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Roula Khalaf, Editor of the FT, selects her favorite tales on this weekly publication.
The author is a bond portfolio supervisor at Barksdale Funding Administration and editor of ‘The Credit score Investor’s Handbook’
The junk bond market has roared again to life, making Could the busiest high-yield bond issuance month within the yr to this point. It was onerous to catch a breath from one new difficulty to the subsequent. This excellent news for credit score traders has a draw back — we’ve got to return to worrying about legal responsibility administration workout routines.
LMEs are debt restructurings the place one creditor can usurp one other. One creditor might need purchased the bonds of a leveraged issuer or a part of a mortgage to at least one on the premise of the deal’s collateral and/or structural safety in its covenants. However then the debt is restructured, typically with new funds raised and one other creditor transferring up the precedence queue to be repaid. The unique creditor can typically solely stand by helplessly as their standing is yanked away from them.
It has been dubbed “creditor-on-creditor violence” and it’s spreading as a pattern. Based on Barclays, distressed debt exchanges — a functionally comparable cousin of LMEs — have accounted for greater than 40 per cent of company defaults over the previous decade. Lately, there have been LMEs at firms akin to J Crew, Serta Simmons and Neiman Marcus. “When firm names grow to be verbs — J Screwed, Serta’d — you understand a pattern is afoot,” notes Michael Gatto, a associate at Silver Level Capital and writer of ‘The Credit score Investor’s Handbook’.
There have been some strikes to instil higher safety for collectors in debt agreements, notably in a high-yield $1.65bn bond deal from advertising and marketing and printing firm RR Donnelley final yr, which featured covenants that will make it tough for future debt offers to favour some collectors on the expense of others.
However the latest flood of junk bond issuance hasn’t normalised an “RR Donnelley clause” or comparable protections. Collectors all too typically give away structural protections for a bit of additional coupon. And because the high-yield bond and syndicated markets shrink as a consequence of competitors from direct lenders, the credit score world continues to be a vendor’s market — that means the porous docs that facilitate LMEs are a characteristic, not a bug, of the method.
When you spent the time required to pore over the documentation of a problem, you’d in all probability discover the smoking gun clauses that, say, permitted the corporate to maneuver its mental property out of collectors’ attain. However with new points coming at a fast clip, who has that type of time? The reply: funding companies with particular conditions teams, previously identified by the much less marketing-friendly moniker of distressed debt traders. As one specialist wryly informed me, the time period is regularly misapplied to traders quite than the debt they’re shopping for.
More and more, the leveraged finance firms are bifurcated between those who have specialist groups that exploit poorly drafted credit score agreements and the have-nots. The latter group does conventional credit score evaluation however typically lacks sufficient assets to establish sloppy documentation.
The weakening of documentation additionally partially outcomes from a quirk of the construction of funding autos often called collateralised mortgage obligations which have expanded enormously in recent times. Roughly two-thirds of broadly syndicated loans are bought at origination by CLOs, based on JPMorgan analysis.
A typical CLO is tranched into slices of differing danger. JPMorgan estimates these rated AAA by credit standing businesses make up 60 per cent or extra of the typical deal — that means that the patrons of that portion of the CLO are taking investment-grade danger. Different tranches are rated larger in danger. It’s an oversimplification to say that almost all junk-rated loans are held by AAA traders — but that’s the finish end result.
Whereas CLO managers make use of credit score analysts, most not often have the time or experience to do the deep dive into documentation {that a} particular scenario group undertakes. That doesn’t matter if the issuer performs as anticipated — however when issues go south, the main target shifts. A truism is that good docs can’t make a low credit deal good — however unhealthy docs could make a foul deal horrible.
Managers at bigger firms with particular scenario teams have benefits, not solely within the capability to guage the docs. The particular scenario groups can clue in managers when a problem is getting, ahem, fascinating, and permit them to promote early. And if a particular scenario group is concerned in an LME, any overlapping place held by a CLO will in all probability be introduced alongside on any offers.
The saying in mounted revenue was, “You may’t get fired for investing with Pimco”. At this time, it’s changing into comparable with extra specialised credit score managers. Giant credit score platforms will proceed to get larger as their analytical assets give them a leg up.
