Debt Download

In the News

• The loan market picked up a bit in August, with gross institutional loan volume hitting an 18-month high due in large part to refinancing of upcoming maturities. Pricing flex continued to favor borrowers with 27 cuts to 2 increases, and average all-in clearing spreads for single-B new issuances decreased to S+484 in August (down from S+493 in July). Although small, the increase in dividend recapitalization volume in the broadly syndicated loan space is promising, though lenders overall have continued to prefer issuing loans for less risky borrowers. Syndicated leveraged loans backing M&A deals, however, continue to decline in volume, with the average pro forma adjusted debt multiple of such deals down to 3.8x first lien leverage and 4.1x total leverage for the last 3 months ending August 31st.
• An interesting outcome of the rise of private credit is that when portfolio companies of private equity firms face defaults and potential foreclosure (particularly in light of rising interest rates), they may ultimately be taken over by competitors of their PE firm owners since a significant portion of private credit originates from the credit arm of a PE firm (e.g., when Envision - a portfolio company of KKR - was restructured, its senior lenders traded debt for equity and became the new owners, which included competitors of KKR, such as Blackstone). Meanwhile, while private credit remains available as a funding source for some tougher-to-finance portfolio companies, the terms may be steep, as evidenced by recent larger loans to hit the market.
• On the other hand, banks are increasingly looking for ways to get in on the wave of private credit in various ways, whether through creating a dedicated fund with money on the balance sheet or raising new capital, or collaborating with other investment firms to create a new fund – Societe Generale is partnering with Brookfield Asset Management to launch a new €10 billion private debt fund; Deutsche Bank launched DB Investment Partners, a new private credit investment manager; and Barclays is in talks with AGL Credit Management to partner in raising a new private credit fund.
• The 2^nd Circuit ruled that syndicated loans are not “securities” subject to securities laws in a long-awaited decision in the Kirschner case. Although the loan market operates in reliance on this long-held position, the Kirschner case resurrected the issue and kept loan market participants on the edge of their seats, including while waiting for the SEC to weigh in at the request of the circuit court. As we covered in the July and August editions of Debt Download, the SEC eventually declined to take a position after requesting multiple extensions, therefore refusing to assert that it had jurisdiction over syndicated loans and ultimately setting the stage for the 2^nd Circuit’s final decision. In response to the aftermath of this litigation, Xtract notes that it has already seen draft credit agreements with new lender and agent representations regarding motivations for holding the loans to try to combat some of the factors that the court considered in the Kirschner case in determining whether the loans were securities.
• In other news in which the SEC is relevant to leveraged finance, the SEC approved new rules targeting private equity firms and hedge funds, including those exempt from SEC registration. In an important win for the loan market, the LSTA advocated for the SEC to exclude CLOs from the new private fund disclosure requirements. The LSTA continues the battle, however, as part of a group of financial trade organizations suing the SEC in light of the new rule, claiming that the SEC “exceeded its statutory authority and acted arbitrarily and capriciously” by adopting the Private Fund Advisers Rule.
• PE firms have been increasingly turning to NAV loans for fund-level financings and have been using NAV facilities not just to bridge add-on M&A activity at the portfolio company level, but also in some cases to help de-risk portfolios by refinancing portfolio company debt in the current high-interest rate environment. Funds are also tapping NAV lines of credit to fund additional capital into investments with longer time horizons – one NAV lender said that you can start to think of using “NAV loan[s] to the fund as an alternative to a holdco PIK instrument at the company level or bringing in outside equity co-invest” in an article by Private Debt Investor. Some investors, however, are not happy with the additional leverage cutting into their returns, especially at current rates.
• Delaware has adopted the new Article 12 of the Uniform Commercial Code (UCC) covering digital assets and cryptocurrency. For a tracker on the latest updates for introduction and enactment in each state, see this ULC tracker (note that New York and California have introduced legislation to pass the new amendments but they have not yet been enacted).
• Since Term SOFR has emerged as the dominant benchmark as a LIBOR replacement, Bloomberg has published a consultation proposing that it cease to publish BSBY.
• As we covered in the May edition of Debt Download, there is a growing trend of private credit funds partnering with insurance companies, allowing such private credit funds to access capital available for longer-term private credit investments while the insurance companies have an additional way to put their capital to work. As further evidence of this trend, Blackstone is combining its corporate credit, asset-based finance and insurance groups into a single unit under the new name Blackstone Credit and Insurance (BXCI). In addition, Fortress made a minority investment in insurance company Nassau Financial Group.
• Quick roundup of recent new direct lender debt funds (and related updates):
  • Blackstone closed its latest tactical opportunities fund focusing on subordinated debt, Blackstone Tactical Opportunities Fund IV, at a record $5.2 billion for Blackstone.
  • Fortress acquired a loan portfolio from Capital One valued at approximately $1 billion.
  • Oaktree is seeking to raise the largest debt fund ever at $18 billion for its Oaktree Opportunistic Fund XII.
  • Apollo is planning to expand its investment in NAV loans, with $4 billion available for near-term funding opportunities.
  • Monomoy Capital closed a $300 million credit opportunities fund.
  • Deutsche Bank launched DB Investment Partners, a new investment manager that will invest in private credit.

Goodwin Insights

Holdco PIK loans and other forms of debt with interest that is paid “in-kind” (as opposed to paid in cash), while always available as a source of financing, have been more prevalent since the Federal Reserve began raising interest rates in March of 2022 in light of the increased cash interest expense for traditional senior debt. Recent trends and points of negotiation in Holdco PIK facilities include:

• Loan Party Structure – The definitive documentation is typically structured as a note purchase agreement (as opposed to a credit or loan agreement) with an “Issuer” (as opposed to a borrower) that will generally be a holding company that sits outside the credit group for any senior debt, which means the Holdco PIK loan will not increase leverage under any senior debt.
• PIK Interest – Interest on Holdco PIK Loans is capitalized at a to-be-negotiated frequency – most often quarterly, although the frequency can also be monthly, semi-annually, annually (in rare instances) and, where the interest rate is not fixed but is based on a floating rate such as SOFR, on the last day of each applicable interest period. The capitalized portion of the interest is added to the total outstanding principal amount of the loan on each capitalization date, and the new, increased principal balance will accrue interest which will be capitalized on the next capitalization date and added to the principal, and so on, and so on. In some cases, lenders will give the borrower the option for a cash pay toggle where the borrower is able to pay interest in cash in exchange for a small discount on the interest rate, or, conversely, a cash pay loan may have a PIK toggle that gives the borrower the option to pay interest in-kind for a premium – care should be taken to ensure that the correct default – cash pay or PIK – is selected, otherwise unknowing borrowers may miss a required notice period and be forced to pay interest in cash, or in-kind with a premium. When considering a cash pay toggle for a company that otherwise has a senior credit facility, it is important to consider whether those cash interest payments would be permitted to be made on Holdco PIK loans under that senior credit facility.  If the Holdco PIK borrower sits outside of the senior credit group, that cash will have to be distributed up and so there will need to be sufficient capacity to do so under any senior credit documents.
• Maturity – The maturity on a Holdco PIK loan is often longer than the maturity of a traditional senior term loan. If a company has senior debt, the Holdco PIK loan should mature outside of the maturity of that senior debt to ensure the Holdco PIK loan can be repaid when it becomes due, as it will otherwise typically be restricted from being repaid under the applicable senior debt documents.  Care should be taken to ensure that any Holdco PIK loan with a maturity date in excess of five years is vetted from a tax perspective to ensure maximum deductibility of interest expense.
• Mandatory Prepayments and Call Protection – Mandatory prepayments typically will be required on Holdco PIK loans in connection with a change of control, IPO or acceleration of the loans under any senior credit facility. It is common for the call protection applicable to the Holdco PIK loans to be higher than what Sponsor and other borrowers may expect for senior credit facilities, including the inclusion of a make-whole premium due on any prepayments made within the first year or two that the debt is outstanding, with a more typical call protection formulation kicking in thereafter.
• Covenants – The same or similar affirmative and negative covenants that are applicable to senior credit facilities are also often applicable to Holdco PIK Loans. In cases where the borrower has a senior credit facility in place, the baskets and thresholds set forth in the covenants may have cushions to the senior agreement baskets and thresholds, usually set at 15-25%. The covenants usually apply to the borrower and all restricted subsidiaries of the borrower. There is often no financial covenant applicable to Holdco PIK loans, and if there is, or for any incurrence-based ratios, a point of negotiation tends to be whether to include the capitalized portion of any interest in calculating the leverage ratio or whether the borrower can exclude that amount.
• Guarantors/Security – Traditional Holdco PIK loans are typically unsecured and subsidiaries of the borrower do not act as guarantors of the Holdco PIK loan.

In Case You Missed It – Check out these recent Goodwin publications: Second Circuit Rules that Syndicated Loans Are Not “Securities” Under State and Federal Law; SEC Adopts Expansive (Albeit Slightly Softened) Private Funds Rules; The SEC’s New Private Fund Rules on Preferential Treatment: How Do They Compare With the AIFMD?; and Till We Meet Again: Eighth Circuit Weighs in on Appropriate Interest Rate in a Cramdown.

 

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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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