Investors Making It Costly To Modify Leveraged Loans

I somehow missed this Bloomberg story last week, but it’s sufficiently important that I thought I should call it to your attention.

Investors have decided that they are sick of being chumps and are now demanding newly-high financial concessions to change the terms of takeover-related debt. Bloomberg attributes the tough-mindedness to the losses investors have taken to date. A second likely culprit is frustration with the cov-lite terms they agreed to earlier. Since borrowers can in many cases get away with a lot that in earlier cycles would have forced them to go to the bank to get waivers (almost never a cost-free process) they are now determined to get their pound of flesh when the debtors do have to seek them out.

Note the story is pretty long; I’ve extracted the key bits. From Bloomberg:

For investors stung by $28 billion of losses on high-yield, high-risk loans, it’s payback time.

Creditors are making borrowers from Carlyle Group’s LifeCare Holdings Inc. to casino owner Tropicana Entertainment LLC increase the interest on their debt by an average 0.83 percentage point to change the terms of their loans, the highest price since at least 1997, according to data compiled by Standard & Poor’s in New York. The penalties are four times higher than six months ago, S&P said.

A total of 179 North American companies have a high risk of default or may need to change details of their debt agreements, Moody’s Investors Service said. Lenders are taking advantage of the distress to recoup losses after the collapse of the subprime mortgage market caused $551 billion of so-called leveraged loans tracked by S&P to fall below 95 cents on the dollar, from 100 cents before June.

“There’s been a dramatic shift in negotiating leverage from borrowers to debt holders,” said Scott D’Orsi, who helps manage $1.4 billion in loans as a partner at Boston-based Feingold O’Keeffe Capital. “We will see more of this with companies that are susceptible to a slower economy.”

Creditors are also demanding fees of as much as 0.35 percentage point of the value of loans to relax terms, or covenants, such as the minimum ratio of earnings to debt they require or deadlines for reporting quarterly financial results, S&P said. Before June, lenders charged 0.125 percentage point.

A 0.35 percentage point penalty and an increase of 0.83 percentage point in rates would cost a borrower $5.9 million in the first year on a $500 million loan….

Companies rated below-investment grade, or less than Baa3 by Moody’s and BBB- by S&P, had no trouble raising money through June….Almost $100 billion, or 29 percent, of bank debt that financed leveraged buyouts in the first half were so-called covenant-lite loans, according to S&P. They typically don’t limit the amount of debt a company can have relative to earnings, or prohibit asset sales.

Demand dried up in July….Loan prices fell 4 percent in July, the biggest drop on record, and now trade at an average of 94.6 cents on the dollar, the lowest since October 2003, according to S&P…

“Anytime you need to go a bank it’s a problem right now,” said Jonathan Rather, general partner and chief financial officer of Welsh, Carson in New York. “Banks are going to extract some flesh. They have to.”

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