Debt Download

In the News

• JPMorgan purchased all deposits and substantially all assets of First Republic Bank (FRB) early in the morning on May 1, 2023, out of a quick FDIC receivership. The sale followed FRB’s closely-watched public struggles in the aftermath of the banking turmoil in March, including quarterly earnings reports that revealed that FRB lost $102 billion in customer deposits in 1Q23, which in turn caused its stock price to plummet to approximately 5% of its valuation pre-SVB collapse. The sale process proved to be tricky, but JPMorgan has a track record of bank takeovers during times of distress.
• Given the shakeup in the banking industry, all eyes were on bank performance during the 1Q23 earnings season. Although the largest banks in the United States fared well – the industry’s overall profits were heavily skewed by the one-time gains recorded by First Citizens and Flagstar from the purchases of SVB’s and Signature Bank’s assets – it is no surprise that the first quarter was tough for small and mid-sized banks, as shockwaves from the collapse of SVB and Signature Bank resulted in many depositors choosing to move their cash from regional to larger banks. From March 1 – March 29, the 25 largest U.S. banks saw an $18 billion increase in deposits, while the rest saw a loss of $212 billion in deposits. Meanwhile, hedge funds made more than $7 billion by betting against bank shares during the turbulence in the banking industry, and the perfect storm created by such turbulence and the higher-rate environment where credit is harder to come by is an opening for distressed debt “vulture” funds. A number of regional banks still face an uncertain future – rating agencies have continued to downgrade regional banks, share prices continue to decline, and some (like Pacific Western Bank) are considering sales and other transactions with potential investors. Then again, at JPMorgan's annual meeting on May 16, 2023, Jamie Dimon said he thinks regional banks are almost out of the woods.
• Government regulators are now looking for ways to prevent a similar collapse in the future, including by increasing deposit insurance for certain business accounts. In the SVB post-mortem, the Fed took some blame for not being forceful enough with SVB regarding risks but also pointed to a “textbook case of mismanagement by the bank”, including with respect to managing interest rate and liquidity risks. With respect to Signature Bank, the post-mortems by the FDIC and the NY Department of Financial Services both pointed to mismanagement of risk, but also noted that each suffered from shortages of regulatory examiners. The Fed is also reviewing whether to close the “loophole” that allowed some mid-sized banks like SVB to not include certain unrealized gains and losses on securities in their capital ratios. Politicians are also weighing in. Non-banks are being scrutinized as well, particularly where they have exposure to similar risks (like rising interest rates and losses on loan and bond assets), including private credit funds, pension and mutual funds, BDCs and life insurance companies.
• Meanwhile, private credit is eager to step in. The FT reports that Blackstone is offering to partner with regional banks to channel loans originated by the banks to Blackstone’s insurance customers who would hold their portion of the loans to maturity – this potential solution would help reduce the risk of regional banks holding loans on their balance sheets while helping insurance companies invest in longer-term assets (which aligns nicely with the longer time horizons they have to deploy capital). Apollo’s Atlas credit firm has stepped in to give a $1.4 billion repo loan to PacWest.
• The U.S. leveraged loan market rebounded in April compared to the turbulence of March. The average all-in clearing spread for single-B new issuances was S+527 for April (down from S+554 in March). Meanwhile, the high-yield bond market also performed relatively well since the turmoil in March, pushing down yields and signaling to the market that investors do not feel a need to price in a premium for recession risk. On the other hand, for the first time in 7 years, decreased LBO volume has led to the average debt to EBITDA ratio for newly issued leveraged loans to fall below 5x. Less M&A activity so far in 2023 also means a bigger share of deal volume going to amend-and-extends, for which borrowers have seen an 84 bps premium on average for such extended loans compared to the loans taken out due to tight market conditions, as reported by Covenant Review for the loans tracked by LevFin Insights. Middle market lenders have also responded to tougher market conditions by tightening up on EBITDA adjustments. Sponsors, however, have been increasingly buying back debt of their portfolio companies that trade below par – Bloomberg notes that these sponsors often hold such debt as an investment (allowing them to receive interest payments), which also sends a message of continued confidence to other investors.
• The Fed raised interest rates by another 25 bps in early May to a range of 5-5.25%, the highest level since 2007, though it signaled that it might be done raising rates (for now). Not surprisingly, middle market borrowers are feeling the impact of the rise in interest rates on their fixed charge coverage ratios, with the average FCCR for middle market borrowers shrinking to 1.24x in 4Q22 (compared to 1.37x in 3Q22 and 1.4x at the start of 2022). The European Central Bank and the Bank of England both followed the Fed’s lead shortly thereafter, with each raising their respective benchmark rates by 25 bps.
• It is not new that private credit has been taking a bigger share of the leveraged loan market and will likely continue to grow, but it is still interesting to see its growth outside of LBOs as compared to the broadly-syndicated market. Even JPMorgan and Goldman Sachs, traditional players in the syndicated loan space, are looking to start trading private debt. Some still view the direct lending market with a dose of skepticism, pointing not only to its unregulated nature, but also to the leeway lenders have when valuing loans that are privately held.
• The loan default rate volume reached a 2-year high with 3 new large Chapter 11 filings this week and credit rating firms speculate that an increase in defaults and downgrades are on the horizon. Indeed, a survey by the International Association of Credit Portfolio Managers (IACPM) found that 86% of credit portfolio managers expect rising corporate defaults globally in the next year. Attention is also being paid to an increase in unrealized losses on loans held by banks due to higher interest rates – such losses will be further compounded if there is an uptick in defaulting borrowers and the lenders have to further write down distressed loans on their books. The Financial Times notes the increased use of out-of-court “distressed exchanges” for companies anticipating a default on their debt, which for many borrowers results in simply kicking the can down the road.
• The U.S. Bankruptcy Court for the Southern District of Texas ruled that the 2020 uptiering exchange in Serta Simmons was valid, finding that the debt exchange fell within the debtor’s rights as an “open market purchase” under the credit agreement, though the (now) subordinated lenders retained the right to pursue claims that the transaction ran afoul of the implied duties of good faith and fair dealing. The lenders who were subordinated in the Serta Simmons transaction have since appealed the Bankruptcy Court decision. In addition to borrowers seeking flexibility through the use of liability management transactions when facing distress, another possible reason for increased “creditor-on-creditor” violence may be due to LBOs retreating from the use of junior capital in financing packages, and therefore increasing the chance that senior lenders will not see a full recovery – Moody’s estimated that first lien lenders recovered approximately 73 cents on the dollar on average during restructurings in 2021 and 2022, a staggering drop from the 95 cents on the dollar that first lien lenders recovered on average in restructurings from 1987 to 2019.
• As we near the end of the publication of representative USD LIBOR, which will cease on June 30th, borrowers who have credit facilities with hardwired fallback language should prepare for the transition to Term SOFR and any credit spread adjustments that will be applied after June 30th (or earlier if parties exercise an early opt-in or execute a Term SOFR amendment in advance). Although the UK Financial Conduct Authority announced it would compel the ICE Benchmark Administration to continue publishing an unrepresentative synthetic USD LIBOR through September 30, 2024 to further help the transition away from LIBOR, it is intended to be used only for legacy contracts with no other fallback mechanism. In an article for LCD, the LSTA notes that this will not have a large impact on the leveraged loan market as most credit agreements require a “representative” LIBOR. As we get closer to LIBOR’s end, Term SOFR amendments are picking up and lenders have increasingly focused on credit spread adjustments (CSAs). Of the transactions tracked by LFI in 1Q23, 47% of deals included the ARRC recommended CSAs of 11/26/43 bps, 44% had a flat 10 bps, and only 7% included 10/15/25 bps. As the leveraged loan market largely stabilized in April, CSA terms loosened a bit, with only 7 of the 24 loans tracked by Covenant Review launching with CSAs, a 5-month low.
• Quick roundup of recent new direct lender debt funds (and related updates):
  
  • Fidelity Private Credit Fund (Fidelity’s first BDC) has begun operations and aims to make loans to middle market and upper middle market private companies.
  • Ares launched a new $10 billion direct lending fund for middle market U.S. companies.
  • Ares also launched a $1.5 billion non-traded BDC called Ares Strategic Income Fund which is tailored to high-net-worth individuals and will invest in senior secured middle market U.S. loans.
  • Blackstone launched a new U.S. direct lending fund targeting $10 billion and will likely be modeled to some extent on its BDC, Blackstone Private Credit Fund.
  • Oak Hill closed its Credit Solutions Fund II at $2.2 billion.
  • Bain launched Legacy Corporate Lending LLC, an asset-based lending platform for middle market companies seeking loans in the $10-40 million range.
  • Hercules formed a new private credit lending platform to back venture and growth-stage companies to help fill the gap left by the collapse of SVB.
  • Diameter Capital closed a $2.2 billion fund focusing on stressed and distressed credits.
  • HPS Investment Partners closed a $17 billion junior capital solutions strategy fund which will focus on providing loans to large, established businesses in North America and Western Europe.

Goodwin Insights

As companies continue to face economic uncertainty caused by a variety of factors, larger leveraged companies in particular may begin to foresee difficulties refinancing or maintaining compliance with their existing debt facilities. Below we provide some high-level considerations for large cap and upper-middle market companies with broadly-syndicated debt facilities for when distress may be on the horizon (please note that this is not legal advice, but rather general observations and any possible action taken would require review of actual relevant documentation and consultation with necessary legal, tax and other advisors).

1. Identify what the catalysts are in advance of any discussions with lenders or other stakeholders and when any may occur, including, for example, potential financial covenant breaches, liquidity concerns and upcoming maturity on material debt.
2. Consider engaging the company’s board regarding debt facility issues and outside counsel to advise on fiduciary duties of directors during a distressed scenario. Discussions may include the preparation of cash flow projections and budgets, use of equity cure provisions, entering forbearance arrangements as the company works on potential solutions, funding separate company payroll and benefit accounts, and assessment of alternative restructuring pathways, refinancings and deleveraging scenarios.
3. Prepare for messaging to lenders and other stakeholders (including timing of the initial conversation and the information to be provided to various constituencies) and follow up negotiations. Companies should acquire all relevant materials, monitor compliance with debt documents and consider confidentiality and leakage risks.
4. Evaluate liquidity (including access to any revolving loans or delayed draw term loans, and whether the company has an option to pay-in-kind any interest or fees), review the company’s cash management systems and accounts, including the ability of the company to operate during a restructuring, and assess whether the company has adequate cash to cover debt service.
5. Consider retaining a financial advisor and/or bankers, and have outside counsel gather referrals and make informal contact with potential candidates.
6. Pay attention to assignments of loans, including whether there has been increased frequency. Companies should also review the register of lenders and consider what voting thresholds are needed for different actions under the loan documents.
7. Monitor the company’s ratings (including inquiries from rating agencies) and any references to the company in trade publications, particularly in any restructuring-specific publications (or request that outside counsel do so).
8. Consider whether refinancing the company’s existing credit facilities or other indebtedness, or engaging in deleveraging transactions, would ease pressure on the company. Assess whether debt buybacks or debt-for-equity exchanges are options.
9. Consider whether the company’s liquidity position may be strengthened (including cost vs. yield, any flexibility under the loan documents or approvals that may be required from lenders, equity investors or otherwise) through various transactions such as asset sales and sale-leasebacks, equity offerings, debt capacity and waiver of mandatory prepayments, including excess cash flow.
10. Consider establishing infrastructure for a restructuring and/or a strategic transaction. Understand the legal, regulatory and contractual requirements and limitations related to any such transaction and any tax implications.

Public companies should also consider regulatory and stock exchange compliance requirements, and be aware that events of default or execution of forbearance agreements, loan agreement amendments, waivers, and binding term sheets will likely trigger an 8-K filing. In addition, Regulation FD limits the sharing of material non-public information with lenders without wider disclosure, and an inability to trade stock may impact whether and for how long lenders are willing to be subject to an NDA. Further, downward stock movement and/or other 8-K disclosure triggers (e.g., potential delisting, quarterly earnings or departure of executive officers or directors) may result in additional negative press and put pressure on discussions with lenders.

For more detail, be on the lookout for a forthcoming article from Goodwin diving into these items with more depth. Please reach out to anyone on the Goodwin Debt Finance team, or your usual Goodwin contact, to discuss any of the options above or for any other questions you have on your existing or new credit facilities.

In Case You Missed It – Check out the Goodwin Bank Failure Knowledge Center which includes helpful FAQs (including for First Republic Bank), webinars, articles and more, and these recent Goodwin publications: Federal Reserve Announces Results From the Review of the Supervision and Regulation of SVB and An Emerging Credit Crisis Could Reshape Real Estate.

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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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