 8x. To me this is way worse. At least you can get like what…a 50% recovery in the pre-08 credit. If you’re a small guy you get a big fat donut in the seventh out term loan post restructuring.
so what, maybe there are other covenants allowing creditor to push for a technical default and thus have leverage in negotiating a forebearance e.g., they may ask in that moment to grant an explicit collateral that can't be moved freely
this to say that they might have been granted this intentionally so the sponsor goes with them, but down the road, creditors have a completely different playbook
There are definitely not those sort of protections...I know the lender counsel. Definitely more concerned with getting more repeat business and not regarding protection. The biggest protection is likely the requirement for an all lenders vote to move all or substantially all of the collateral, but removing 30% of assets (even if those are the only assets that are valuable) is probably fine. Of course you could argue fraudulent conveyance if those assets are transferred to the sponsor, but a new term loan raised under an unrestricted sub is likely kosher if the proceeds are to fund liquidity or repurchase debt at a discount.
Sounds like you are saying there’s effectively a cap on moving collateral representing >30% of total assets? With any investment of collateral in non-loan parties beyond subject to all lender vote (ie a sacred right)? In which case, to me, that is just a non-loan party basket available to permitted investments (and I would expect other negative covenants too). Having a non-loan party basket is not atypical, but I could be misunderstanding this specific situation.
I worked on a deal earlier this year for an asset lite biz where most of the collateral value was in IP. Sponsor wanted to use precedent doc that allowed for a 60% non loan party bucket, which would’ve allowed them to transfer most if not all of the valuable collateral outside of our credit pool. Ultimately we got them to bring that down to I think 30%…mind you this was a $15-20mm ebitda business and we had to fight to bring that down.
Separately - appreciate you posting about the nuances of credit docs - I feel like there is a lack of discussion around actual terms and structuring on this forum. Terms & docs are rapidly eroding in this asset class so it’s useful to hear what others are seeing…I remember not long ago private credit would advertise that it was getting two covenants, higher pricing than the bank/BSL markets, and tighter credit docs…….
The good 'ol self-imposed LME to accrue default interest. Truly the golden age of credit.
Adequate pricing for optimistic creditors that’ll buy up the new issue and have a surprised pikachu face when the company drops down assets and they scramble to form a group to litigate it
Guessing from your username that your cohort in the industry is relatively recent.
This is just your first experience with cyclicality. What you are seeing is usual and customary. When the music is playing, capital gonna dance.
What we are experiencing right now is abnormal. Sometimes when I get bored I look back at old credit agreements over the last 30 years. Documents are the weakest they've ever been right now. Some of this is structural - the majority of credit investors in syndicated deals are CLOs versus mutual funds and banks in the past, some of this is poor underwriting from the banks, some of this is the dominance of private equity backed deals in the syndicated market, etc.
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