Lenders are increasingly demanding additional safeguards in subprime corporate loans to counteract a rising trend in which distressed companies use inventive financing methods to secure new funds, according to a recent Moody’s report released on Thursday.
Over the past year, numerous subprime-rated firms, including At Home Group and Trinseo, have utilized “double dip” liability-management transactions.
These maneuvers involve issuing debt through a subsidiary, which then loans it to the parent company, thereby creating collateral for the new debt.
Derek Gluckman, a Vice President at Moody’s Private Credit team, explained the strategy: “Double-dips allow borrowers to attract new money by offering some lenders a bigger share of any recovery pie.”
This technique not only allows firms to generate liquidity for repaying maturing debts or maintaining solvency but also provides certain lenders a superior position in any potential recovery scenarios, leading to what is sometimes referred to as “creditor-on-creditor violence.”
The growing use of this tactic has led to a backlash from lenders, as existing loan agreements typically do not restrict companies from undertaking further similar transactions.
In response, new loan documentation is beginning to include clauses that limit these maneuvers.
For example, a new proposed term loan for Thryv and two other borrowers now features a provision that bars the borrower from securing intercompany loans that could conflict with new debt obligations.
This clause, dubbed the At Home provision, references a restructuring maneuver by At Home in May 2023.
It is designed to ensure that any intercompany loan repayments are subordinate to those owed to existing lenders, thereby preserving the unimpaired claims of senior creditors.
The report emphasizes that such protections are likely to become more common, even as other loan covenants, which act as structural safeguards in loan agreements, may weaken.
The Moody’s report strongly suggests that lenders will continue to enforce these protections vigorously.
“Lenders will insist on these features even where they are accommodating elsewhere – threats to a lender’s position in the capital structure are simply too powerful to ignore,” the report concludes.
This shift marks a significant change in how lenders manage risk in high-yield loan markets, aiming to maintain order and fairness among creditors.