Welcome to the inaugural edition of Debt Download, Goodwin’s monthly newsletter covering what you need to know in the leveraged finance market.

Note: Some of the links in this newsletter may redirect you to a subscription-only resource.

In the News

• There was very little new institutional loan issuance in October 2022 and investors continued to have a decreased appetite for risky transactions. Nevertheless, in the syndicated loan market, the average all-in clearing spread tightened slightly to S+658 in October for single-B rated loans tracked by Covenant Review (from S+727 in September). As a result of tough market conditions and shifting risk tolerance, the pro rata market has taken a larger share of new loan issuance, ABL volume has increased and venture debt has performed well.

• Given current market conditions, private credit funds have been pulling back on funding supersized direct loans, particularly financings for mega-buyouts and large unitranches (see our take on this below under Goodwin Insights). One reason is that as rates rise, companies are less likely to refinance debt, resulting in their private credit fund lenders receiving less proceeds from repayments to deploy into new deals. Nevertheless, debt markets aren’t completely closed for business if companies need to access capital, the debt solutions are just more expensive and borrowers should take advantage of windows of time when terms are slightly more favorable.

• As the Federal Reserve continues to raise interest rates, smaller banks have been more severely impacted than their larger counterparts because large banks tend to cater to a more diversified clientele and generally have more deposits to offset losses. On the company side, the WSJ estimates that North American companies will need at least $155 billion to cover increased interest costs in 2022 and 2023, resulting in companies aggressively paying down debt and trying to formulate plans for funding operations with earnings.

• As the market continues to brace for a potential downturn, a historical look at how recoveries by creditors in default situations compared by sector may be informative. Meanwhile, the Federal Reserve’s most recent semi-annual Financial Stability Report highlighted its concern regarding how leverage at “shadow banks” may impact the financial system in times of distress, particularly because bank lending to private equity sponsor portfolio companies and non-bank lenders has increased, creating a more interconnected and vulnerable system.

• Borrowers and issuers have continued to look to liability management transactions in an effort to avoid bankruptcy and creditors continue to challenge these transactions in court. A few transactions worth highlighting include the recent lawsuit by certain of Revlon’s lenders regarding the company’s transfer of valuable IP assets to a subsidiary outside of the collateral package, Incora bondholders suing to void the company’s uptiering “lien-stripping” transaction from March 2022, the Serta Simmons first lien lenders having filed a new complaint seeking to invalidate the company’s 2020 uptier exchange (following recent decisions in NY to allow such lawsuits to move forward and despite having had a request for an injunction to stop such transaction denied in 2020), and the lawsuit challenging the super-priority uptiering transaction in Boardriders surviving a motion to dismiss in NY state court.

• Covenant Review recently surveyed the loans in the Credit Suisse Leveraged Loan Index for Serta, PetSmart/Chewy and J. Crew “loopholes” and found that 69.5% of the loans included a Serta (or majority consent voting) loophole; 42.2% of the loans included a PetSmart/Chewy (or “phantom guarantee”) loophole; and only 7.4% of the loans included a J. Crew trapdoor (or ability to transfer material IP to unrestricted subsidiaries outside of the credit group). This Covenant Review report analyzes language and trends in recent transactions like Incora and Revlon where companies seeking amendments to approve lien-stripping transactions (but lack the necessary votes) have instead issued new debt to creditors that would vote in favor of the amendment.

• In other recent news from the courts, a NY Bankruptcy Court denied a motion to dismiss a lawsuit by creditors in the Tops bankruptcy case against PE-fund owners related to the company’s distributions of dividends that the creditors argue left the company insolvent.

• In an effort to create a standardized environmental, social and governance (ESG) disclosure questionnaire and to promote consistency of ESG data in the loan market, the Loan Syndications and Trading Association (LSTA), together with certain credit investors (including Oak Hill and Apollo) and other trade organizations, have released a new template for borrowers to provide ESG data as part of the launch of the ESG Integrated Disclosure Project.

• Quick roundup of recent new direct lender debt funds:
  • HighVista Strategies closed its $450 million Opportunistic Private Credit Fund II
  • Catalio Capital closed its inaugural $85 million special situations fund
  • General Atlantic Partners will acquire Iron Park Capital Partners to create General Atlantic Credit (or GA Credit)
  • U.S.-based Nuveen is buying Arcmont Asset Management, one of the largest private lenders in Europe
  • Castlelake closed its $782 million fund focusing on specialty finance, aviation and real assets
  • Ares closed a $7.1 billion special opportunities fund
  • Hamilton Lane launched the Hamilton Lane Senior Credit Opportunities Fund (SCOPE), a new senior private credit fund, through its evergreen platform
  • TA closed its $1.1 billion TA Debt Fund V

Goodwin Insights

As of the date of publication of this inaugural Debt Download, the credit markets remain challenging. Nevertheless, we are seeing glimmers of optimism: a hope that with the approaching new year (with its attendant refreshed quotas and mandates for deploying capital) we will see a slow, but steady, improvement of market conditions. By way of recap of current trends we are seeing:

• The broadly-syndicated market recently has been all but shut, save for a slow trickle of new issue deals, with a backlog of paper on Twitter and other committed deals, and the tortured syndication of Citrix and other deals underwritten during the first half of 2022 before the credit markets deteriorated. As a result of the incredible uncertainty in the economy, the war in Ukraine, raising interest rates and other unprecedented challenges, arrangers have become increasingly hesitant to underwrite big commitments like they did in 2021.

• For performing companies, by contrast, opportunities continue to exist, but with significantly higher pricing and fees because of the increased risk environment, opportunities for investors to buy term B paper at a steep discount to par in the secondary market and the dearth of existing loan repayments as compared to 2021.

• In order to fill the gap left by the decreased activity in the syndicated loan market and tighter direct lending market, financial buyers and other market participants have looked to alternative means to raise capital. For example, preferred equity instruments with dividends that are paid “in kind” instead of in cash, which had started to make up an increasing percentage of LBO capital structures prior to the credit market downturn, remain on trend as a way to fill the hole created.

• Likewise, private credit deals remain popular. But even as borrowers increasingly turn to direct lenders—including mega-unitranche facilities in excess of $1 billion—the private credit markets have similarly seen a significant reduction in overall transaction volume and, while incremental facilities and add-on activity remain a moderate bright spot, they are often accompanied by an increase in fees and interest expense, frequently triggering MFN protection on the initial loans then outstanding. As a result, the fleeting moment where direct lenders eagerly competed to hold mega-unitranche loans on their books is all but past, and where two or three lenders alone could finance an aforementioned mega-unitranche loan in 2021, in the latter half of 2022 these deals are requiring a significant number of lenders to write the necessary checks (if at all).

• Recurring revenue loans, often with covenant “flip” mechanics—historically provided to rapidly growing, but not yet profitable, businesses—have become more mainstream, in part because top-tier financial sponsors have pivoted away from traditional broadly-syndicated loans to the private credit markets, where lenders are more willing to lend to such businesses. Even still, closing date recurring revenue leverage multiples have decreased meaningfully in recent months and like direct cash flow loans, financial sponsors are chasing an increasing number of lenders on each deal to fill the books on new issuances.

• Lastly, lower middle market loans have remained almost business as usual, given the traditional low leverage, high amortization, inclusion of financial maintenance covenants and tight documentation terms.

In Case You Missed It – Check out this recent Goodwin publication: Breach of Contract and Implied Covenant of Good Faith Claims Survive Motion to Dismiss in Boardriders Uptier Exchange Dispute

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