On top of that, a higher percentage of loan collateral is intangible assets -- about two thirds, up from about 60 percent in 2009, according to UBS Group AG. Those kinds of assets, like brand names, are harder to value and liquidate than tangible assets. And more borrowers have just loans and no other form of debt this time around, meaning if the company fails, there are fewer other creditors to absorb losses.
Add it all up, and Moody’s Investors Service reckons that investors will recover just 61 cents on the dollar when first-lien term loans go bad whenever the market turns, well below the historical average of 77 cents.
A key to loosening investors’ hold over collateral has been tweaking the tests that determine if a company is earning enough relative to its debt obligations, known as leverage. As long as corporations are generating enough income, managers often have the freedom to move assets around and pull money from the company, among other things. Companies have been easing the requirements for these tests, making it easier for them to clear the hurdles and keep their flexibility.
“These leverage tests are like a master key that unlocks all these flexibilities,” said Derek Gluckman, analyst at Moody’s, “and the master key is working better and easier.”
J. Crew
One of the first signs of the potential trouble ahead for loan investors came from J. Crew Group. In 2016, the preppy clothing retailer told lenders it was moving intellectual property including its brand name into a new unit that was out of the reach of creditors as part of a restructuring, a process it completed in July 2018. Litigation ensued, as angry lenders said that collateral was being taken away from them. But the company has showed signs of recovering, and its term loan now trades at 92 cents on the dollar, up from around 55 cents in November 2017.
J. Crew’s efforts seem to have inspired other private-equity owned retailers as well. PetSmart Inc. and Neiman Marcus Group Inc., for example, have shuffled online businesses into different units where lenders can’t reach them.
“If new terms get through, all the private equity firms and their counsels start to claim that the new term is becoming standard in the market and they point to the precedent,” said Justin Smith, an analyst who looks at high-yield lending agreements at Xtract Research. “There are too many lenders who don’t care enough about covenant packages or don’t pay attention.”
This article was provided by Bloomberg News.