Even the Safest Corporate Loans Now Get Back About 60 Cents on the Dollar
With no junior bonds to absorb losses and senior lenders fighting each other for priority, being first in line no longer means getting paid in full.
The Wall Street Skinny · The Financial Times' Go-To Reporter on All Things Private Equity & Private Credit TELLS ALLThe safest loan in a corporate buyout used to be almost safe. When a debt-heavy company failed, the lenders first in line, the holders of what is called first lien debt, once got back about 80 cents on the dollar. Now that recovery is about 60 cents, according to Moody's data cited by Sujeet Indap, a Financial Times reporter.
First lien means senior and secured, sitting at the top of the stack and backed by company assets. The interest rate floats with prevailing rates, and because the loans are senior and secured, vehicles that bundle corporate loans have long favored them as relatively safe paper that still paid a decent yield.
In the past 10 years, Indap says, many buyouts have become loan only. There are more loans, against higher purchase prices, and no junior bonds to take the hit. When trouble comes, a bigger crowd of first lien lenders must split the same leftovers, so each one gets less.
There is a second cut. Some of this debt is covenant light, meaning lenders gave up the old tripwires that let them force a bankruptcy early. Instead, a struggling company can pit equally ranked lenders against each other in a fight to supply rescue money, a practice known as creditor-on-creditor violence. The winners get to move their old loans into a new, super senior slot. The losers, who thought they owned the safest piece, suddenly find themselves at the back of the line without ever agreeing to move.
Senior, in other words, no longer guarantees first in line, and that is why a loan that was built to be boring now behaves a lot more like risky debt.
Questions people ask
What is covenant light debt?
It is a corporate loan with few maintenance tests, like requirements to keep leverage or cash flow above a set level. That gives borrowers more freedom, but it means lenders get fewer early warnings and less power to force a restructuring before the money runs out.
What does super senior mean in a creditor fight?
It means a new layer of debt created on top of the old first lien in a rescue deal. The lenders who provide fresh money get their old loans moved up with it, so they are paid before the first lien lenders who were left out. The old first lien is still called senior, but it is effectively junior to the new layer.
Why do many buyouts now have no junk bonds under the loans?
Issuing a high-yield bond typically requires a relatively big company. There has been a flight to quality in junk bonds. Many recent buyouts have instead used loan-only structures with no junk bonds below the loans to absorb losses.