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“It’s A Civil War”: Decade Of Covenant-Lite Deals Leads To Leveraged Loan “Panic”

"It’s A Civil War": Decade Of Covenant-Lite Deals Leads To Leveraged Loan "Panic"



"It’s A Civil War": Decade Of Covenant-Lite Deals Leads To Leveraged Loan "Panic" Tyler Durden Wed, 10/07/2020 - 20:06

It was a little over two years ago that we last looked at the "covenant lite" insanity sweeping the loan market for the past decade, where as a result of a buying frenzy among yield-starved investors, corporations had managed to get away with selling "secured" debt that was anything but secured, and offered only the slimmest - if any - protections to investors. In fact, by early 2018, the amount of covenant-lite loans hit an unprecedented 75%...

... which meant that Moody's Loan Covenant Quality Indicator (LCQI) dropped to its record-worst level in the first quarter of 2018.

"While the rate of deterioration in covenant quality has slowed, protections remain distressingly weak on average," said  Derek Gluckman, Moody's VP-Senior Covenant Officer. "Investors should remain wary given the risks presented by most loan documents and the likelihood that any steadying of covenant protections is temporary."

But it wasn't just the sheer volume of cov-lite outstandings that mattered: an analysis by LCD looked at the debt cushion of outstanding loans – the amount of debt in a borrower’s capital structure that is subordinated to the senior loan – and found that most cov-lite deals have little or no debt cushion beneath them. Consider that by mid-2018, an all time high 23% of all cov-lite loans did not have any debt, such as a mezzanine tranche, high yield bond, or other, below the cov-lite facility. That number was up from 18% in 2013 and from just 10% at the end of 2007, shortly before the financial crisis.

This is also why we explicitly warned that "the lack of a debt cushion significantly lessens what an investor will recover on a loan, if that credit defaults" and left readers with the following:

In other words, during the next default cycle, whenever the business cycle finally turns, loan investors not only will have virtually no "secured" protection, but are now the de facto equity tranche in numerous deals, or said otherwise, for the first time in history, loan investors are looking at 0 recoveries in default.

Well, fast forward to today when the chickens from the covenant-lite euphoria of the past decade have come home... for the slaughter.

In a transaction which has terminally tilted the "landscape in favor of distressed borrowers and pitted creditors against each other" a $120 million loan to cash-strapped restaurant supplier TriMark USA has "not only unilaterally placed the new lenders above everyone else in the repayment pecking order, but it also stripped some of the older creditors of safeguards they had written into the contracts to protect their investments" according to Bloomberg, which notes that when word of the deal spearheaded by Howard Marks and his distressed debt giant, Oaktree, first hit the market in mid-September, "it sparked a panic", prompting investors to puke the old loan so fast it cratered 20 cents in days, an unheard of move in the world of secured finance where underlying assets never reprice so fast, even in bankruptcy.

Of course, for those who had been following the degradation of creditor protections and the ascent of cov-lite deals over the past decade, what just took place is hardly a surprise: as investors bargained away most of their legal rights in hopes of getting a modest allocation in the latest "high yielding" note, they now find themselves with virtually no protection for their investments just as the pandemic is causing a wave of corporate bankruptcies across the country.

And just to underscore that "anything goes" in the brave new world of leveraged (and unsecured) loans, the presence of Marks - who had long been seen as one of the more staid voices in a distressed-debt world full of pugnacious vultures - served to upend the market only further and spark fears about what is coming next as tens of billions of other "secured" loans are about to see their investors crammed down or otherwise wiped out, just as we warned in 2018.

"It’s a civil war between lenders, and we’re going to see more of this," said Thomas Majewski, managing partner and founder at Eagle Point Credit Management. “Nearly every company restructuring debt is looking at these possibilities.”

So what exactly happened?

The TriMark transaction, which according to Bloomberg was similar to another loan that surf-clothing maker Boardriders entered recently, followed in the "priming" footsteps of a divisive financing by Serta Simmons Bedding earlier this year. The mattress maker got $200 million of fresh capital from existing lenders including Eaton Vance Corp. and Invesco Ltd. Those lenders jumped to the top of the capital stack meaning they would be repaid first if the company defaulted, pushing Serta Simmons’ other lenders further back, in a process known as priming.

There’s nothing new about priming - in fact it happens all the time in bankruptcy when a company issues what is known as a "priming DIP" - but the way lenders did it in the Serta Simmons deal resulted in litigation. The new investor group led by Eaton Vance and Invesco didn’t give all other lenders the right to participate in the new loan, a move that is allowed by many deals’ documents, but hadn’t really been done before. Lenders who were left out, including Apollo Global Management, sued the company but a state court let the deal go ahead, ushering in a new precedent in the market where existing "secured" creditors hiding behind the thin defense of non-existent covenants, realize they are in fact, unsecured.

“Serta did open the floodgates in that regard,” said Tim Sullivan, an analyst at Xtract Research, "because it showed how provisions which are very common in agreements today can be used to incur priming debt."

Of course, creditors have only themselves to fault: nobody put a gun to their heads in 2010-2018 when they signed the dotted line on yet another high-yielding loan that offered no covenant protection. Yet they just had to do it. Well, now that the catastrophic event that nobody thought could possibly happen happened, and as investors pore through their covenant term sheets, they finally realize why all those warnings over the past decade hit home.

The catalyst for this realization, of course, is the covid crisis, as a result of which countless companies in the U.S. are going broke as the pandemic saps their revenues. Fitch Ratings projects 7% to 8% of leveraged loans will default by the end of 2021, compared with 1.8% in 2019, a cataclysmic event for the $1.2 trillion loan market. Making matters worse, after years of the loan market growing rapidly, failing corporations that issued debt and pledged assets now have less in the way of income or assets to fork over to creditors, which is making fights among all parties more acrimonious.

It also means that those investors with fresh capital can trample over the gullible ones who received a couple of years of interest payments and are now facing near complete losses on principal.

In the case of Boardriders, Oaktree was one of the equity owners: as Bloomberg details, the company negotiated a $135 million financing including a $45 million loan that has priority over all others. The debt came from Boardriders’ bigger lenders, a group that included Brigade Capital Management, Canyon Capital and MidOcean Credit Partners, according to people with knowledge of the situation.

The $45 million loan, which is effectively a pre-petition DIP, ranks ahead of all investors that didn’t participate in the new financing. Just as a secured bankruptcy loan does. The minority lenders that were primed argue that was unfair because they weren’t given a chance to participate in the deal, the people said. Good luck to them: meanwhile, the new loan which is secured by all the assets, is trading around 100 cents on the dollar; the old loan that was primed? About a third of that, or around 35 cents.

The situation was similar for TriMark. The company saw its revenue falling and hired advisers to help it consider its options. It ultimately picked a transaction to raise $120 million from lenders including Oaktree and Ares Management Corp. The group of existing lenders also included Blackstone’s credit arm GSO Capital Partners, Sculptor Capital Management, and BlackRock. Their new loan is trading around face value, about 40 cents on the dollar higher than the loan that was primed. TriMark is owned by Centerbridge, which is about to get a big fat doughnut on its investment.

So how did the new investors prime existing lenders? In both Boardriders and TriMark, minority lenders had covenants including limits on future company borrowings removed, while the debt amortization schedule was slowed down.

According to Etract’s Sullivan, the additional step of removing covenants is highly unusual in the loan world and is a big loss for investors. On the other hand, such covenant stripping would never had been possible if the loans were not covenant-lite to begin with. 

“It’s gone beyond Serta -- now it’s worse. By stripping it down to the ultra bare bones, all that leaves you with is just a promise to pay,” he said.

It also means that the entire $1.2 trillion universe of secured loans - because by definition first and second-lien bank debt is secured by company assets and has first dibs on them in case of default - is effectively no longer secured.

* * *

To be sure the primed lenders are fighting back, and some companies are deciding not to embrace these transactions (they can of course do that, but one way or another a priming loan will come, the only difference is that if it is in bankruptcy, it is called a DIP Loan). Meanwhile, covenant lite deals have resulted in even more ingenious instances of asset stripping. In May debtholders rebelled against Elliott Management and Siris Capital Group, the owners of global travel reservation company Travelport, after those two firms tried to move assets out of the reach of creditors. And when Oaktree proposed a priming transaction for PSAV, the borrower elected to raise new capital through a loan that was in the same class as the existing facility.

"Priming transactions such as those executed by Serta and Boardriders are still the exception and the priming play is not the ‘new normal,’” said Judah Gross, a director at Fitch Ratings. "That being said, the higher degree of frequency with which such deals get done may indicate that priming transactions are not as taboo as once assumed."

He is right, and the real kicker will take place some time in 2021 if there is no new fiscal stimulus, and a default wave washes over the leveraged loan market: only then will our warning from 2018 become clear - years of issuance of loans that were "secured" only in name, has ensured that recoveries for these unsecured creditors will be the lowest in history; in fact depending on the severity of the coming double dip, it is likely that "secured" lenders are looking at the unthinkable - a total wipeout on principal.

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Pentagon Boss ‘Clarifies’ Russia & China Pose Biggest Threats After Biden Says It’s Climate Change

Pentagon Boss ‘Clarifies’ Russia & China Pose Biggest Threats After Biden Says It’s Climate Change

On Wednesday, President Biden told US troops stationed in the UK that the Joint Chiefs told him "the greatest threat facing America" is…



Pentagon Boss 'Clarifies' Russia & China Pose Biggest Threats After Biden Says It's Climate Change

On Wednesday, President Biden told US troops stationed in the UK that the Joint Chiefs told him "the greatest threat facing America" is "global warming" - a curious pivot from "white supremacy."

On day later, the Chairman of the Joint Chiefs 'corrected' Biden, asserting instead that the biggest threats facing the US are China and Russia, according to US News, (and who allegedly had a big role in scamming half of pandemic unemployment funds to the tune of hundreds of billions of dollars).

"Climate change does impact, but the president is looking at a much broader angle than I am," Army Gen. Mark Milley, the chairman of the Joint Chiefs of Staff, told a congressional panel Thursday morning in response to a question by Sen. Kevin Cramer (R-ND) "I'm looking at it from a strictly military standpoint. And from a strictly military standpoint, I'm putting China, Russia up there."

Milley then backpedaled a bit, saying "Climate change is a threat. Climate change has a significant impact on military operations, and we have to take that into consideration."

"Climate change is going to impact natural resources, for example," he told the Senate Armed Services Committee,adding, "It's going to impact increased instability in various parts of the world, it's going to impact migrations and so on."

When asked how his assessment that Russia and China pose the biggest threats, Milley said "This is not, however, in conflict with the acknowledgement that climate change or infrastructure or education systems– national security has a broad angle to it. I'm looking at it from a strictly military standpoint."

On Wednesday, Biden spoke to US forces at Royal Air Force Base Mildenhall, where he recounted an alleged discussion which took place while he was Vice President with the Joint Chiefs in their cloistered "tank" meeting room at the Pentagon.

"This is not a joke. You know what the Joint Chiefs told us the greatest threat facing America was? Global warming," he claimed.

In response to Biden's Wednesday comments, former President Trump issued a statement.

"Biden just said that he was told by the Joint Chiefs of Staff that Climate Change is our greatest threat. If that is the case, and they actually said this, he ought to immediately fire the Joint Chiefs of Staff for being incompetent," said Trump.

Tyler Durden Fri, 06/11/2021 - 19:20

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Spread & Containment

Middle-aged Americans in US are stressed and struggle with physical and mental health – other nations do better

Adults in Germany, South Korea and Mexico reported improvements in health, well-being and memory.

Middle age was often a time to enjoy life. Now, it brings stress and bad health to many Americans, especially those with lower education levels. Mike Harrington/Getty Images

Midlife was once considered a time to enjoy the fruits of one’s years of work and parenting. That is no longer true in the U.S.

Deaths of despair and chronic pain among middle-aged adults have been increasing for the past decade. Today’s middle-aged adults – ages 40 to 65 – report more daily stress and poorer physical health and psychological well-being, compared to middle-aged adults during the 1990s. These trends are most pronounced for people who attained fewer years of education.

Although these trends preclude the COVID-19 pandemic, COVID-19’s imprint promises to further exacerbate the suffering. Historical declines in the health and well-being of U.S. middle-aged adults raises two important questions: To what extent is this confined to the U.S., and will COVID-19 impact future trends?

My colleagues and I recently published a cross-national study, which is currently in press, that provides insights into how U.S. middle-aged adults are currently faring in relation to their counterparts in other nations, and what future generations can expect in the post-COVID-19 world. Our study examined cohort differences in the health, well-being and memory of U.S. middle-aged adults and whether they differed from middle-aged adults in Australia, Germany, South Korea and Mexico.

A middle-aged woman looking sad sitting in front of artwork.
Susan Stevens poses for a photograph in her daughter Toria’s room with artwork Toria left behind at their home in Lewisville, N.C. Toria died from an overdose. Eamon Queeney/For The Washington Post via Getty Images

US is an outlier among rich nations

We compared people who were born in the 1930s through the 1960s in terms of their health and well-being – such as depressive symptoms and life satisfaction – and memory in midlife.

Differences between nations were stark. For the U.S., we found a general pattern of decline. Americans born in the 1950s and 1960s experienced overall declines in well-being and memory in middle age compared to those born in the 1930s and 1940s. A similar pattern was found for Australian middle-aged adults.

In contrast, each successive cohort in Germany, South Korea and Mexico reported improvements in well-being and memory. Improvements were observed in health for each nation across cohorts, but were slowed for Americans born in the 1950s and 1960s, suggesting they improved less rapidly than their counterparts in the countries examined.

Our study finds that middle-aged Americans are experiencing overall declines in key outcomes, whereas other nations are showing general improvements. Our cross-national approach points to policies that could could help alleviate the long-term effects arising from the COVID-19 pandemic.

Will COVID-19 exacerbate troubling trends?

Initial research on the short-term effects of COVID-19 is telling.

The COVID-19 pandemic has laid bare the fragility of life. Seismic shifts have been experienced in every sphere of existence. In the U.S., job loss and instability rose, household financial fragility and lack of emergency savings have been spotlighted, and children fell behind in school.

At the start of the pandemic the focus was rightly on the safety of older adults. Older adults were most vulnerable to the risks posed by COVID-19, which included mortality, social isolation and loneliness. Indeed, older adults were at higher risk, but an overlooked component has been how the mental health risks and long-haul effects will likely differ across age groups.

Yet, young adults and middle-aged adults are showing the most vulnerabilities in their well-being. Studies are documenting that they are currently reporting more psychological distress and stressors and poorer well-being, compared to older adults. COVID-19 has been exacerbating inequalities across race, gender and socioeconomic status. Women are more likely to leave the workforce, which could further strain their well-being.

A older women hugs her daughter.
Middle-aged people often have parents to take care of as well as children. Ron Levine/Getty Images

Changing views and experiences of midlife

The very nature and expectations surrounding midlife are shifting. U.S. middle-aged adults are confronting more parenting pressures than ever before, in the form of engagement in extracurricular activities and pressures for their children to succeed in school. Record numbers of young adults are moving back home with their middle-aged parents due to student loan debt and a historically challenging labor and housing market.

A direct effect of gains in life expectancy is that middle-aged adults are needing to take on more caregiving-related duties for their aging parents and other relatives, while continuing with full-time work and taking care of school-aged children. This is complicated by the fact that there is no federally mandated program for paid family leave that could cover instances of caregiving, or the birth or adoption of a child. A recent AARP report estimated that in 2020, there were 53 million caregivers whose unpaid labor was valued at US$470 billion.

The restructuring of corporate America has led to less investment in employee development and destabilization of unions. Employees now have less power and input than ever before. Although health care coverage has risen since the Affordable Care Act was enacted, notable gaps exist. High numbers of people are underinsured, which leads to more out-of-pocket expenses that eat up monthly budgets and financially strain households. President Biden’s executive order for providing a special enrollment period of the health care marketplace exchange until Aug. 15, 2021 promises to bring some relief to those in need.

Promoting a prosperous midlife

Our cross-national approach provides ample opportunities to explore ways to reverse the U.S. disadvantage and promote resilience for middle-aged adults.

The nations we studied vastly differ in their family and work policies. Paid parental leave and subsidized child care help relieve the stress and financial strain of parenting in countries such as Germany, Denmark and Sweden. Research documents how well-being is higher in both parents and nonparents in nations with more generous family leave policies.

Countries with ample paid sick and vacation days ensure that employees can take time off to care for an ailing family member. Stronger safety nets protect laid-off employees by ensuring that they have the resources available to stay on their feet.

In the U.S., health insurance is typically tied to one’s employment. Early on in the COVID-19 pandemic over 5 million people in the U.S. lost their health insurance when they lost their jobs.

During the pandemic, the U.S. government passed policy measures to aid people and businesses. The U.S. approved measures to stimulate the economy through stimulus checks, payroll protection for small businesses, expansion of unemployment benefits and health care enrollment, child tax credits, and individuals’ ability to claim forbearance for various forms of debt and housing payments. Some of these measures have been beneficial, with recent findings showing that material hardship declined and well-being improved during periods when the stimulus checks were distributed.

I believe these programs are a good start, but they need to be expanded if there is any hope of reversing these troubling trends and promoting resilience in middle-aged Americans. A recent report from the Robert Wood Johnson Foundation concluded that paid family leave has a wide range of benefits, including, but not limited to, addressing health, racial and gender inequities; helping women stay in the workforce; and assisting businesses in recruiting skilled workers. Research from Germany and the United Kingdom shows how expansions in family leave policies have lasting effects on well-being, particularly for women.

Middle-aged adults form the backbone of society. They constitute large segments of the workforce while having to simultaneously bridge younger and older generations through caregiving-related duties. Ensuring their success, productivity, health and well-being through these various programs promises to have cascading effects on their families and society as a whole.

[Get the best of The Conversation, every weekend. Sign up for our weekly newsletter.]

Frank J. Infurna receives funding from the National Institute on Aging and previously from the John Templeton Foundation. The content is solely his responsibility and does not necessarily represent the official views of the funding agencies.

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Inflation In Context: A Liquidity Adjusted CPI Index

First, folks, please send your prayers, thoughts, good feelings, positive energy, miracles, healing touch, whatever you got, and whatever it takes to GMM’s beloved Carol K., who keeps battling, never giving up against a serious disease in Boston at…



First, folks, please send your prayers, thoughts, good feelings, positive energy, miracles, healing touch, whatever you got, and whatever it takes to GMM’s beloved Carol K., who keeps battling, never giving up against a serious disease in Boston at one, if not the best hospital in the world.  Even in her critical condition, she contributed to this post — though she may not agree with all its final points.  She’s truly an amazing and incredibly strong human being.  Semper Fi and Godspeed, CK.  

We had a few requests to write up something about today’s hot U.S consumer price inflation data. So we put together a quick note in honor of our friend from down in the Land of Oz, GMac, one of the most decent human beings on earth. He is one proud father of a super studly 18-year son, who is an incredible surfer and someday wants to surf Mavericks.  God. Bless. His. Soul.

Let us preface our inflation note with one of our favorite quotes:

World War II was transitory – GMM

Recall our post in January, Ready For 4 Percent CPI By Mid-Year?, when we speculated the U.S. would be experiencing 4 percent inflation, possibly 5 percent by mid-year.  We were beaten down like a red-headed stepchild (I am at liberty to say that as I have been a ginger most of my life).

GMM was also one of the first to point out the base effects (12-month comps) would kick in April and May 2021 due to the deflation that troughed last year from the COVID crash.  But don’t be gaslighted the lastest few month-on-month core prints essentially negate the base effect excuse for high inflation as three-month core CPI is now running at 7.9 percent on an annual basis.

We don’t know for certain if inflation will stick and move higher or lower but as better folk we are taking the over, however.

Liquidity Tsunami

We do know the major global central banks have pumped in a shitload of high-powered money into the global financial system over the past year — as in around $10 trillion, close 50 percent increse of their collective balance sheets.   Here’s Dr. Ed’s excellent chart,

Moreover, banks now seem eager to start lending, thus creating more endogenous money on top of the trillions upon trillions of base money central banks have already injected.

Transitory?  Yeah, right.   

It’s not a question whether the Fed has the tools to reign it in, it’s do they have the ‘nads?  Given the multiple asset bubbles that would burst, and bust spectacularly, if the Fed draws it word,  we seriously doubt it. 

The following chart from Dr. Ed also illustrates not only has the digital printing press been working overtime, the credit system is just fine and dandy as deposits are expanding.  Don’t be confused by, yes, the base effect, as the money aggregates have a much large base to grow from they did a year ago before the pandemic.

Tough to beat comps after expanding over 25 percent 

Note, these are monetary aggregates, which include cash in circulation, bank deposits among near money and other short-term time deposits, not the expansion of the Fed’s balance sheet, though it does hugely influence the data.  

This image has an empty alt attribute; its file name is yardeni.png

Big spurts from the digital printing press without a credit crisis and an impaired financial system — as was the case after the Great Financial Crisis — will almost always generate inflationary pressures.   Stimulating demand without production during a supply shock is not optimal unless carefully targeted to those who need it most.   

It’s very amusing to us to see the FinTweets, “peak inflation has arrived.”  True, if the financial markets crash.  But what do they base their conclusion on?  A warm feeling in their tummy?   

Show me the money data, Jerry.  

Banks Itching To Lend

Banks now seem eager to start lending, thus creating more endogenous money on top of the trillions of base money central banks have injected.  

Loans are “starting to pick up,” and there’s plenty of borrowing capacity because companies have unused credit lines, {BofA CEO Brian ]Moynihan said. Loan growth has been a challenge across the banking industry because many consumers and businesses are sitting on cash from savings and stimulus during the pandemic. – Bloomberg, June 6

This should send shivers up the Fed’s spine, but we are not so sure.  We are also not so sure they are not flying blind and will again miss the next big one just as they have in the past. 

The Chart: Liquidity Adjusted Inflation. 

It’s late and we want to present the chart in honor of GMac. 

We have taken the non seasonaly adjusted year-on-year change of CPI and subtracted a scaled up version of the Chicago Fed’s  National Financial Conditions Index (NFCI), which measures how loose or tight monetary conditions are in the U.S..  It’s has been running at an extreme historical low — i.e., very loose financial conditions.   

You can see the 105 indicators it is based upon here.

We are trying to give context to the inflation data of how loose and accomodative finnancial market and monetary conditions are currently.   As you can see, today’s year-on-year CPI print less the NFCI is at the highest level since November 1990, which was in the middle of the first Gulf war, Where the Fed was facing spiking inflation due to the run-up in oil and a recession.  

Prior to that our adjusted inflation index hasn’t been so high since the high inflation late 197Os and early ‘80s.  Gulp. 

Clearly, it is a different environment in today’s economy.  In fact, just the opposite – the economy is ready to roar for the next several quarters as consumers are flush with cash, the supply chain is still a mess due to the “bullwhip effect” (more on this in a future post), and new businesses should be looking for credit and loans to rebuild and start new ventures.    

Most of all, folks, the central banks still have their pedal to the metal and balls to the walls, and as we all know (well some of us),

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. – Milton Friendman 

The Upshot

Inflation is way too high given exremely easy financial and monetary conditions.  There will be blood. 


Life is transitory. 

Inflation has eroded my purchasing power in my transitory life.  Bring back the $.35 Big Mac, which was only about 20 percent of the minimum wage.  Now?  About 40-50 percent.  Enough to spark a revolution. 

Finally, the Democrats should begin to worry.

Stay tuned. 

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