Debt Download

In the News

• The new year began with some positive activity in the primary syndicated loan space (though debt backing M&A activity was still scarce) and continued robust trading in the secondary leveraged loan market. Likewise, corporate bonds – both investment grade and high-yield – have leapt out of the starting gate to begin 2023, with a notable increase in high-yield bonds used to take out leveraged loans earmarked for refinancing in January (including so called “pro rata” loans – i.e., term loan As). Borrowers received slightly better pricing in January, with pricing flex favoring borrowers 11 cuts to no increases and the average all-in clearing spread for syndicated single-B new issuances dropping to S+563 (from S+593 in December 2022). Lower-rated companies are taking advantage of this slight opening in the market by refinancing debt to extend maturities. On the other hand, the leveraged loan default rate rose slightly to 0.83% in January (from 0.72% in December 2022) due to new bankruptcy filings, which notably remains well be the 10-year average default rate of 1.88% and historical average of 2.71%. Relatedly, Debtwire’s Distressed Watchlist has grown as it anticipates an increase in distressed debt in 2023.
• Meanwhile, private credit remains attractive for borrowers and investors alike. The gap left by brick-and-mortar banks increasingly has been filled by pension funds, with their allocation to private loans reaching an 8-year high in 2022. For example, the California State Teachers’ Retirement System (CalSTRS) board directed staff to include private credit in the new asset allocation proposals that will be voted on later in the year, and the Ohio Public Employees Retirement System (OPERS) allocated 1% of its portfolio to private credit  ̶  these pension funds oversee $300 billion and $90 billion in capital, respectively. Insurance companies are also wading into the private credit pool by partnering with direct lenders like Blackstone, Carlyle and Centerbridge to launch insurance ventures, which can result in higher returns for insurance companies while giving the debt funds access to capital from annuities, reinsurance and other insurance assets for investment. Some insurance companies have also created their own internal private credit teams. Even family offices are increasingly turning to private credit for its higher yield in exchange for investment liquidity.
• On the other hand, the effect of increased interest rates and macro-economic headwinds is still negatively impacting existing credits in private credit fund portfolios as borrowers find it harder to service existing debt, particularly with floating interest rates. On top of that, funds are contending with the “denominator effect”, where recent losses in public markets have shrunken the relative value of public asset exposure, leaving investors overly allocated to private assets. This Private Debt Investor article takes a look at the impact of the denominator effect on LPs as they look to rebalance their portfolios, and as greater liquidity coupled with increased interest rates are making high-yield bonds appear attractive again. Some suggest this can be an opening for funds specializing in more niche assets like structured credit and stressed credit. There has also been an increase in the private debt secondaries market as investors search for liquidity.
• On the topic of interest rates, the Federal Reserve Bank raised its benchmark interest rate by only 25 bps on February 1st, the smallest increase since March 2022. Despite signaling that it will continue to raise rates in 2023, the upswing in the markets may signal that investors are optimistic that the increases will be short-lived. However, recent inflation data is muddying the waters as it relates to the prospects of future Federal Reserve rate hikes. On the other side of the Atlantic, the European Central Bank and the Bank of England each raised their respective benchmark rates by another 50 bps. Interestingly, as the gap between interest rates across jurisdictions narrows, the use of cross-currency swaps to manage the rising cost of debt, a tactic that gained popularity in 2022, starts to lose its appeal.
• The healthcare and software sectors are leading distressed loan metrics in the Morningstar LSTA US Leveraged Loan Index, and Wells Fargo notes that software providers are experiencing financial challenges, with additional slowdowns and downgrades expected. Borrowers in the software sector have historically benefited from positive attention from private credit lenders as such borrowers were perceived as being insulated from general economic slowdowns, including by receiving a large share of recurring revenue loans, but recent layoffs and weaker performance may lead to direct lenders and BDCs seeking to lessen their exposure to loans in the software sector.
• Lenders remain wary of borrowers “pulling a J. Crew”  ̶  when borrowers move valuable assets from the credit group to unrestricted subsidiaries outside of the credit group (i.e., outside the reach of existing secured creditors), usually with the intention of raising new debt supported by the assets in the unrestricted subsidiary  ̶  as a new potential J. Crew transaction is in the market, this time with Instant Brands. Another recent liability management transaction by Envision Healthcare has led to the coining of the term “Envision blocker”, which refers to the set of protections needed in a credit agreement to protect lenders against the type of transactions that Envision Healthcare used to raise new debt, including a J. Crew-like transfer of valuable assets to unrestricted subsidiaries, Serta-like multi-layered uptiering transactions and other non-pro rata debt exchanges resulting in existing lenders being primed (e.g., relegating lender holdouts to a fourth-out debt tranche). The proposed “Envision blocker” protections include a J. Crew blocker (restriction on moving certain valuable assets, including IP, to an unrestricted subsidiary), Serta protections (not allowing subordination of loans without consent of all affected lenders), and limitations on investment basket capacity required to move valuable assets to unrestricted subsidiaries. This Covenant Review Trendlines Report looks at how prevalent Envision Blockers are in deals in the Credit Suisse Leveraged Loan Index and this report tracks deals in the Credit Suisse Leveraged Loan Index with various of these “loopholes”  ̶  interestingly, there isn’t a huge delta between inclusion of these provisions in PE-backed deals and non-PE-backed deals.
• Amend-and-extend volume hit new highs in 2022 as borrowers sought to push out loans maturing in 2023 and 2024, and with LBO activity down in 2022, a significant portion of the debt deals that closed were amend-and-extends. For an interesting analysis of how collateralized loan obligations (CLOs) can potentially use “deemed consent” provisions as a way around restrictive language in their fund documents that might otherwise prohibit voting for amend-and-extends in its loan portfolio, take a look at this Covenant Review report.
• Given the increased pushback by lenders (including CLOs) over the transition from LIBOR to Term SOFR without credit spread adjustments, the WSJ reports that some companies may choose to use “synthetic LIBOR”, a product that is currently being considered by UK regulators, though the Loan Syndications and Trading Association (LSTA) warns against thinking of synthetic LIBOR as a panacea. Interestingly, in January, only 8 of 23 SOFR loans tracked by Covenant Review had credit spread adjustments (down from 71% in December).
• All eyes have been on struggling retailer Bed Bath & Beyond and investors have been bracing for a bankruptcy filing, particularly after the company received a default notice from JPMorgan as the agent on its loans and then subsequently missed a coupon payment on its bonds. Instead of filing for bankruptcy, the company will address liquidity issues by raising approximately $1 billion in an esoteric convertible equity and warrants transaction and will draw approximately $100 million on a new revolver from Sixth Street Partners, one of its existing lenders. In other distressed borrower news, Serta Simmons filed for bankruptcy in January, and key to its pre-negotiated bankruptcy deal is whether the bankruptcy court will affirm its controversial 2020 uptiering transaction as valid.
• Quick roundup of recent new direct lender debt funds (and related updates):
  
  • Ares closed its first infrastructure debt fund at $5 billion.
  • Goldman Sachs Asset Management closed on its latest mezz fund at $15.2 billion.
  • JPMorgan is expanding its private credit arm with a $10 billion investment.
  • Audax Private Debt closed its latest direct lending fund at $3 billion.
  • Natixis CIB has launched a direct lending arm targeting borrowers with $40 million+ in EBITDA.
  • Atalaya Capital closed a $1.8 billion debt and equity special opportunities fund focusing on asset-based solutions.
  • MetLife Investment Management enters the private credit world by purchasing Raven Capital Management, which focuses on middle market asset-based lending.
  • Sagard has raised $555 million for its Sagard Senior Lending Partners fund, which will focus on non-sponsored borrowers in the $10 million - $50 million EBITDA range.
  • Investcorp is expanding its private credit business through its BDC and middle-market direct lending arm.

Goodwin Insights

Last year’s collapse of the Terra stablecoin (UST) and its sister token (Luna) triggered a freefall in cryptocurrency markets and, ultimately, the failure of several cryptocurrency lenders and other digital assets-based platforms. The bankruptcy filings that followed are leading to interesting issues of first impression as bankruptcy courts weigh in on previously untested areas of law. One such decision, from the U.S. Bankruptcy Court for the Southern District of New York in the Celsius Network, LLC, et al. chapter 11 cases, examined questions of ownership of digital assets on deposit with, or otherwise held by, a bankrupt cryptocurrency platform. There, the bankruptcy court looked to the documentation governing the relationship between Celsius and customers of its “Earn Program” and found that, based on the unambiguous terms of use to which such customers agreed when opening their accounts, they were transferring ownership of any cryptocurrency deposited in Earn accounts to Celsius. Accordingly, the court found that when Celsius filed for chapter 11, digital assets held in Earn accounts were not owned by the customer, but rather became property of the bankruptcy estate.

The Celsius Network decision will help guide, but not bind, how the courts in the Voyager Digital Ltd., FTX Trading Ltd., BlockFi Inc., and other similar bankruptcy cases decide related issues in those cases.

Key takeaways from the Celsius Network decision include:

• The terms of use to which customers agree with cryptocurrency platforms are critical to the analysis of ownership and property of the estate issues; courts are likely to apply principles of applicable contract law to determine the outcome.
• If the terms of use to which customers agree when depositing digital assets on a platform provide that the platform may lend such assets to third parties, pledge such assets as collateral, or otherwise use such assets to generate income, and further that the customer relinquishes its right to exercise rights of ownership over such assets while on deposit with the platform  ̶  as did the terms of use for Celsius’s “Earn Program”  ̶  such digital assets are likely to be deemed property of the bankruptcy estate if the platform files for bankruptcy.
• The decision does not negate defenses customers may have to claiming ownership of digital assets, including the presence of fraud or other criminal activity or material misrepresentations, which could lead a court to find customers are entitled to receive their assets back.
• Because the digital assets held in the relevant accounts in the Celsius Network cases are considered property of Celsius’s bankruptcy estate rather than property of Celsius’s customers, Earn customers do not get their assets back and become general unsecured creditors of Celsius, and Celsius is permitted to sell the digital assets to underwrite the administrative costs of its bankruptcy cases and, ultimately, to distribute consideration received or remaining assets to its creditors pursuant to a chapter 11 plan.

To learn more, check out this recent Goodwin publication: Who Owns Digital Assets When a Cryptocurrency Platform Files Bankruptcy? The Terms of Use Answer the Question

In Case You Missed It – Check out these recent Goodwin publications:
Innovations in Private Fund Liquidity Solutions and New York Finalizes Commercial Financing Disclosure Regulations

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For inquiries regarding Goodwin’s Debt Download or our Debt Finance practice, please contact Dylan S. Brown, and Robert J. Stein.

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