Creditor violence is escalating | USAEMALL.com

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Internecine creditor bloodletting is one of FT Alphaville’s favourite spectator sports, so we were naturally intrigued when an interesting new report on the topic from Barclays’ credit strategists landed in our inbox.

Corry Short and Bradley Rogoff say “weak covenant protections and increasingly onerous bankruptcies have permanently changed the default landscape”. This will lead to more creditor-on-creditor violence on both sides of the Atlantic, they predict, and include a bit of a heartfelt sigh on behalf of their community.

We believe distressed exchanges and other forms of LME are challenging for the market as a whole, given that credit analysts are now allocating a larger proportion of their time to game theory rather than modelling fundamentals.

The first factor they highlight is that a 91 per cent of the entire leveraged loan market is now “covenant-lite” — lacking maintenance covenants that restrict indebtedness levels — up from under 20 per cent before the financial crisis.

At the same time, other common covenants have been eviscerated by indentures that open up various loopholes for companies to try funny business. Unsurprisingly, private equity-owned companies have particularly creditor-unfriendly loans.

And the cost of bankruptcies has been going up, with Barclays citing the $48mn that WeWork’s lawyers asked for as a recent example. (To be fair, that’s only about 6 per cent of what Adam Neumann extracted out of the company.)

As a result, more companies are taking advantage of lax loan documentation to finagle coercive debt exchanges through something called “liquidity management exercises”. This might sound like a euphemism for bankers popping off to the pub for a boozy lunch, but LMEs are a powerful tool to restructure a company’s debts without going through bankruptcy.

In fact, “distressed exchanges” like this now account for over half of all global defaults, according to Barclays. And if you include them in default rate calculations then we are now back near the Covid-19 peak.

This has in turn led to the emergence of creditor “co-ops” — temporary alliances between lenders to protect their interests and to shaft others. These are becoming a major issue, according to Barclays.

While there is evidence that co-ops can be used both defensively and offensively by lender groups, their usage has increased in both complexity and frequency in recent years, creating a seismic shift in leveraged finance market structure.

You can see their influence in some surprising findings that Short and Rogoff arrived at when analysing 24 recent LMEs.

Firstly, herding into the first maturing bond or loan for maximum negotiation leverage doesn’t actually help, with “insufficient evidence to suggest that the nearest-dated maturity consistently outperforms post-LME”. 

Secondly, senior debt instruments tend to do worse than debts further down a company’s capital structure. Though there obviously isn’t a whole lot of data — there weren’t senior and junior creditors in every case Barclays looked at — it probably indicates who is doing most of the screwing. As Barclays puts it:

While it is difficult to speak in broad strokes about situations as bespoke as LMEs, the fact that less-senior instruments outperform senior a majority of the time speaks to the concern that investors should have on the efficacy of their existing liens.

Quite.

Anyway, we’ve talked Barclays into letting us share the report, so if you’re interested in a deeper exploration of the world of uptiers, trapdoors, dropdowns, double dips, and other legal weapons companies and creditors wield against each other with gleeful savagery then enjoy the full thing here.