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In the News

• This month's market wrap looks back on February, which saw repricings dip from January's record high and demand once again surpassing supply: repricings stood at $11.1 billion, or 21% of overall volume, from $87 billion, or 53% of volume, in January, while $17 billion in new loans were issued against a demand of $20.1 billion (demand is calculated from aggregate of CLO issuances, loan repayments not associated with new loans and loan mutual fund inflows). This trend has continued into March, as borrowers that most recently took out expensive new debt in 2023 made hasty returns to the market, repricing $38.3 billion in loans through March 14, well ahead of February’s but behind January’s total, though this activity is expected to trail off. 
  • Turning back to February’s stats, 36 loans were tightened against six that were loosened, or 6:1, against a January flex ratio of 10:1, and the average all-in clearing spread of single-B loans grew to S+435 (S+410/99.2 OID), from S+395 (S+382/99.6 OID) in January, while the B3/B- clearing spread grew more slowly to S+429 (S+406/99.3), from S+415 (S+401/99.6) in January. Of the 22 loans reviewed by Covenant Review in February, 16 didn't flex any terms, with that 73% rate being the highest since December 2022. 
  • PitchBook's lookback at the month highlighted an increase in M&A financing activity, with $10.9 billion in loans for buybacks, tack-on acquisitions and other M&A transactions, from $8 billion in January—a 20-month high. The first months of the year featured a resurgence of dividend recapitalizations, with total volume at $13.2 billion through February—a record for any two months.
  • Borrowers also closed $17.6 billion in amend-and-extend (A&E) transactions in February, a drop from $23.9 billion in January, though still ahead of the $14.7 billion per-month average in 2023 and $9.1 billion in 2022. This high level of A&E transactions came despite a 9.2% average yield-to-maturity, not far off the 23-year high of 9.6% seen in 2023. 
  • Also off to a hot start—another record start in fact—is the high-grade bond market ($427 billion in issuances for the first 10 weeks of the year, a gain of 27% from 2023), which shows little sign of slowing down and is the tide that is tightening margins throughout the credit world. 
  • These factors have contributed to high demand seen in the secondary market, which in turn has created a great opportunity for loan repricing, with $105 billion being repriced in the year to date, the fastest rate since 2021. This is a trend that should last as long as secondary prices continue to climb.
• Competition between Wall Street banks and private credit providers is heating up as each side continues to encroach on the other’s turf. One impact of this competition has been shrinking spreads at the top end of the market as private lenders and Wall Street banks fight for the same share of business, a trend that is migrating to the lower middle market, in addition to a loosening of covenants in private credit deals. As private lenders meet traditional lenders on their own territory, increased regulation may be on the horizon. Here are the blows that the two sides have recently traded:
  • Higher-for-longer rates are pushing more borrowers to refinance their relatively expensive private debt—particularly second-lien facilities—into cheaper broadly syndicated loans (BSLs), with $10.5 billion of private debt being refinanced into BSLs so far this year. This trend is most pronounced among lower-rated borrowers (B-minus or B3), which have also disproportionately benefitted from repricing opportunities and have won an average spread of S+425, a four-year low.
  • Private lenders are trying to wrest some business back by picking up asset-based financing deals in the consumer arena, which includes auto loans, credit cards, mortgages, and equipment financing, with such private lending transactions (outside of mortgages) expected to reach $900 billion over the next few years, from its current level of $350 billion. Private credit has also not let up on continuing to expand into BSL’s corporate space, including through stapled commitments on behalf of PE sellers, and is increasingly being used to finance the issuance of preferred equity by portfolio companies to reward investors who have been waiting (and waiting) for the exit market to improve.
  • BSL lenders are also cashing in on dividend financing, somewhat, with loans backing dividends hitting $13.2 billion in 1Q through March 15, the highest quarterly amount since 4Q 2021.
  • Both private and BSL lenders are scrambling to pick up some of Barings’ 200 direct loans as that private lender (a subsidiary of Mass Mutual) reels from losing upwards of 20 staff in the U.S. and Europe to Nomura’s Corinthia Global Management. Barings has responded with legal action alleging contractual violations and breaches of fiduciary duty.
• All that said, BSL lenders and private credit can play nicely together in these troubled times, as we see in the effort to refinance distressed and soon-to-be distressed debt, closing a gap created by the loss of some regional banks that have their own issues with commercial real estate (CRE) exposure (and those troubles have created an investment opportunity for private equity picking up valuable pieces of regional banks). In these transactions, larger banks are funding private lenders, which in turn are lending for debt buybacks, mezzanine debt and, as mentioned, preferred equity, including by bringing second-lien and junior debt facilities back into fashion. The growth of 2L loans follows a trend in which private lenders provide junior debt to the BSL’s senior stack. KKR acknowledges this common ground in its own report, with better-rated borrowers supplementing its BSL loans with private junior debt—a hybrid approach with a projected typical mix of 35% syndicated senior debt, an equity cushion of 50% and—between them and with elements of both—10-15% private junior debt.
• PitchBook notes that liability management (LM) transactions ticked up in February, pointing to four distressed transactions from out-of-court restructurings, exchanges and buybacks at less than par, while the payment default rate by issuer count ticked up to 2.07%, the highest level since April 2021. Of the loans analyzed by Covenant Review in February, 57.4% of all loans and 56.8% of private-equity-backed loans required all affected lenders to approve amendments (Serta protection), which compares with 61.9% and 75% in 4Q 2023; the mean free-and-clear incremental tranche cap was 1.01x pro forma EBITDA for the trailing 3 months, unchanged from 4Q 2023; and 7.4% of all loans and 5.4% of PE-backed loans included the pass-through trapdoor associated with J.Crew, from 6.8% and 4.5%, respectively, in 4Q 2023. 
• In fact, PitchBook finds that LM transactions are having a moment, and given that the Morningstar LSTA US Leveraged Loan Index distress ratio was 5.08% and the S&P US High Yield Corporate Bond Index distress ratio was 5.94% at February 29 (representing $125 billion in distressed debt), that moment may continue for some time. The linked article provides a primer on the terms and activities that comprise LM transactions—from tender offers and buybacks to drop-downs and double dips. And once you’re up to speed on the double dip, get ready for a possible “triple dip” (or maybe enhanced double dip). As described by Xtract Research, Spirit Airlines’ LM transaction consisted of (i) a guaranty by Spirit of an affiliate’s issuance of senior secured notes, (ii) an intercompany loan (reflecting proceeds of the senior secured notes loaned from the affiliate issuers to Spirit) pledged by the affiliate issuers to noteholders and (iii) collateral (including IP and loyalty program assets) dropped down by Spirit to the affiliate issuers to support the issuance—hence, the triple dip.
• Higher-for-longer interest rates and the vacuum created by the collapse of Silicon Valley Bank (SVB) have forced public BDC lenders to navigate a rapidly changing venture debt landscape. In a report looking back at the 2023 earnings of Hercules Capital, Horizon Technology, Runway Growth Capital, Trinity Capital and TriplePoint Venture Growth, PitchBook notes that higher rates helped these lenders reap high returns, though lower volume has disproportionately favored safer borrowers and forms of debt (i.e., senior secured). Looking forward, these lenders’ emphasis is shifting from seed funding to late-stage financing, again part of a general flight to quality. These trends—performing borrowers, late-stage financing and strong competition in the wake of SVB’s demise—have buoyed the market overall, though because of these limitations the overall recovery appears “gradual” (as noted in the report).
• Looking forward, the debt finance world is particularly focused on the pressures that higher interest rates are imposing on regional banks. New York Community Bancorp lost $2.4 billion in 4Q 2023 followed by a large chunk of its market capitalization along with its CEO after reporting the need to further disclose "material weaknesses in internal controls" related to oversight, risk assessment, and monitoring.” NYCB later received a $1 billion investment/lifeline in a sale of common stock and convertible preferred stock. Among other stories related to the acute challenges faced by regional banks:
  • Bank Runs Spooked Regulators. Now a Clampdown Is Coming. (New York Times); big banks want regulators to pick on regional banks with respect to the Basel III end game requirements, and regulators are receptive
  • Why People Are Switching to Their Hometown Banks (Wall Street Journal); smaller regional banks seem to have found a sweet spot in the market and are doing surprisingly well
• Quick roundup of recent new direct lender debt funds:
  • Partners Group launches dedicated NAV financing vehicle (Private Debt Investor)
  • Ares grabs bank assets to expand in asset-based credit market (PitchBook)
  • GoldenTree closes debut private credit fund (Private Debt Investor)
  • Apollo launches Middle Market Apollo Institutional Private Lending fund backed by Mubadala (Debtwire)

Goodwin Insights – Delaware Court of Chancery Invalidates Governance Rights in Stockholder Agreement

For this edition of Debt Download, Goodwin partners Jordan D. Weiss, Michael J. Kendall, Jennifer L. Chunias and Joseph P. Rockers and associate Dylan Schweers examine a recent case in the Delaware court of chancery that threatens to upend fairly common control provisions in stockholder agreements.

On February 23, 2024, the Delaware Court of Chancery issued a decision in a class action lawsuit (West Palm Beach Firefighters’ Pension v. Moelis & Co.) that concluded most of the control provisions in a stockholder agreement in favor of a stockholder were facially invalid under Delaware’s General Corporation Law (“DGCL”) because they were not in the Charter.

Key Takeaways:

• Most or all of the invalidated governance provisions would be valid if included in a company’s certificate of incorporation, rather than a stockholders’ agreement
• Stockholder agreement provisions could also be incorporated by reference into certificates of incorporation to make amending those provisions easier
• Existing arrangements that may be subject to challenge on the same basis as Moelis can be amended to be compliant, subject to fiduciary considerations
• This ruling does not impact similar governance provisions for limited liability companies (LLCs) or limited partnerships (LPs)

At the center of the case is a 2014 stockholder agreement (the “Stockholder Agreement”) that provides Moelis & Co.’s (the “Company”) founder, CEO, and Chairman, Ken Moelis, certain negative covenants, or “blocking rights,” with respect to eighteen of the Company’s key decisions, including stock issues, financing, contracts, litigation decisions, dividend payments, and senior officer selections (the “Pre-Approval Requirements”). In addition, under the Stockholder Agreement, the Company’s board of directors (the “Board”) was required to ensure that Moelis can select a majority of its members (the “Board Composition Provisions”).

In its motion for summary judgment, plaintiff stockholder alleged that the Pre-Approval Requirements and the Board Composition Provisions are invalid on their face because they violate the “bedrock” principles of director decision making under Delaware law. More specifically, plaintiff argued that the challenged provisions in the Stockholder Agreement violate Delaware law because they effectively remove from directors “in a very substantial way” their duty to use their own best judgment on matters of management. Meanwhile, the Company argued that Delaware corporations possess the power to contract, including contracts that may constrain a board’s freedom of action, and the Stockholder Agreement should not be treated any differently.

After a painstaking analysis of applicable Delaware cases, the court found that several of the Board Composition Provisions, and all of the Pre-Approval Requirements, were facially invalid under Delaware law. The court decided that each of the Pre-Approval Requirements went “too far” because they forced the Board to obtain Moelis’s prior written consent before taking “virtually any meaningful action” and, thus, “the Board is not really a board.” Potentially worth noting, the court decided only to address the Pre-Approval Requirements together, rather than individually, leaving open the possibility that some of them, standing alone, could be valid. It is not clear whether that choice was meant to convey legal significance, but at a minimum it leaves open the question for future litigation of how any particular blocking right might have been viewed when analyzed through the multi-prong test laid out in the opinion.

Offering some counsel to market participants, the court makes the point that the provisions it invalidated could have been accomplished consistent with Delaware law if they had been included in the Company’s certificate of incorporation, rather than in a stockholder agreement. The court also posited that, even now, the Board could implement many of the challenged provisions by using its blank check authority to issue Moelis a single “golden share” of preferred stock carrying a set of voting rights and director appointment rights.

Additionally, because this decision arises out of the DGCL, it does not apply to other corporate forms such as LLCs or LPs.

The Opinion will likely have a ripple effect on cases already pending in the Chancery Court that involve similar “new wave” stockholder agreements. Beyond those matters, in this Firm’s view and based on our experience, the most likely practical impact is that the next time that a target’s counsel argues against including one or more stockholder rights in the target’s certification of incorporation—perhaps based on the efficiency of leaving certain matters to the Board, instead of requiring stockholder votes—the potential investor will win that negotiation.

Our team will continue to monitor the Moelis & Co. case, including with respect to any appeals, and will continue to give thought to the decision’s impact. Please contact Jordan Weiss, Mike Kendall, Jennifer Chunias, Joe Rockers or Dylan Schweers with any questions. 

In Case You Missed It – Check out these recent Goodwin publications: US Government Moves to Regulate Cross-Border Transactions Involving Sensitive Data; CFPB Issues Guidance Regarding Comparison-Shopping Results for Credit Cards and Other Financial Products; Approaches Funds Take to Catch-Up Payments Vary by Asset Class; The CFPB’s Final Rule Imposes Significant Restrictions on Credit Card Late Fees; Federal Reserve Announces Final Rule Updating Risk Management Requirements for Certain Systemically Important Financial Market Utilities; Dos and Don'ts of Interacting with Bank Regulators; Series 1 - The World’s First AI Regulation Is Here; Chamber of Commerce Sues CFPB To Eliminate or Enjoin $8 Late Fee Cap

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

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