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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a former investment banker and author of ‘Power Failure: The Rise and Fall of an American Icon’
The time has come for buyers of new corporate debt to push back against issues and deals that have been stripped of protective covenants, often rendering investors sitting ducks for the Wall Street pastime of creditor-on-creditor violence.
In fact, it’s been a mystery for years as to why creditors have been putting up with such agreements when they know better, and for what? A few extra basis points of yield? The trade-off isn’t worth it.
As is becoming an all too regular occurrence on Wall Street, when things start going awry on corporate balance sheets, loose covenants allow the cleverer creditors — often those who have bought the distressed debt at a discount and know how the game is played — to take advantage. The slower, clunkier “par” buyers, who often seek to hold debt to maturity, often end up losing out in the high-stakes restructuring game.
If, instead, from the start, the first buyers of a corporate debt issue insisted on agreements with meaty and protective covenants — as used to be the standard — instead of caving in to issuers and underwriters in return for a little more yield, their long-term interests would be far better served. The question remains: will these creditors have the guts to fight for their rights?
One of the latest examples of creditor-on-creditor violence came with the recent restructuring at Saks Global Enterprises, the company created in December by the $2.7bn merger of luxury retailers Saks Fifth Avenue and Neiman Marcus.
As part of that deal, Saks Global issued a $2.2bn bond, due in 2029, yielding 11 per cent annually in a deal led by Jefferies. Demand for the debt, in the weeks after Donald Trump’s presidential triumph, was robust. But financial trouble started within months: the company also stretched its payment terms for suppliers in February, a sure sign of a cash squeeze; bondholders wondered if it would be able to make its first interest payment in June. The bonds traded down rapidly, reaching a low of 34 cents on the dollar in late June. In six months, the creditors who paid 100 cents on the dollar had lost nearly two-thirds of their investment at the low point.
The vultures were circling. High-priced lawyers and investment bankers were hired to advise Saks Global and its creditors on a restructuring. In late June, the hammer dropped. A group comprising 54 per cent of the Saks Global bondholders had organised quickly and agreed to provide Saks with as much as $600mn in new financing. In exchange, they made themselves senior in priority to the other 46 per cent of the Saks Global bondholders. All they needed to do it was a simple majority vote.
Unhappy Saks bondholders can ameliorate some of their bad fortune if they step up and participate in the $600mn of new financing. If they don’t, they get pushed down the creditor stack. That is not the place to be in the precarious Saks Global capital structure. Yes, it’s unfair — but perfectly legal because of the skimpy covenants in the original bond agreement.
The Saks Global situation is hardly unique. Some creditors suffered when the Hollywood studio Lionsgate was spun out of a company that also included the cable television and streaming network Starz. While some savvier creditors got the better Lionsgate credit, others complained they were stuck with less creditworthy Starz debt. Other examples where one group of creditors savaged another include Serta Simmons, TriMark, Boardriders and Incora.
Occasionally, creditors get together and thwart the planned evisceration. Take Carvana, for instance, where creditors rejected a proposal to convert their bonds into new bonds at a discount and in return get a higher priority in the capital structure. It wasn’t easy. But bondholders representing some 90 per cent of the online used-car dealer’s debt joined together to block the company’s proposals, repeatedly. In the end, bonds that were trading at 30 cents on the dollar got exchanged at 90 cents on the dollar and traded up to 120 cents on the dollar. The Carvana stock soared, too. Everyone was happy.
Co-operation among creditors is rare. Creditor-on-creditor violence has become the norm, often happening so fast that the losing creditors get caught flat-footed. I’m told there were nearly 50 coercive exchange offers in 2024, where one group of creditors got the better of another group. It doesn’t have to be that way. But it will be until creditors wise up and insist that corporations won’t get their money unless and until the original governing bond agreements protect them from getting screwed when things go off the rails.