Operating out of a Chicago suburb, in a low-slung, red-brick building wedged between a Hyatt and a Radisson, Clover Technologies is in the mundane business of recycling everything from inkjet cartridges to mobile phones.
But in the past week it abruptly -- and alarmingly -- caught the attention of Wall Street. Almost overnight, a $693 million loan Clover took to the market five years ago lost about a third of its value. The startling nosedive stung even sophisticated investors, people who deal in the arcane business of trading corporate loans.
Clover’s loan isn’t especially large by Wall Street standards, yet its stark and swift decline set off fresh alarm bells -- bells that regulators have been sounding for months. It immediately became a real life example of the perils of investing these days in the $1.3 trillion market for leveraged loans, where a global chase for yield has allowed an explosion in borrowing and lax underwriting. In a market where trading can be thin -- and at a time when illiquidity is suddenly becoming a prominent concern in credit circles -- the episode shows how loans to highly leveraged companies can quickly implode when fortunes change.
When buyers “head for the exits at the same time, prices can drop fast and furiously” given the lack of liquidity, said Soren Reynertson of investment bank GLC Advisers & Co., which specializes in debt restructuring.
A representative for 4L Technologies Inc., Clover’s legal name, and its private equity owners, Golden Gate Capital, declined to comment.
Clover had been operating since 1996 when it was acquired by Golden Gate in 2010 for an undisclosed price. Golden Gate followed the usual path of private equity buyouts -- it piled debt on the underlying company to extract dividends.
Using the leveraged loan market as a wallet, the company took loans that funded dividend payments totaling at least $278 million -- $100 million in 2013 and $178 million in 2014. (Portions of the overall proceeds went to shareholders as well as to refinance the company’s existing debt and certain fees, according to a Moody’s report.) Clover also asked lenders for a further $100 million in 2014 to pay for an acquisition.
Those loans, as is typically done, were bought mostly by mutual funds and collateralized loan obligations, which bundle such leveraged debt into higher-rated securities that are pitched to more risk-averse investors. There’s been little trouble finding buyers for CLOs in recent years. With yields on high-grade bonds hovering near zero across much of the world, investors have been hungry for the juicy returns that these loans offer and, more and more, tend to overlook the lack of protection afforded.
Covenant Problems
Indeed, Clover’s deal, like many these days, was known as “covenant-lite.’’ It contained no provisions that required Clover to alert investors to signs of trouble after undergoing financial tests every quarter. That meant that investors were left with little leverage over the company. Jessica Reiss, head of leveraged loan research at Covenant Review, describes the growing number of weak credit agreements as “death by a thousand paper cuts.”