Welcome to Debt Download, Goodwin's monthly newsletter covering what you need to know in the leveraged finance market. We hope you are enjoying some early summer weather and (if you live in the Northeast) are breathing easier!
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In the News
- The U.S. leveraged loan market was fairly quiet in
May with lenders favoring higher-rated borrowers and new
issuances mostly arising from refinancings. Although overall
M&A activity remains relatively quiet for new platforms,
private equity investors have been able to deploy capital through add-on acquisitions. In
the broadly-syndicated loan market, average all-in clearing spreads for new single-B
loans were mostly flat at S+520 (compared to S+524 in April).
Looking ahead to the summer, Covenant Review expects loan activity to remain
subdued, but posits that we will continue to see
amend-and-extends, deals for good credits being done on a selective
basis and bond-for-loan take-outs. Relatedly, as yields on loans
outpace yields on high-yield bonds, borrowers are starting to shift their focus to
issuing high-yield bonds in lieu of borrowing loans.
- Although the Federal Reserve agreed to hold its benchmark rate
steady yesterday after ten consecutive increases, the rise in
interest rates has had a significant and adverse impact on interest
coverage ratios for borrowers. LCD looked back at the 20
largest LBOs closed prior to the current round of interest rate
increases and found that, on average, interest coverage ratios decreased from 3.5x at
closing to 2.0x based on today's rates (assuming the same
EBITDA). On a similar note, Covenant Review reports that both leverage at
closing and permitted leverage levels under documentation for
post-closing transactions has decreased, including with respect to
first-lien gross leverage, by almost a full turn on average since
1Q22 (down to 4.47x for the three months ended April 2023 compared
to 5.39x for 1Q22). Finally, higher interest rates are acting as a
"a natural cap on leverage", which may upend private
equity sponsor expectations for internal rates of return on
investment.
- As the number of defaults and companies facing distress
continues to rise, private credit is likely to outperform bonds
according to a Goldman Sachs report, due in part to the way
that private loans are structured and the strength of the
relationships between borrowers and private lenders. There is also
talk of further consolidation of private credit managers, as mainstream alternative investment managers look
for ways to get into private credit (including TPG, who has agreed to buy Angelo Gordon).
While asset managers, insurance companies and other investors look
to increase exposure to private credit and raise new direct lending
funds, experienced fund managers have been more
successful fundraising in the current market than first-time
managers. Meanwhile, politicians are urging the SEC to implement
increased oversight for private credit funds due to the lack of
formal supervision compared to banks. Although direct lending
continues to be the main source of funding in the leveraged loan
market, the Financial Times notes that Wall Street banks are
starting to fund LBOs again, including for recent deals by
Apollo, Elliott Management, Blackstone and Veritas Capital.
- As a result of the current high interest rate environment, the tightening of
lending conditions and the lack of available sources of
capital, the number of large companies filing for bankruptcy
protection is on the rise (including a notable increase in healthcare filings). In May alone, eight companies with liabilities
totaling more than $500 million filed for chapter 11 bankruptcy
(compared to a monthly average of just three over the course of
2022). Interestingly, Fitch notes that first-lien term loan
recoveries for private middle market companies – those with
less than $500 million in debt at the time of filing – is only slightly below recoveries on first-lien
term loans for large companies.
- Although there are notable differences between the current economic
environment and the Global Financial Crisis, there are some interesting parallels in the current
leveraged loan market to that time, including low volume for
new institutional loan issuance (which so far in 2023 is comparable
to the corresponding period in 2008 and the lowest since 2009),
refinancing costs are the highest since 2008, funding costs are at
the highest for all comparable periods going back to 2009 and
repayments are stalling, putting repayment volume at the lowest
level since 2009. Consumers are also increasingly feeling the
pressure – the WSJ notes an increase in delinquent debt of
American consumers in 1Q23.
- First Citizens filed a lawsuit against HSBC
seeking at least $1 billion in damages alleging that HSBC stole
trade secrets and proprietary information from SVB as dozens of
former SVB bankers quit to work at HSBC in the wake of SVB's
collapse. This PitchBook article shows where ex-SVB
bankers ended up as of mid-May, with 78 professionals that held a
director position or above having left since the sale to First
Citizens in March. In other post-SVB news, banks are seeing a large increase in customers
using "reciprocal accounts" (otherwise known as
"sweep" programs), which spread deposits across
multiple banks, allowing customers to ensure their cash is insured
beyond the $250,000 FDIC limit applicable to deposits at any one
bank.
- The uptiering transaction in Serta Simmons was
effectively approved by the bankruptcy court overseeing the
company's chapter 11 restructuring when the judge in the
case confirmed the debtor's plan on June 7th. Notably, the
court highlighted the sophisticated nature of the parties and
stated that "[l]ender exposure to these types of transactions
can be easily minimized with careful drafting of lending documents.
While the result seems harsh, there is no equity to achieve in this
case. Sophisticated financial titans engaged in a winner-take-all
battle. There was a winner and a loser. Such an outcome was not
only foreseeable, it is the only correct result." In other
news, two recent liability management transactions for
At Home Group and Sabre Corporation highlight ways in which
non-guarantor subsidiaries can be used as financing vehicles to
give additional recovery rights to participating
lenders/bondholders.
- The Supreme Court denied review of two high-profile bankruptcy
cases concerning the so-called "solvent debtor
exception", leaving in place the 5th Circuit's holding in Ultra
Petroleum that although the claim for a $201 million
"make-whole" premium constituted "unmatured
interest" (which is disallowed by the bankruptcy code),
the solvent-debtor exception allowed creditors to recover such
amount from Ultra Petroleum (as well as an additional $186 million
in post-petition interest at steep contractual default rates) and
the 9th Circuit's holding in PG&E
that such exception mandates payment of post-petition interest at
contractual or statutory default rates when the debtor is
solvent.
- Quick roundup of recent new direct lender debt funds (and
related updates):
- HPS Investment closed on its $10 billion direct lending fund, Core Senior Lending Fund II, which will focus on senior corporate debt for a variety of geographies.
- BlackRock is expanding its private credit business by buying Kreos Capital, one of Europe's largest tech startup lenders.
- Energy Capital Partners has created a new strategy called ECP ForeStar, which will provide private sustainable credit and currently has $2.5 billion in investments.
Goodwin Insights
This month marks the last month of the publication of a representative USD LIBOR, which will cease being published on June 30th. Companies that have yet to switch their debt or other LIBOR-linked products to a replacement rate face operational difficulties starting next month. The WSJ reports that approximately 55% of loans in CLOs were still tied to LIBOR as of May 30th, which may serve as a proxy to estimate how much of the loan market in general had not yet transitioned away from LIBOR as of that date, though there has been a steady stream of SOFR transition amendments. However, interest rates under contracts that have yet to transition from LIBOR will soon be determined by reference to CME Term SOFR. Pursuant to federal law and related regulations adopted by the Federal Reserve, on July 3, 2023, applicable U.S.-governed agreements with no fallback language will automatically transition to CME Term SOFR plus the applicable ISDA/ARRC spread adjustments of ~11 bps for 1 month, ~26 bps for 3 months, and ~43 bps for 6 months. Likewise, for non-U.S.-governed agreements with no fallback mechanism, the FCA announced that an unrepresentative synthetic USD LIBOR – which is also just CME Term SOFR plus the same ISDA/ARRC spread adjustments – will be published through September 30, 2024. In both cases, the automatic fallback is intended to be used only for legacy deals with no fallback mechanism – not for new deals – and is not expected to have a large impact on the leveraged loan market.
In Case You Missed It – Check out these recent Goodwin publications: ILPA Publishes Guidance on Continuation Funds and Durations in M&A Exclusivity Periods Increased Significantly Since 2021.
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