NEW YORK, Feb 19 (LPC) – US Collateralized Loan Obligations (CLOs) are increasingly seeking flexibility to provide rescue financing to distressed companies after other lenders have been able to swoop in and offer lifelines to borrowers and often obtain a senior claim on assets in the process.
CLO managers can be prohibited from participating in restructuring or workout scenarios due to constraints in their deal documents, so when sales and marketing firm Acosta reworked its debt late last year, their funds were essentially forced to sit on the sideline. The result could impact returns to CLO investors, especially in the next downturn when recovery rates are already predicted to be more than 20 percent lower than the historical average.
In November, some investors agreed to provide US$250m of equity capital to Acosta as part of a restructuring that wiped out about US$3bn of the company’s debt. CLOs, forced to the wings, have started to push for the ability to either provide companies with rescue financing or increased flexibility to receive equity in a workout situation in order to be able to participate in future reorganizations.
“The dynamic we have seen is that non-CLO lenders would pick up the distressed loans and would drive the restructuring and the economics of the restructured debt,” said Sean Solis, a partner at law firm Milbank. “The non-CLO lenders are keenly aware that by putting all the economics in a super-priority loan, (the existing CLO lenders) would be much more subordinated.”
Years of sustained growth and low interest rates fueled a debt binge by borrowers that were able to lock in more loan-only capital structures with looser lender protections. Regulators have said the US$1.2trn US leveraged loan market does not pose a systemic risk, but Federal Reserve (Fed) Chairman Jerome Powell noted that corporate debt could be an amplifier of the next downturn.
The US leveraged loan default rate ended January at 3.7 percent, up from 1.9 percent a year earlier, according to Moody’s Investors Service. Recoveries for first-lien loans are forecast to be about 61 percent, down from the average historical recovery of 77 percent, according to the ratings firm. Recoveries for second-lien loans are forecast to be just 14 percent, down from the average historical rate of 43 percent. The US$677bn US CLO market is the largest buyer of leveraged loans.
“Some CLO managers have begun to react to certain defaults – Acosta was one example – where in those situations the CLOs were maybe at a bit of a disadvantage to provide additional money to participate in a restructuring because by virtue of their documents they didn’t have a provision to do that,” said Algis Remeza, associate managing director at Moody’s.
“The provisions are being added in anticipation of a downturn by providing flexibility for the manager to trade.”
Acosta said it reached an agreement with more than 70 percent of its lenders and more than 80 percent of its noteholders on the reorganization agreement that eliminated the US$3bn of long-term debt. Investors then committed to provide the US$250m in new equity, according to a 2019 news release.
An Acosta spokesperson could not be reached for comment.
In the case of Acosta, some investors had greater flexibility to take other securities whereas CLOs had strict limits and these assets were not considered a collateral obligation, according to Derek Miller, head of US structured credit at Fitch Ratings.
“Listed in the indenture are items a CLO can invest in. If what a non-CLO lender is proposing as an alternative to extract recovery and the CLO can’t participate, then the CLO manager is at a disadvantage,” he said. “We have seen more transactions with greater flexibility in what they can invest in as a result.”
While the US CLO market has seen just a handful of new-issue deals – US$5.2bn in 2020 through February 12 compared to US$8.6bn during the same period in 2019 – market participants expect more funds to push for the additional flexibility to participate in restructurings.
“Some CLOs have added provisions to allow themselves to participate in these types of workouts, where they have the potential to put additional money into that kind of workout,” Moody’s Remeza said. “We think it’s very credit positive because it will help improve the overall recovery the CLO experiences.” (Reporting by Kristen Haunss. Editing by Michelle Sierra)
Source: Read Full Article