July 31, 2025 • 43 mins
Fox Legal Training sees debt documentation risks rising as too much cash chases a limited number of high-yield deals. “Provisions these days are drafted in a way that they are very much departures from reality,” Sabrina Fox, the company’s founder, tells Bloomberg News’ James Crombie and Bloomberg Intelligence’s Aidan Cheslin in this episode of the Credit Edge podcast. “That creates an alternate universe, like La La Land, where the numbers don’t match the performance of the business,” says Fox, who specializes in covenant analysis. Fox and Cheslin also discuss lack of transparency in high-yield debt deals, lessons learned from the Altice debt restructuring, how aggressive liability management spreads to Europe from the US and where to spot trouble in prospectuses.
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Episode Transcript
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Speaker 1 (00:18):
Hello, and welcome to the Credit Edge Weekly Markets podcast.
My name is James Crombie. I'm a senior editor at
Bloomberg and I.
Speaker 2 (00:24):
Made in Chessin a senior analyst and head of Credit
Research Europe for Bloomberg Intelligence. This week, we're very pleased
to welcome Sabrina Fox, founder of Fox Legal Training and
former head of the European Leverage Finance Association. How are you, Sabrina,
I'm very well.
Speaker 3 (00:38):
Thank you so much for having me.
Speaker 2 (00:40):
And Sabrina spends a large amount of time talking to
lev finn market participants, educating on legal and covenant risks,
something that we've been talking a lot about on our
podcasts in the last year or so on names like
how to cease? Isn't that right?
Speaker 1 (00:53):
James, Yeah, that's right, And we're delighted to have you here. Sabrina,
thanks so much. Before we get started, I just want
to say credit markets are looking pretty complacent at the moment,
with junk bonds trading ever tighter as demand for yield
rises and supply of corporate debt dries up. Companies are
taking advantage, however, rushing to reprice tens of billions of
dollars in leverage loans and high yield bonds so called
(01:14):
liability management exercises are meanwhile getting ever more aggressive as
those with too much debt try to buy some time
to turn things around. The situation in Europe doesn't seem
as extreme as what we've seen in the US, where
there's the sense that some of the law firms and
other advisors in those deals are taking a bit of
a pause, fearing reputational risk if they push too hard.
But Sabrina, before we get to the covenants, first of all,
(01:34):
on the rush to market, what's your take. Why is
everyone trying to get deals done now? And is the
risk being properly priced?
Speaker 3 (01:41):
Well, I leave the question of pricing risk to the experts.
I have my own views about that, but I'm not
put in that position. I certainly don't envy them. It's
a difficult market right now. There is such a you know,
a rush to get things done. Part of that is
because the windows can be shorter than you might predict.
(02:03):
They're particularly unpredictable leaders across the world that can cause
markets to shut within a day, which we saw recently,
and I think that has caused you know, bar wars
to become more and their advisors to become more opportunistic
and get the deal done while they can, which of
(02:23):
course does then squeeze lenders ever tighter. Whilst they you know,
they want the deals to come and they've got the
cash to deploy, they've also got tighter timelines during which
they have to absorb and digest pages and pages and
pages of documentation that they are now seeing before their
(02:44):
very eyes the consequences of these additional flexibilities because of
the enemies that are happening. So we're in this very
unique time in the market that I have not lived
through before, where you see both negotiating for you know,
flexibility that seems to be getting ever wider as if
there is no limit to it, and alongside the actual
(03:08):
cost that this results in due to the liability management
exercises and also restructurings and bankruptcies and et cetera. It's
kind of all playing out before us. And you would
think one would cause the other, you know, would influence
the other to some degree, but it really doesn't seem
to be the case at all.
Speaker 2 (03:27):
I remember early in my cell side career, we used
to have weeks of a leading into a new issue.
We'd be writing new issue research and going around and
seeing clients and talking to them about the new issue
that was coming some way down the road. Now it's
all done and dusted in a day. The investors that
you speak to, how do they cope with that, particularly
(03:49):
when it's a new name that they might be less
familiar with.
Speaker 3 (03:52):
I there's a lot of heavy lifting that happens, and
it becomes the best you can do under the circle ccumstances.
It's supported. They do have access to resources that provide
summaries on things, but even those providers I know, having
worked for them, struggle with the timeline, so those summaries
(04:14):
might not be out in time for lenders to make
their decisions on that basis. So no matter how excellent
they are, if they don't come out in time, they're
not really going to help folks make decisions. Which is
why Fox Legal Training is offering training to bring lenders
and other market participants up to speed on how to
(04:35):
review documentation quickly. And it's actually something that I take
great pride in doing and in teaching people how to
do because it is actually possible. And I have lots
of videos on YouTube for Fox Legal Training where I
do just that I take a deal and I say, Okay,
we're going to go through and look at it right now,
and it could be the first time I've seen the deal.
(04:56):
So I'm taking people through step by step. Okay, this
is how I would do it. But the biggest obstacle
for most people is actually lack of confidence. They don't
believe that they can do it. They believe, because they're
not lawyers, that actually this legal documentation is too complex
or somehow outside of their ability to grasp. But it's
(05:18):
just not true. I want to get a mug on
my desk that says covenants are complicated, but they're not
rocket science, because that's that's the reality a contract. Once
you learn how it's created, you know how it's how
it's put together, and how to navigate it. It is
actually designed to be navigated. It's got a table of contents,
(05:39):
it's got to find terms. It tells you how to
interpret certain words. So if you can get a basic
sense of how to do that, and we've heard this
from our clients, the process does get easier and it
goes a bit faster. So credit analysts can focus on
what they do well, which is analysing credit.
Speaker 1 (05:56):
But I think you know, to Aiden's point, you know
there is such volume coming through. We've seen over sixty
billion dollars worth of just leverage loans in the US
coming in one week, which is you know, very very unpresent.
I mean, it's not common at all. So even if
you are confident, I'm confident I can get through this,
but I haven't got the time.
Speaker 2 (06:13):
What do I do you read Bloomberg Research.
Speaker 3 (06:15):
James, I think that I think that's why you're starting
to see some sort of specific terms come in that
lenders are requesting in documentation, like LEM blockers that go
to the heart of some of the most aggressive lemies
that we've seen. Most notably, I would say the omni blocker,
which is an an anti lem language that applies in
(06:40):
a number of different circumstances, in which I wrote for
the Ft quite passionately that they should be used in
every deal, that in my ideal world, every deal has
an omniblocker. But it's it is a way to perhaps
guard against the worst excesses of the potential future outcomes,
(07:05):
and so I'm not surprised to see that the appearance
of these types of protections has increased. It's the natural
evolution of the market up to this point, I think.
Speaker 1 (07:15):
So break it down for as omniblocker. You might have
already lost some listeners there. So what does it actually mean?
Basic terms?
Speaker 3 (07:21):
Yeah, okay, so on the meaning you know, kind of
overall multiple it goes in the document. It basically says
that the barber will not use its terms to structurally
or effectively subordinate lenders. So it won't use the terms
it's negotiated for things like priming debt capacity or you know,
(07:45):
drop downs to opportunistically rejig the capital structure to the
disadvantage of some creditors over others. So it is taking
into account a sort of an umbrella protection overall whole
range of different potential ls which allows for maybe some
(08:05):
peace of mind. You know, it's not perfect. No one
of these protections is perfect, but it is better. I'm
certainly better than nothing.
Speaker 1 (08:14):
Is it actually a phrase that would show up in
the documentation when I see a new debt deal coming through?
Is that how easy it is to spot?
Speaker 3 (08:21):
No, it wouldn't be that easy. I think you could
search for liability management and you might get there. I'm
a big fan of control f so I'm constantly giving
my clients control F hacks for things so that they
can get to the you know, the juicy stuff quickly. Yeah,
I think that will probably get you there.
Speaker 1 (08:41):
And Alloway's using other phrases, other terms to avoid being
spotted in these documents.
Speaker 3 (08:47):
I don't think they are actively true. I know this,
Maybe people will disagree with me, but I don't think
they're actively trying to hide things, you know. I do
think it can be hard to find things. And of course,
when you talk about the word loophole, the whole idea
is that it is a way of getting through what
would be considered an established protection. So, yes, there are loopholes,
(09:12):
but if you know where to look for the protection,
then you know where to look for the loophole because
it will be more or less in the same place.
Speaker 1 (09:19):
And it can be found with a control F search
on the document.
Speaker 3 (09:23):
I control F can do a lot, definitely, But I
think also having a general sense of how these documents
are put together really helps. Once you've done that, you
put in the work to get that foundational knowledge, then
the fact that you're looking at the documents day in
and day out, you begin to see the patterns, which
is where you know, having looked to probably thousands of deals,
(09:45):
now I feel like I've got to where I sort
of know. Even if you tell me which law firm
is you know has written the deal, I could probably
tell you where the bodies are buried.
Speaker 2 (09:55):
And presumably you need to know a little bit about
the company as well, because if company, for example, allows
you to or allows the issuer to exclude certain subsidiaries
or assets from the restricted group or move pieces around,
you need to be able to do your due diligence
on what the corporate structure looks like and where the
(10:16):
profits are coming from.
Speaker 3 (10:17):
Too, right, Yes, that's right, And that's what I call
point A. So whenever I'm teaching covenants to anyone, I
say to them you will be delighted to hear that
the first part of your analysis has nothing to do
with covenance, and in fact, probably the last question you
ask yourself won't have anything to do with covenants, because
(10:38):
it's the question is what could the bar we're do,
What would the bar were be willing to do? And
how bad would things have to get before they would
be willing to take advantage of some of this flexibility.
But the first question is absolutely you know, capital structure,
basic stuff. Who are the lenders next to you? Do
they have some advantage? For example, the supersede your RCF
(11:00):
or an earlier maturing bond or facility that has your
you know, temporally is senior to you. And then how
much and where and who who has become very important
we have seen in recent years. You know the fact
that there are certain lenders who have raised funds specifically
to invest in liability management exercises and opportunities tells you
(11:25):
all you need to know about the importance of the
identity of the other lenders who are sitting alongside you.
And then of course, yes, who is the sponsor, what
have they done in the past, Who is the barrow
or what has it done in the past? What you know?
And then you go into the support the credit support.
What is your collateral? What unencumbered assets are available? Is
(11:46):
there anything of value that the borrower could offer to
a third party lender to entice them into the structure.
What's your guaranteur coverage? If you're in Europe, how much
is that guaranteur coverage really worth? Because of all the
local law complexities involved there and that entire analysis there
is no covenant related information in there at all. It's
(12:09):
just a basic first step. So now you have point A,
and once you have point A, you can analyze for
point B, which is to consider if things got difficult
for the bar where if they were painted into a
corner and they needed to look at a way of
dealing with the capital structure without dealing with their lenders,
(12:30):
what could they achieve? And I always suggest, I'm not
sure how many people actually do this, because it might
be kind of depressing, but I always suggest max out
all the secure deck capacity, max out all the dividend capacity,
investments and unrestricted subsidiaries, and then look at that business
and decide if that's something you want to be involved in.
Speaker 2 (12:50):
And do you think there is enough information in documentation
these days or do you think, particularly on the business
side of things, that it could be more information or
there's anything particularly that we miss out.
Speaker 3 (13:03):
I don't think the issue is information provided at the
time of the offering. I actually think there's good Actually
they're good regulations around that which are kind of followed
in terms of market practice in Europe as well, you know,
having been kind of originated in the US, and folks
do not want to get sued for misrepresentation or frauds,
(13:25):
so there is there are some other protections in place.
I think where you get it gets tricky for a
lender is the ongoing information. And there are of course
contractual requirements around borrowers being required to report certain things,
but as with the rest of the covenant package, those
contractual requirements have also been watered down over the years,
(13:49):
and I would say the biggest glaring omission in the
whole picture for a lender is something that was never
required to be reported in the first place, but is
a more critical piece of information now than it ever
has been, and that is covenant capacity. How much is
actually there? How much could the barrower use for a
(14:12):
drop down or priming debt capacity? And because these calculations
are very complicated, and also barrowers are the only ones
with access to all of the information that they need
to conduct the calculation, it would be a huge win
for the market if they were to report it. But
(14:33):
they wouldn't do that, and there are a number of
reasons why they wouldn't do that. Barbers wouldn't want to
be held to one number. They will always have a
range and if you asked two law firms to give
you a calculation of covenant capacity for a barrower, you
would get three numbers because two of the lawyers and
one of the law firms are not going to agree.
So it is notoriously difficult, but it would be a
(14:56):
very useful exercise for barrowers to they provide even for example,
their build up basket capacity. There are some borrowers in
the US who do provide build up basket capacity numbers
if they are offering a follow on deal and they've
got built up capacity there. And this is just for
those who don't know what that means. This is for
(15:18):
paying dividends, investing in unrestrict subsidiaries, you know the restricted
payments covenant, which provides for flexibility based on usually fifty
percent of a consolidated net income, and that builds over time.
And because this number is not required to be reported
and there is no market practice around it being reported,
(15:40):
it is it is a big blackpool of information. And
I think Altis France is the perfect example of a
barrower that was able to use that lack of information
around that number and around the barrower's ability to utilize
that capacity very much to its advantage.
Speaker 1 (15:57):
Since you posted up to bring altase huge story for us,
and Aiden was all over it with his great research
as well. But what did we learn from that, what
precedents was set, and what impact does it have on
the wider market.
Speaker 3 (16:09):
Yeah, so I think there were a number of lessons.
One of them is co ops can be very useful.
It was one of the situations where the lenders organizing
into a co op agreement was a really helpful way
for them to avoid the worst of these sort of
onslaught in the negotiation and divide and conquer is much
(16:31):
easier when lenders aren't organized, So that was really useful.
Definitely a massive lesson to take away from it is
that understanding how to read the docs is really important.
It was a sort of moment where I thought, well,
this is I really feel for the lenders here, but
also if there was ever a better example of a
(16:52):
time when it would have helped to know how the
docs work, this is it. And it felt quite justifying
from that respective because of the specific term that they
used and the fact that this this there's usually conditions.
There are usually guardrails in place to protect this giant
bucket of cash from being able to be accessed and
(17:14):
often require the borrower to test a leverage ratio for example,
and that requirement specifically was not present in the case
of Altees. So that is a huge lesson as well.
Reading the docks and understanding the docks is actually really important.
It gives you a you know, kind of competitive edge.
(17:34):
Maybe you wouldn't have traded out at that moment, but
maybe you would have known that there was a possibility
for this to happen, and then you would have been
able to make a more informed decision.
Speaker 1 (17:45):
Do other borrowers try and mimic what went on? There
were the benefits to Eltis from, you know, the way
they structured things and the way that they did their documentation.
Speaker 3 (17:54):
There definitely was Altis Friends was a name that I
covered for a long time, so I actually want how
they were able to craft this provision over time and
to ensure that it was always backdated. And it was
a risk that I flagged a number of times as
a covenant analyst, just saying, you know, I remember there
(18:15):
was a particular bond that they refinanced which unlocked a
whole load of value for them due to it kind
of having one of the leverage ratio requirements that fell
away from that point on. So from that point when
that deal was refinanced, this suddenly this capacity was available
to them. Up to that point, I was arguing that
this bond was a really great deal because if they
(18:37):
ever wanted to use that capacity, that was the only
bond that would have, you know, a consent solicitation potentially
used to amend it so that they could get to
that capacity. So I think it's it's unusual that you
see backdated builder baskets to that extent, but I think
that now that it's been done that way, there is
(18:59):
definitely more of a foot focus on it, so lenders
are aware, and it does often take big situations like
this for lenders to see the potential damage that one
provision can do. And provisions these days, they are drafted
in a way that they are very much departures from reality.
(19:21):
They do not reflect the bar wars economic reality, and
that to me is one of the biggest red flags
because you're seeing provisions that allow specifically builder baskets to
only go up. So normally they would be measured from
fifty percent of consolidated aat income, but they would deduct
one hundred percent of losses and they could go below zero.
(19:42):
That was the standard formulation, but in these days the
numbers only go up fifty percent CNI and then maybe
there's a zero floor, which means that it will never
go below zero. Once it hits zero, it doesn't go below.
But there are also new versions that will not count
negative numbers at all, so literally the numbers never go down,
(20:05):
and that creates an kind of alternate universe like La
La Land that we're operating in, where the numbers don't
match the performance of the business, which to me goes
against the fundamental nature and purpose of these covenants in
the first place. But of course that's what's going to happen,
because the negotiating power has then in the hands of
(20:26):
the folks who want more flexibilly for a long.
Speaker 1 (20:28):
Long time and sorry, build a baskets can explain what
they are to our broadly listenership, Yes.
Speaker 3 (20:34):
Absolutely so. In a typical Hyo Vondon also leverage loans,
though they take slightly different formulations in terms of the calculation.
There is a basket which basically it strikes a bargain
between the highly levered issuers of the world and the lenders,
and it says, Okay, look, we don't want you paying dividends,
(20:56):
repurchasing your own stock, investing in entities outside of the
credit group, leaking value. We really don't want you to
do that, but we realize that sometimes you will. So
we will let you dividend out fifty percent of your
cash profits, and we will offset that by losses, and
(21:16):
not fifty percent of losses, but one hundred percent of losses,
because if you make a loss, you need to take
responsibility for that. Basically, so this basket starts essentially a
zero on day one, and then it builds over time,
and it allows the private equity sponsor or borrower to
take some money off the table if they're making profits.
And I remember learning that when I was a baby
(21:37):
lawyer and thinking, actually, that makes sense to me. This
is how you allow for some give and take in
a contract, and there's a real sense of balance there.
But that balance is gone because these provisions now just
completely ignore losses in many cases, so borrowers don't have
to take responsibility for that anymore, and they only get
(22:00):
the benefit of the profits, which they can then use
to pay dividends to move value outside of the creditor group.
To repay subordinated indebtedness. There are all sorts of you know,
just additional ways that value can be leaked which don't
reflect that fundamental bargaining agreement that yes, you can take
(22:22):
fifty percent the cash off the table, but you need
to leave fifty percent of the profits in the business.
Speaker 2 (22:28):
Yeah, I would definitely echo the call for more detail
on where companies stand on some of these calculations that
are in the documentation. It's a nightmare for US self
side analysts as well trying to work out where a
company is against against some of these targets. With the
lack of disclosure, even when we ask, we don't always
get the information from the companies that are a bit
(22:49):
bit scared to provide it. One of the other issues
I think has been non ir forr US definitions of
financial terms, some like SBB might be as supposed to
child for that one. What do you think can be
done to standardize or better clarify some of the terms
for whether it's net debt or just coverage or whatever
(23:11):
the calculation being used is and is that on investors'
radar a much more post SPB to try and get
a better definition of what it is that the company
is being judged against.
Speaker 3 (23:24):
I think that there is a distinction between what the
financials as they're reported and the financials that are used
in the covenants. And IFRS Foundation does great work around
ensuring that there are standard formulations and understandings of the
terms and you know in the financial measures that need
to be reported, but in terms of the covenant calculations,
(23:46):
it's the same issue that you have with all of
the other types of erosion, and that is that if
standardization doesn't benefit those with the negotiating power, then standardization
will not be a focus willing buyer willing seller, despite
all of the other dynamics involved, of course, because of
their being one negotiating against many. The nature of the
(24:10):
market and the way that most market participants want it
to stay is that there are no regulations around how
you contract your agreement. Now, there are organizations like the
European Leverage Finance Association, which I was formerly at the
head of, that also put out great guidance around transparency
(24:31):
and disclosure and ensure that market practices stay at a
high at least market practice guidance stays at a high level.
But ultimately it's down to the individual market participants and
until something blows up. As you noted, there's potentially not
as much focus on that as there could be, but
(24:51):
that could change. If lenders want that to change, then
they come together and they make that decision and they
do their very best to affect that change. And I
think the LME blockers are a good example of where
that has been a successful a successful fight. Though they
aren't panacea. They don't solve for everything. They are there,
(25:12):
and there are more of them, and they do in
their own way prevent against some things. But it really
does require a concerted effort from lenders to hold the line,
and that does mean often there's blood on the streets.
Speaker 1 (25:28):
It doesn't seem like there's any incentive to hold the
line that at this point, given there is a lot
more demand for credit product than there is supply, and
you know a lot of that supply has been taken
away by private markets as well. So you know, I
could read the document and I can spend hours looking
for these scary terms, but still I've got a ton
of cash I just got to put to work. You know,
I might just turn the blind eye. What stops it turning?
Speaker 3 (25:52):
I do think as well, that all. You can't kind
of put all lenders in the same bucket. They have
different strategies. They can just side to trade out of
the more liquid names. They have options even after they
buy the deal. But I agree with you that the
negotiating dynamics have not changed, and i'd like to I'm
probably not the only person to use this phrase, but
(26:14):
it's like a teflon market, like nothing really sticks, even
Liberation Day, and then it was backtracked and then everything's like, okay, cool,
that's fine then, And I just I've never seen anything
quite like it. There are it's something like four or
five different macroeconomic events happening in the world right now
(26:37):
that a decade or two ago would have just one
of them alone had a bigger impact on the market
that the aggregate of them is having now, and it
makes it very difficult to understand, you know, what comes next.
I don't envy the lenders in this position.
Speaker 1 (26:57):
I mean, meanwhile, the US IG market spreads the tiers
into thirty years or something, and it just seems to
get tight in despite all of that macroeconomic risk that
you rightly point out. It is, as you use the
phrase earlier, Lala land, it doesn't end well. Often when
you get into these situations where everything just gets you
really pumped up, and then at the undercurrent level you've
(27:17):
got this bad documentation which only seems to get worse.
What are the big pressure points do you think in
terms of documentation?
Speaker 3 (27:26):
Well, I do believe that these provisions which detach from
reality are the biggest issue and are a great also
big focus for lenders as well. So I don't know
if you've ever heard the phrase supergrower before, probably not
in the context of contracts, but also high water marking
(27:48):
is another word for it, where basically many of these
baskets they're called though they're not obviously electual baskets, but
carveouts to do things like incur debt or pay dividends.
They are presented in the greater of a fixed amount
and a grower, which is usually based on EBITDA, And
in this the case of these supergrowers, the fixed amount
(28:11):
actually increases in line with the EBITDA grower when it
goes up, but when EBITDAD goes back down again, it
has no effect whatsoever on the fixed amount. So this
is another one of those instances where it is detached
from reality, and it appears, you know, in a greater
(28:32):
frequency of deals, but it's also a focus for lenders.
There are also the uncapped cost savings and synergies. Management
is notoriously optimistic. They think that everything's going to go
up forever, and if they didn't, they wouldn't be management.
So having some contractual guard rails would be useful, and
(28:55):
once upon a time you could expect to see caps
around twenty five percent of EBITDA on these types of
cost savings and synergies add backs. But what we've seen
instead is barrowers pushing the envelope. Just post teriffs, there
was a barrower who came out with a term that
(29:16):
would add back the effect of terraces and that did
thankfully get removed during the syndication of that deal, but
it would have been the first presentation of EBITDAT even
the alusteriffs. And then there also portability has become a
big topic of focus. Private equity firms love portability. So
(29:38):
portability basically means that if the private equity sponsor sells
the barwer to another private equity sponsor or another party,
that they won't have to either make an offer for
a change of control to bondholders or in the case
of a loan, there will be no event of default
or mandatory prepayment, depending on which you're astction you're in.
There's no effect if certain conditions are met, including that
(30:03):
the barwer can comply with a specified leverage ratio. And
obviously where that leverage ratio is set is going to
be very important, and in many deals this is an
option that is available on day one, so it isn't
even as if the barer needs to delever in order
to take advantage of that provision. And other deals we're
seeing that those ratios are calculated based on first lean debt,
(30:28):
so first lean secure debt, rather than total debt, so
that obviously gives the barwer an easier hurdle to pass.
So you know, in the last one, I will point
out and this goes back to the famous J Crew
or infamous JA Crew. Actually think the top I'm wearing
is from J Crew, which is quite ironic in a way,
(30:49):
but you know, J Crew was one of the first
to take assets and put them in an unrestricted subsidiary
away from the lender group, assets that were once part
of its collateral. And there are provisions in the restricted
payments covenant that actually would prevent restricted unrestricted subsidiaries for
being used for certain things that restricted subsidiaries can't be
(31:12):
used for. So this is the concept of an indirect
restricted payment. But again, those who have the negotiating power
really like using unrestricted subsidiaries, so they want to be
able to use them without any restrictions. So there are
provisions that basically say you can use unrestricted subsidiaries to
(31:33):
do anything that are the restricted subsidiary can't do. It's
absolutely fine, and that language has also become more prevalent.
But again this makes sense, right because it's the market evolving,
and the market is evolving to benefit those who have
most negotiating power, and then those who are negotiating are
(31:53):
coming up with ways of coming, you know, fighting back,
So lemy blockers and co ops and you know, and
we all have litigation. That's another route that the disgruntled
you know lender can can take to potentially bite back
against the unfairness of a particular situation. But whether or
(32:13):
not that is going to be successful is obviously uncertain,
but it is another I guess tool that they can use.
Speaker 2 (32:21):
Well. That leads me onto the question I was going
to ask you, which is is there a discrepancy here
between large sophisticated investors with lots of resources and the
smaller investor obviously in terms of trying to digest new
issuance and bonds as if they come to market, but
thinking more about actually how incentivized larger investors are to
(32:46):
clean this all up and standardize everything. Don't they stand
to benefit to a greater extent from having things a
little murky? Or is that just me being horrifically cynical?
Speaker 3 (32:57):
Oh I am ever the optimists, So I myself would
say there are certainly hedge funds that benefit from leaving
things quite murky, But the vast majority of lenders prefer
transparency because that's how they price risk, and there is
a heck of a lot of risk embedded in covenant flexibility.
(33:18):
So my personal view is that everyone benefits from transparency.
I actually think the whole market benefits from transparency, and
they're study after study after study that agrees with me.
But what I would say about the smaller the minority
lender co op agreements have been in some ways kind
of great equalizer because nothing is stopping any lender from
(33:40):
picking up the phone and ringing round to their fellow
lenders to find out what their plans are on a
particular deal. Nothing is stopping any lender from ringing up
barwer to make an opportunistic proposal for how they could
rejig the capital structure. And yes, of course they're you know, money,
so the more you have to deploy, the easier that
(34:02):
it's going to be. But in terms of bringing people together,
bringing lenders together to cooperate maybe under a cooperation agreement
or to a lead into something like that, minority lenders
can do that just as well as as the bigger
the bigger fish, as it were.
Speaker 1 (34:19):
On transparency, I mean, there's always someone making money when
there isn't any transparency. You presume it's the hedgephones, the advisors.
The borrow was certainly benefiting.
Speaker 3 (34:26):
Oh, it is a really good time to be a lawyer,
I will tell you that is for sure. I mean
the advisors are doing very very well, and they're working
really hard.
Speaker 1 (34:36):
But in terms of you know, we've talked about ALTIS
and SVV, but who else is on you know, in
terms of this kind of activity that's pushing it, who's
on the naughty step?
Speaker 3 (34:46):
So I think SELECTA is another one that I would
highlight as being as being on the naughty step, as
it were, and that one isn't a really interesting example
of a borrower that you used co op a co
op agreement actually as an defensive maneuver rather than a
defensive maneuver that it was used to bring together an
ad hoc group that then was able to benefit from
(35:08):
positive you know, commercials as compared to the non ad
hoc group, and the non ad hoc group had no
opportunity to participate, and that is, you know, that leaves
it very difficult to challenge as well. But it's sort
of an open question whether there will be litigation and
connection with that. And I would say in general that
(35:29):
there are there's a reticence on the borrowers side to
take these really aggressive actions because they don't really want
to get sued. You know, most borrowers are not coming
together with their lenders to try to come up with
a plan that's going to land them in court. They
ideally want to do a deal that is going to
pass the sniff test, as it were, and then they
(35:50):
will come up with ways of doing an enemy which
is not non pro raada but is actually Parada to
all of their lenders and take that route so that
they they don't end up in court. But there are
some that are really willing to push the envelope.
Speaker 1 (36:04):
And in terms of pushing the envelope, as I mentioned earlier,
we are seeing a lot of extreme stuff in the US,
but not so much in Europe. And the sense that
we get is that Europe is maybe slightly more genteel
and well behaved in relative terms. But is that true?
I mean, surely, you know, markets just move wherever they go,
and money follows, and you know, capitalism at work is
one of our guests. Once put, it will take hold
(36:26):
in Europe and it will just get worse there.
Speaker 3 (36:28):
I think that many expect there to be more liability
management exercises in Europe, and the potential limitations on that
have more to do with local law restrictions directors duties
management being more nervous about falling afoul of those because
sometimes can actually have personal liability for the directors themselves
(36:52):
in the case of Germany. But there are some countries
where the director's duties protection is not as intense or
or strong, and France is one example of that. So
it really does depend on where the borrower is located
as to whether that is a proper dissuading factor. I
wouldn't say that, it's sort of. I know there was
(37:13):
a lot of to talk about Europe being more concerned
about reputation, and I really think that reputation only gets
you so far. That maybe because Europe is a smaller market,
maybe there is more of a focus on can I
bring the next deal? Will I be able to get
the next deal done? But that's a commercial question that yes,
(37:34):
reputation feeds into, but it's more of a would lenders
work with me again? And if not, then that will
affect my LPs because at the end of the day,
I work for them. I don't work for.
Speaker 1 (37:48):
Lenders, right, But as we talked about, you know, there's
so much liquidity that you know, people have a pretty
short memory for bad things, certainly in this market as
long as it lasts. But in terms of you know,
the jurisdiction, as you mentioned, there are lots of different
jurisdictions in Europe and it is more complex than the US.
But where do you think we will see more of
(38:10):
this kind of activity in Europe? Do you think which
jurisdictions are most prone to it.
Speaker 3 (38:15):
I would say you probably are not looking less toward Germany,
though there are always going to be exceptions to that,
of course, potentially France, Spain, the UK. I mean, those
are some I would just mention off the top of
my head. But it is potentially an issue in any country.
(38:36):
It just requires a very careful jurisdiction by jurisdiction analysis
to think through what the implications are or could be.
Speaker 1 (38:45):
So you do then expect Europe to actually mimic the
US ultimately in terms of the way things have gone here.
Speaker 3 (38:53):
I do expect there to be more leens in Europe. Absolutely, yes,
I'm not sure that there will be as much litigation
there tends to it tends that there are less litigious
folks here in Europe, but that could also change.
Speaker 1 (39:07):
And when their assistant wheels in a massive pile of
prospectuses and they've got to weighe their way through, are
there any kind of red flags that you kind of
you know, look at this one for this name or
this sector or this you know, these are the ones
you've got to focus on, because these are the ones
that are most problematic. Any red flags at all, I don't.
Speaker 3 (39:22):
Want to name any names that would be very inappropriate.
Speaker 1 (39:26):
Mell sector types of businesses.
Speaker 3 (39:29):
I would say more that when you've got very large
capital structures and cross border deals, those are the ones
that are going to float to the top in terms
of flexibility. They're going to have the most in terms
of convergence between the two markets, so the kind of
worst of both. And if you've got multiple capital structures,
(39:50):
then you get the worst of the convergence in the
terms and highal bonds and leverage loans. So those are
the ones you have to be really focused on. They
also tend to be the ones that end up in
syndication being upsized. So maybe the equity check reduces and
we've just seen this recently in the bootsteal and so
then that can have an effect on loosening ratios because
(40:10):
of the change in the capital structure. You're upsizing debt
and you're downsizing equity and things tend to loosen a bit.
So those are the ones I would say to focus
the most on. You will tend to find the most
in terms of flexibility in those types of deals. Taking
into count all of the different dynamics at play.
Speaker 1 (40:28):
Can you use AI to do this?
Speaker 3 (40:31):
Unfortunately, not yet. AI. It is as smart as the
people who are using it. So if you know how
to ask the right questions, then you may get better answers.
The temptation is to rely on AI without knowing what
you're supposed to ask, or without having enough information to
(40:54):
know whether the answer actually makes sense, and because it
feels so easy to type in a question and you
get an answer, and AI is designed to make you
believe that it's true. It is unequivocal every single time.
And so unless you know and we have our own
AI tool that we give to our students, and it
(41:16):
has been trained on hundreds of hours of me talking
about covenants, because it has been trained on every single
word I've ever uttered for Fox Legal Training, and I
spent months interrogating this tool and asking it questions and
getting answers and correcting it and refining and refining and refining.
So that's a great teaching tool that's great to learn from.
(41:38):
But even that, I say to my students, if it
doesn't seem right to you, remember it's still AI. It's
not infallible. And unless you know more or less what
the right answer is in the ballpark could be the
fundamentals of the principles involved. You're not going to know
if the answer is true, and AI is always going
(42:00):
to make you believe that it's right every single time.
Speaker 1 (42:03):
Maybe we get to a world, though, where the AI
is writing the covenants, syndicating the deals, buying the deals,
and also assessing the covenants.
Speaker 3 (42:10):
That's the future a member of We're all on the
beach like drinking mergury at.
Speaker 1 (42:15):
That point, exactly, that's the plan. Great stuff. Sabrina Fox,
founder of Fox Leagual Training. Thank you so much for
being on the Credit Edge.
Speaker 3 (42:22):
Thank you so much for having me. It was a
really fun conversation, and of.
Speaker 1 (42:26):
Course very grateful to Aidan Cheslin from Bloomberg Intelligence.
Speaker 2 (42:29):
Cheers, Thanks James.
Speaker 1 (42:30):
Great to be here for even more credit market analysis
and insight. Read all of Aiden's great work on the
Bloomberg terminal. Bloomberg Intelligence is part of our research department,
with five hundred analysts and strategists working across all markets.
Coverage includes over two thousand equities and credits, plus outlooks
on more than ninety industries and one hundred market industries,
currencies and commodities. Please do subscribe to the Credit Edge
(42:52):
wherever you get your podcasts. We're on Apple, Spotify, and
all other good podcast providers, including the Bloomberg Terminal at
b pod go. Give us a review. It helps other
people find us, Tell your friends, or email me directly
at jcromb eight at Bloomberg dot net. I'm James Crombie.
It's been a pleasure having you join us again. Next
week on the Credit Edge,
Hello, and welcome to the Credit Edge Weekly Markets podcast.
My name is James Crombie. I'm a senior editor at
Bloomberg and I.
Speaker 2 (00:24):
Made in Chessin a senior analyst and head of Credit
Research Europe for Bloomberg Intelligence. This week, we're very pleased
to welcome Sabrina Fox, founder of Fox Legal Training and
former head of the European Leverage Finance Association. How are you, Sabrina,
I'm very well.
Speaker 3 (00:38):
Thank you so much for having me.
Speaker 2 (00:40):
And Sabrina spends a large amount of time talking to
lev finn market participants, educating on legal and covenant risks,
something that we've been talking a lot about on our
podcasts in the last year or so on names like
how to cease? Isn't that right?
Speaker 1 (00:53):
James, Yeah, that's right, And we're delighted to have you here. Sabrina,
thanks so much. Before we get started, I just want
to say credit markets are looking pretty complacent at the moment,
with junk bonds trading ever tighter as demand for yield
rises and supply of corporate debt dries up. Companies are
taking advantage, however, rushing to reprice tens of billions of
dollars in leverage loans and high yield bonds so called
(01:14):
liability management exercises are meanwhile getting ever more aggressive as
those with too much debt try to buy some time
to turn things around. The situation in Europe doesn't seem
as extreme as what we've seen in the US, where
there's the sense that some of the law firms and
other advisors in those deals are taking a bit of
a pause, fearing reputational risk if they push too hard.
But Sabrina, before we get to the covenants, first of all,
(01:34):
on the rush to market, what's your take. Why is
everyone trying to get deals done now? And is the
risk being properly priced?
Speaker 3 (01:41):
Well, I leave the question of pricing risk to the experts.
I have my own views about that, but I'm not
put in that position. I certainly don't envy them. It's
a difficult market right now. There is such a you know,
a rush to get things done. Part of that is
because the windows can be shorter than you might predict.
(02:03):
They're particularly unpredictable leaders across the world that can cause
markets to shut within a day, which we saw recently,
and I think that has caused you know, bar wars
to become more and their advisors to become more opportunistic
and get the deal done while they can, which of
(02:23):
course does then squeeze lenders ever tighter. Whilst they you know,
they want the deals to come and they've got the
cash to deploy, they've also got tighter timelines during which
they have to absorb and digest pages and pages and
pages of documentation that they are now seeing before their
(02:44):
very eyes the consequences of these additional flexibilities because of
the enemies that are happening. So we're in this very
unique time in the market that I have not lived
through before, where you see both negotiating for you know,
flexibility that seems to be getting ever wider as if
there is no limit to it, and alongside the actual
(03:08):
cost that this results in due to the liability management
exercises and also restructurings and bankruptcies and et cetera. It's
kind of all playing out before us. And you would
think one would cause the other, you know, would influence
the other to some degree, but it really doesn't seem
to be the case at all.
Speaker 2 (03:27):
I remember early in my cell side career, we used
to have weeks of a leading into a new issue.
We'd be writing new issue research and going around and
seeing clients and talking to them about the new issue
that was coming some way down the road. Now it's
all done and dusted in a day. The investors that
you speak to, how do they cope with that, particularly
(03:49):
when it's a new name that they might be less
familiar with.
Speaker 3 (03:52):
I there's a lot of heavy lifting that happens, and
it becomes the best you can do under the circle ccumstances.
It's supported. They do have access to resources that provide
summaries on things, but even those providers I know, having
worked for them, struggle with the timeline, so those summaries
(04:14):
might not be out in time for lenders to make
their decisions on that basis. So no matter how excellent
they are, if they don't come out in time, they're
not really going to help folks make decisions. Which is
why Fox Legal Training is offering training to bring lenders
and other market participants up to speed on how to
(04:35):
review documentation quickly. And it's actually something that I take
great pride in doing and in teaching people how to
do because it is actually possible. And I have lots
of videos on YouTube for Fox Legal Training where I
do just that I take a deal and I say, Okay,
we're going to go through and look at it right now,
and it could be the first time I've seen the deal.
(04:56):
So I'm taking people through step by step. Okay, this
is how I would do it. But the biggest obstacle
for most people is actually lack of confidence. They don't
believe that they can do it. They believe, because they're
not lawyers, that actually this legal documentation is too complex
or somehow outside of their ability to grasp. But it's
(05:18):
just not true. I want to get a mug on
my desk that says covenants are complicated, but they're not
rocket science, because that's that's the reality a contract. Once
you learn how it's created, you know how it's how
it's put together, and how to navigate it. It is
actually designed to be navigated. It's got a table of contents,
(05:39):
it's got to find terms. It tells you how to
interpret certain words. So if you can get a basic
sense of how to do that, and we've heard this
from our clients, the process does get easier and it
goes a bit faster. So credit analysts can focus on
what they do well, which is analysing credit.
Speaker 1 (05:56):
But I think you know, to Aiden's point, you know
there is such volume coming through. We've seen over sixty
billion dollars worth of just leverage loans in the US
coming in one week, which is you know, very very unpresent.
I mean, it's not common at all. So even if
you are confident, I'm confident I can get through this,
but I haven't got the time.
Speaker 2 (06:13):
What do I do you read Bloomberg Research.
Speaker 3 (06:15):
James, I think that I think that's why you're starting
to see some sort of specific terms come in that
lenders are requesting in documentation, like LEM blockers that go
to the heart of some of the most aggressive lemies
that we've seen. Most notably, I would say the omni blocker,
which is an an anti lem language that applies in
(06:40):
a number of different circumstances, in which I wrote for
the Ft quite passionately that they should be used in
every deal, that in my ideal world, every deal has
an omniblocker. But it's it is a way to perhaps
guard against the worst excesses of the potential future outcomes,
(07:05):
and so I'm not surprised to see that the appearance
of these types of protections has increased. It's the natural
evolution of the market up to this point, I think.
Speaker 1 (07:15):
So break it down for as omniblocker. You might have
already lost some listeners there. So what does it actually mean?
Basic terms?
Speaker 3 (07:21):
Yeah, okay, so on the meaning you know, kind of
overall multiple it goes in the document. It basically says
that the barber will not use its terms to structurally
or effectively subordinate lenders. So it won't use the terms
it's negotiated for things like priming debt capacity or you know,
(07:45):
drop downs to opportunistically rejig the capital structure to the
disadvantage of some creditors over others. So it is taking
into account a sort of an umbrella protection overall whole
range of different potential ls which allows for maybe some
(08:05):
peace of mind. You know, it's not perfect. No one
of these protections is perfect, but it is better. I'm
certainly better than nothing.
Speaker 1 (08:14):
Is it actually a phrase that would show up in
the documentation when I see a new debt deal coming through?
Is that how easy it is to spot?
Speaker 3 (08:21):
No, it wouldn't be that easy. I think you could
search for liability management and you might get there. I'm
a big fan of control f so I'm constantly giving
my clients control F hacks for things so that they
can get to the you know, the juicy stuff quickly. Yeah,
I think that will probably get you there.
Speaker 1 (08:41):
And Alloway's using other phrases, other terms to avoid being
spotted in these documents.
Speaker 3 (08:47):
I don't think they are actively true. I know this,
Maybe people will disagree with me, but I don't think
they're actively trying to hide things, you know. I do
think it can be hard to find things. And of course,
when you talk about the word loophole, the whole idea
is that it is a way of getting through what
would be considered an established protection. So, yes, there are loopholes,
(09:12):
but if you know where to look for the protection,
then you know where to look for the loophole because
it will be more or less in the same place.
Speaker 1 (09:19):
And it can be found with a control F search
on the document.
Speaker 3 (09:23):
I control F can do a lot, definitely, But I
think also having a general sense of how these documents
are put together really helps. Once you've done that, you
put in the work to get that foundational knowledge, then
the fact that you're looking at the documents day in
and day out, you begin to see the patterns, which
is where you know, having looked to probably thousands of deals,
(09:45):
now I feel like I've got to where I sort
of know. Even if you tell me which law firm
is you know has written the deal, I could probably
tell you where the bodies are buried.
Speaker 2 (09:55):
And presumably you need to know a little bit about
the company as well, because if company, for example, allows
you to or allows the issuer to exclude certain subsidiaries
or assets from the restricted group or move pieces around,
you need to be able to do your due diligence
on what the corporate structure looks like and where the
(10:16):
profits are coming from.
Speaker 3 (10:17):
Too, right, Yes, that's right, And that's what I call
point A. So whenever I'm teaching covenants to anyone, I
say to them you will be delighted to hear that
the first part of your analysis has nothing to do
with covenance, and in fact, probably the last question you
ask yourself won't have anything to do with covenants, because
(10:38):
it's the question is what could the bar we're do,
What would the bar were be willing to do? And
how bad would things have to get before they would
be willing to take advantage of some of this flexibility.
But the first question is absolutely you know, capital structure,
basic stuff. Who are the lenders next to you? Do
they have some advantage? For example, the supersede your RCF
(11:00):
or an earlier maturing bond or facility that has your
you know, temporally is senior to you. And then how
much and where and who who has become very important
we have seen in recent years. You know the fact
that there are certain lenders who have raised funds specifically
to invest in liability management exercises and opportunities tells you
(11:25):
all you need to know about the importance of the
identity of the other lenders who are sitting alongside you.
And then of course, yes, who is the sponsor, what
have they done in the past, Who is the barrow
or what has it done in the past? What you know?
And then you go into the support the credit support.
What is your collateral? What unencumbered assets are available? Is
(11:46):
there anything of value that the borrower could offer to
a third party lender to entice them into the structure.
What's your guaranteur coverage? If you're in Europe, how much
is that guaranteur coverage really worth? Because of all the
local law complexities involved there and that entire analysis there
is no covenant related information in there at all. It's
(12:09):
just a basic first step. So now you have point A,
and once you have point A, you can analyze for
point B, which is to consider if things got difficult
for the bar where if they were painted into a
corner and they needed to look at a way of
dealing with the capital structure without dealing with their lenders,
(12:30):
what could they achieve? And I always suggest, I'm not
sure how many people actually do this, because it might
be kind of depressing, but I always suggest max out
all the secure deck capacity, max out all the dividend capacity,
investments and unrestricted subsidiaries, and then look at that business
and decide if that's something you want to be involved in.
Speaker 2 (12:50):
And do you think there is enough information in documentation
these days or do you think, particularly on the business
side of things, that it could be more information or
there's anything particularly that we miss out.
Speaker 3 (13:03):
I don't think the issue is information provided at the
time of the offering. I actually think there's good Actually
they're good regulations around that which are kind of followed
in terms of market practice in Europe as well, you know,
having been kind of originated in the US, and folks
do not want to get sued for misrepresentation or frauds,
(13:25):
so there is there are some other protections in place.
I think where you get it gets tricky for a
lender is the ongoing information. And there are of course
contractual requirements around borrowers being required to report certain things,
but as with the rest of the covenant package, those
contractual requirements have also been watered down over the years,
(13:49):
and I would say the biggest glaring omission in the
whole picture for a lender is something that was never
required to be reported in the first place, but is
a more critical piece of information now than it ever
has been, and that is covenant capacity. How much is
actually there? How much could the barrower use for a
(14:12):
drop down or priming debt capacity? And because these calculations
are very complicated, and also barrowers are the only ones
with access to all of the information that they need
to conduct the calculation, it would be a huge win
for the market if they were to report it. But
(14:33):
they wouldn't do that, and there are a number of
reasons why they wouldn't do that. Barbers wouldn't want to
be held to one number. They will always have a
range and if you asked two law firms to give
you a calculation of covenant capacity for a barrower, you
would get three numbers because two of the lawyers and
one of the law firms are not going to agree.
So it is notoriously difficult, but it would be a
(14:56):
very useful exercise for barrowers to they provide even for example,
their build up basket capacity. There are some borrowers in
the US who do provide build up basket capacity numbers
if they are offering a follow on deal and they've
got built up capacity there. And this is just for
those who don't know what that means. This is for
(15:18):
paying dividends, investing in unrestrict subsidiaries, you know the restricted
payments covenant, which provides for flexibility based on usually fifty
percent of a consolidated net income, and that builds over time.
And because this number is not required to be reported
and there is no market practice around it being reported,
(15:40):
it is it is a big blackpool of information. And
I think Altis France is the perfect example of a
barrower that was able to use that lack of information
around that number and around the barrower's ability to utilize
that capacity very much to its advantage.
Speaker 1 (15:57):
Since you posted up to bring altase huge story for us,
and Aiden was all over it with his great research
as well. But what did we learn from that, what
precedents was set, and what impact does it have on
the wider market.
Speaker 3 (16:09):
Yeah, so I think there were a number of lessons.
One of them is co ops can be very useful.
It was one of the situations where the lenders organizing
into a co op agreement was a really helpful way
for them to avoid the worst of these sort of
onslaught in the negotiation and divide and conquer is much
(16:31):
easier when lenders aren't organized, So that was really useful.
Definitely a massive lesson to take away from it is
that understanding how to read the docs is really important.
It was a sort of moment where I thought, well,
this is I really feel for the lenders here, but
also if there was ever a better example of a
(16:52):
time when it would have helped to know how the
docs work, this is it. And it felt quite justifying
from that respective because of the specific term that they
used and the fact that this this there's usually conditions.
There are usually guardrails in place to protect this giant
bucket of cash from being able to be accessed and
(17:14):
often require the borrower to test a leverage ratio for example,
and that requirement specifically was not present in the case
of Altees. So that is a huge lesson as well.
Reading the docks and understanding the docks is actually really important.
It gives you a you know, kind of competitive edge.
(17:34):
Maybe you wouldn't have traded out at that moment, but
maybe you would have known that there was a possibility
for this to happen, and then you would have been
able to make a more informed decision.
Speaker 1 (17:45):
Do other borrowers try and mimic what went on? There
were the benefits to Eltis from, you know, the way
they structured things and the way that they did their documentation.
Speaker 3 (17:54):
There definitely was Altis Friends was a name that I
covered for a long time, so I actually want how
they were able to craft this provision over time and
to ensure that it was always backdated. And it was
a risk that I flagged a number of times as
a covenant analyst, just saying, you know, I remember there
(18:15):
was a particular bond that they refinanced which unlocked a
whole load of value for them due to it kind
of having one of the leverage ratio requirements that fell
away from that point on. So from that point when
that deal was refinanced, this suddenly this capacity was available
to them. Up to that point, I was arguing that
this bond was a really great deal because if they
(18:37):
ever wanted to use that capacity, that was the only
bond that would have, you know, a consent solicitation potentially
used to amend it so that they could get to
that capacity. So I think it's it's unusual that you
see backdated builder baskets to that extent, but I think
that now that it's been done that way, there is
(18:59):
definitely more of a foot focus on it, so lenders
are aware, and it does often take big situations like
this for lenders to see the potential damage that one
provision can do. And provisions these days, they are drafted
in a way that they are very much departures from reality.
(19:21):
They do not reflect the bar wars economic reality, and
that to me is one of the biggest red flags
because you're seeing provisions that allow specifically builder baskets to
only go up. So normally they would be measured from
fifty percent of consolidated aat income, but they would deduct
one hundred percent of losses and they could go below zero.
(19:42):
That was the standard formulation, but in these days the
numbers only go up fifty percent CNI and then maybe
there's a zero floor, which means that it will never
go below zero. Once it hits zero, it doesn't go below.
But there are also new versions that will not count
negative numbers at all, so literally the numbers never go down,
(20:05):
and that creates an kind of alternate universe like La
La Land that we're operating in, where the numbers don't
match the performance of the business, which to me goes
against the fundamental nature and purpose of these covenants in
the first place. But of course that's what's going to happen,
because the negotiating power has then in the hands of
(20:26):
the folks who want more flexibilly for a long.
Speaker 1 (20:28):
Long time and sorry, build a baskets can explain what
they are to our broadly listenership, Yes.
Speaker 3 (20:34):
Absolutely so. In a typical Hyo Vondon also leverage loans,
though they take slightly different formulations in terms of the calculation.
There is a basket which basically it strikes a bargain
between the highly levered issuers of the world and the lenders,
and it says, Okay, look, we don't want you paying dividends,
(20:56):
repurchasing your own stock, investing in entities outside of the
credit group, leaking value. We really don't want you to
do that, but we realize that sometimes you will. So
we will let you dividend out fifty percent of your
cash profits, and we will offset that by losses, and
(21:16):
not fifty percent of losses, but one hundred percent of losses,
because if you make a loss, you need to take
responsibility for that. Basically, so this basket starts essentially a
zero on day one, and then it builds over time,
and it allows the private equity sponsor or borrower to
take some money off the table if they're making profits.
And I remember learning that when I was a baby
(21:37):
lawyer and thinking, actually, that makes sense to me. This
is how you allow for some give and take in
a contract, and there's a real sense of balance there.
But that balance is gone because these provisions now just
completely ignore losses in many cases, so borrowers don't have
to take responsibility for that anymore, and they only get
(22:00):
the benefit of the profits, which they can then use
to pay dividends to move value outside of the creditor group.
To repay subordinated indebtedness. There are all sorts of you know,
just additional ways that value can be leaked which don't
reflect that fundamental bargaining agreement that yes, you can take
(22:22):
fifty percent the cash off the table, but you need
to leave fifty percent of the profits in the business.
Speaker 2 (22:28):
Yeah, I would definitely echo the call for more detail
on where companies stand on some of these calculations that
are in the documentation. It's a nightmare for US self
side analysts as well trying to work out where a
company is against against some of these targets. With the
lack of disclosure, even when we ask, we don't always
get the information from the companies that are a bit
(22:49):
bit scared to provide it. One of the other issues
I think has been non ir forr US definitions of
financial terms, some like SBB might be as supposed to
child for that one. What do you think can be
done to standardize or better clarify some of the terms
for whether it's net debt or just coverage or whatever
(23:11):
the calculation being used is and is that on investors'
radar a much more post SPB to try and get
a better definition of what it is that the company
is being judged against.
Speaker 3 (23:24):
I think that there is a distinction between what the
financials as they're reported and the financials that are used
in the covenants. And IFRS Foundation does great work around
ensuring that there are standard formulations and understandings of the
terms and you know in the financial measures that need
to be reported, but in terms of the covenant calculations,
(23:46):
it's the same issue that you have with all of
the other types of erosion, and that is that if
standardization doesn't benefit those with the negotiating power, then standardization
will not be a focus willing buyer willing seller, despite
all of the other dynamics involved, of course, because of
their being one negotiating against many. The nature of the
(24:10):
market and the way that most market participants want it
to stay is that there are no regulations around how
you contract your agreement. Now, there are organizations like the
European Leverage Finance Association, which I was formerly at the
head of, that also put out great guidance around transparency
(24:31):
and disclosure and ensure that market practices stay at a
high at least market practice guidance stays at a high level.
But ultimately it's down to the individual market participants and
until something blows up. As you noted, there's potentially not
as much focus on that as there could be, but
(24:51):
that could change. If lenders want that to change, then
they come together and they make that decision and they
do their very best to affect that change. And I
think the LME blockers are a good example of where
that has been a successful a successful fight. Though they
aren't panacea. They don't solve for everything. They are there,
(25:12):
and there are more of them, and they do in
their own way prevent against some things. But it really
does require a concerted effort from lenders to hold the line,
and that does mean often there's blood on the streets.
Speaker 1 (25:28):
It doesn't seem like there's any incentive to hold the
line that at this point, given there is a lot
more demand for credit product than there is supply, and
you know a lot of that supply has been taken
away by private markets as well. So you know, I
could read the document and I can spend hours looking
for these scary terms, but still I've got a ton
of cash I just got to put to work. You know,
I might just turn the blind eye. What stops it turning?
Speaker 3 (25:52):
I do think as well, that all. You can't kind
of put all lenders in the same bucket. They have
different strategies. They can just side to trade out of
the more liquid names. They have options even after they
buy the deal. But I agree with you that the
negotiating dynamics have not changed, and i'd like to I'm
probably not the only person to use this phrase, but
(26:14):
it's like a teflon market, like nothing really sticks, even
Liberation Day, and then it was backtracked and then everything's like, okay, cool,
that's fine then, And I just I've never seen anything
quite like it. There are it's something like four or
five different macroeconomic events happening in the world right now
(26:37):
that a decade or two ago would have just one
of them alone had a bigger impact on the market
that the aggregate of them is having now, and it
makes it very difficult to understand, you know, what comes next.
I don't envy the lenders in this position.
Speaker 1 (26:57):
I mean, meanwhile, the US IG market spreads the tiers
into thirty years or something, and it just seems to
get tight in despite all of that macroeconomic risk that
you rightly point out. It is, as you use the
phrase earlier, Lala land, it doesn't end well. Often when
you get into these situations where everything just gets you
really pumped up, and then at the undercurrent level you've
(27:17):
got this bad documentation which only seems to get worse.
What are the big pressure points do you think in
terms of documentation?
Speaker 3 (27:26):
Well, I do believe that these provisions which detach from
reality are the biggest issue and are a great also
big focus for lenders as well. So I don't know
if you've ever heard the phrase supergrower before, probably not
in the context of contracts, but also high water marking
(27:48):
is another word for it, where basically many of these
baskets they're called though they're not obviously electual baskets, but
carveouts to do things like incur debt or pay dividends.
They are presented in the greater of a fixed amount
and a grower, which is usually based on EBITDA, And
in this the case of these supergrowers, the fixed amount
(28:11):
actually increases in line with the EBITDA grower when it
goes up, but when EBITDAD goes back down again, it
has no effect whatsoever on the fixed amount. So this
is another one of those instances where it is detached
from reality, and it appears, you know, in a greater
(28:32):
frequency of deals, but it's also a focus for lenders.
There are also the uncapped cost savings and synergies. Management
is notoriously optimistic. They think that everything's going to go
up forever, and if they didn't, they wouldn't be management.
So having some contractual guard rails would be useful, and
(28:55):
once upon a time you could expect to see caps
around twenty five percent of EBITDA on these types of
cost savings and synergies add backs. But what we've seen
instead is barrowers pushing the envelope. Just post teriffs, there
was a barrower who came out with a term that
(29:16):
would add back the effect of terraces and that did
thankfully get removed during the syndication of that deal, but
it would have been the first presentation of EBITDAT even
the alusteriffs. And then there also portability has become a
big topic of focus. Private equity firms love portability. So
(29:38):
portability basically means that if the private equity sponsor sells
the barwer to another private equity sponsor or another party,
that they won't have to either make an offer for
a change of control to bondholders or in the case
of a loan, there will be no event of default
or mandatory prepayment, depending on which you're astction you're in.
There's no effect if certain conditions are met, including that
(30:03):
the barwer can comply with a specified leverage ratio. And
obviously where that leverage ratio is set is going to
be very important, and in many deals this is an
option that is available on day one, so it isn't
even as if the barer needs to delever in order
to take advantage of that provision. And other deals we're
seeing that those ratios are calculated based on first lean debt,
(30:28):
so first lean secure debt, rather than total debt, so
that obviously gives the barwer an easier hurdle to pass.
So you know, in the last one, I will point
out and this goes back to the famous J Crew
or infamous JA Crew. Actually think the top I'm wearing
is from J Crew, which is quite ironic in a way,
(30:49):
but you know, J Crew was one of the first
to take assets and put them in an unrestricted subsidiary
away from the lender group, assets that were once part
of its collateral. And there are provisions in the restricted
payments covenant that actually would prevent restricted unrestricted subsidiaries for
being used for certain things that restricted subsidiaries can't be
(31:12):
used for. So this is the concept of an indirect
restricted payment. But again, those who have the negotiating power
really like using unrestricted subsidiaries, so they want to be
able to use them without any restrictions. So there are
provisions that basically say you can use unrestricted subsidiaries to
(31:33):
do anything that are the restricted subsidiary can't do. It's
absolutely fine, and that language has also become more prevalent.
But again this makes sense, right because it's the market evolving,
and the market is evolving to benefit those who have
most negotiating power, and then those who are negotiating are
(31:53):
coming up with ways of coming, you know, fighting back,
So lemy blockers and co ops and you know, and
we all have litigation. That's another route that the disgruntled
you know lender can can take to potentially bite back
against the unfairness of a particular situation. But whether or
(32:13):
not that is going to be successful is obviously uncertain,
but it is another I guess tool that they can use.
Speaker 2 (32:21):
Well. That leads me onto the question I was going
to ask you, which is is there a discrepancy here
between large sophisticated investors with lots of resources and the
smaller investor obviously in terms of trying to digest new
issuance and bonds as if they come to market, but
thinking more about actually how incentivized larger investors are to
(32:46):
clean this all up and standardize everything. Don't they stand
to benefit to a greater extent from having things a
little murky? Or is that just me being horrifically cynical?
Speaker 3 (32:57):
Oh I am ever the optimists, So I myself would
say there are certainly hedge funds that benefit from leaving
things quite murky, But the vast majority of lenders prefer
transparency because that's how they price risk, and there is
a heck of a lot of risk embedded in covenant flexibility.
(33:18):
So my personal view is that everyone benefits from transparency.
I actually think the whole market benefits from transparency, and
they're study after study after study that agrees with me.
But what I would say about the smaller the minority
lender co op agreements have been in some ways kind
of great equalizer because nothing is stopping any lender from
(33:40):
picking up the phone and ringing round to their fellow
lenders to find out what their plans are on a
particular deal. Nothing is stopping any lender from ringing up
barwer to make an opportunistic proposal for how they could
rejig the capital structure. And yes, of course they're you know, money,
so the more you have to deploy, the easier that
(34:02):
it's going to be. But in terms of bringing people together,
bringing lenders together to cooperate maybe under a cooperation agreement
or to a lead into something like that, minority lenders
can do that just as well as as the bigger
the bigger fish, as it were.
Speaker 1 (34:19):
On transparency, I mean, there's always someone making money when
there isn't any transparency. You presume it's the hedgephones, the advisors.
The borrow was certainly benefiting.
Speaker 3 (34:26):
Oh, it is a really good time to be a lawyer,
I will tell you that is for sure. I mean
the advisors are doing very very well, and they're working
really hard.
Speaker 1 (34:36):
But in terms of you know, we've talked about ALTIS
and SVV, but who else is on you know, in
terms of this kind of activity that's pushing it, who's
on the naughty step?
Speaker 3 (34:46):
So I think SELECTA is another one that I would
highlight as being as being on the naughty step, as
it were, and that one isn't a really interesting example
of a borrower that you used co op a co
op agreement actually as an defensive maneuver rather than a
defensive maneuver that it was used to bring together an
ad hoc group that then was able to benefit from
(35:08):
positive you know, commercials as compared to the non ad
hoc group, and the non ad hoc group had no
opportunity to participate, and that is, you know, that leaves
it very difficult to challenge as well. But it's sort
of an open question whether there will be litigation and
connection with that. And I would say in general that
(35:29):
there are there's a reticence on the borrowers side to
take these really aggressive actions because they don't really want
to get sued. You know, most borrowers are not coming
together with their lenders to try to come up with
a plan that's going to land them in court. They
ideally want to do a deal that is going to
pass the sniff test, as it were, and then they
(35:50):
will come up with ways of doing an enemy which
is not non pro raada but is actually Parada to
all of their lenders and take that route so that
they they don't end up in court. But there are
some that are really willing to push the envelope.
Speaker 1 (36:04):
And in terms of pushing the envelope, as I mentioned earlier,
we are seeing a lot of extreme stuff in the US,
but not so much in Europe. And the sense that
we get is that Europe is maybe slightly more genteel
and well behaved in relative terms. But is that true?
I mean, surely, you know, markets just move wherever they go,
and money follows, and you know, capitalism at work is
one of our guests. Once put, it will take hold
(36:26):
in Europe and it will just get worse there.
Speaker 3 (36:28):
I think that many expect there to be more liability
management exercises in Europe, and the potential limitations on that
have more to do with local law restrictions directors duties
management being more nervous about falling afoul of those because
sometimes can actually have personal liability for the directors themselves
(36:52):
in the case of Germany. But there are some countries
where the director's duties protection is not as intense or
or strong, and France is one example of that. So
it really does depend on where the borrower is located
as to whether that is a proper dissuading factor. I
wouldn't say that, it's sort of. I know there was
(37:13):
a lot of to talk about Europe being more concerned
about reputation, and I really think that reputation only gets
you so far. That maybe because Europe is a smaller market,
maybe there is more of a focus on can I
bring the next deal? Will I be able to get
the next deal done? But that's a commercial question that yes,
(37:34):
reputation feeds into, but it's more of a would lenders
work with me again? And if not, then that will
affect my LPs because at the end of the day,
I work for them. I don't work for.
Speaker 1 (37:48):
Lenders, right, But as we talked about, you know, there's
so much liquidity that you know, people have a pretty
short memory for bad things, certainly in this market as
long as it lasts. But in terms of you know,
the jurisdiction, as you mentioned, there are lots of different
jurisdictions in Europe and it is more complex than the US.
But where do you think we will see more of
(38:10):
this kind of activity in Europe? Do you think which
jurisdictions are most prone to it.
Speaker 3 (38:15):
I would say you probably are not looking less toward Germany,
though there are always going to be exceptions to that,
of course, potentially France, Spain, the UK. I mean, those
are some I would just mention off the top of
my head. But it is potentially an issue in any country.
(38:36):
It just requires a very careful jurisdiction by jurisdiction analysis
to think through what the implications are or could be.
Speaker 1 (38:45):
So you do then expect Europe to actually mimic the
US ultimately in terms of the way things have gone here.
Speaker 3 (38:53):
I do expect there to be more leens in Europe. Absolutely, yes,
I'm not sure that there will be as much litigation
there tends to it tends that there are less litigious
folks here in Europe, but that could also change.
Speaker 1 (39:07):
And when their assistant wheels in a massive pile of
prospectuses and they've got to weighe their way through, are
there any kind of red flags that you kind of
you know, look at this one for this name or
this sector or this you know, these are the ones
you've got to focus on, because these are the ones
that are most problematic. Any red flags at all, I don't.
Speaker 3 (39:22):
Want to name any names that would be very inappropriate.
Speaker 1 (39:26):
Mell sector types of businesses.
Speaker 3 (39:29):
I would say more that when you've got very large
capital structures and cross border deals, those are the ones
that are going to float to the top in terms
of flexibility. They're going to have the most in terms
of convergence between the two markets, so the kind of
worst of both. And if you've got multiple capital structures,
(39:50):
then you get the worst of the convergence in the
terms and highal bonds and leverage loans. So those are
the ones you have to be really focused on. They
also tend to be the ones that end up in
syndication being upsized. So maybe the equity check reduces and
we've just seen this recently in the bootsteal and so
then that can have an effect on loosening ratios because
(40:10):
of the change in the capital structure. You're upsizing debt
and you're downsizing equity and things tend to loosen a bit.
So those are the ones I would say to focus
the most on. You will tend to find the most
in terms of flexibility in those types of deals. Taking
into count all of the different dynamics at play.
Speaker 1 (40:28):
Can you use AI to do this?
Speaker 3 (40:31):
Unfortunately, not yet. AI. It is as smart as the
people who are using it. So if you know how
to ask the right questions, then you may get better answers.
The temptation is to rely on AI without knowing what
you're supposed to ask, or without having enough information to
(40:54):
know whether the answer actually makes sense, and because it
feels so easy to type in a question and you
get an answer, and AI is designed to make you
believe that it's true. It is unequivocal every single time.
And so unless you know and we have our own
AI tool that we give to our students, and it
(41:16):
has been trained on hundreds of hours of me talking
about covenants, because it has been trained on every single
word I've ever uttered for Fox Legal Training, and I
spent months interrogating this tool and asking it questions and
getting answers and correcting it and refining and refining and refining.
So that's a great teaching tool that's great to learn from.
(41:38):
But even that, I say to my students, if it
doesn't seem right to you, remember it's still AI. It's
not infallible. And unless you know more or less what
the right answer is in the ballpark could be the
fundamentals of the principles involved. You're not going to know
if the answer is true, and AI is always going
(42:00):
to make you believe that it's right every single time.
Speaker 1 (42:03):
Maybe we get to a world, though, where the AI
is writing the covenants, syndicating the deals, buying the deals,
and also assessing the covenants.
Speaker 3 (42:10):
That's the future a member of We're all on the
beach like drinking mergury at.
Speaker 1 (42:15):
That point, exactly, that's the plan. Great stuff. Sabrina Fox,
founder of Fox Leagual Training. Thank you so much for
being on the Credit Edge.
Speaker 3 (42:22):
Thank you so much for having me. It was a
really fun conversation, and of.
Speaker 1 (42:26):
Course very grateful to Aidan Cheslin from Bloomberg Intelligence.
Speaker 2 (42:29):
Cheers, Thanks James.
Speaker 1 (42:30):
Great to be here for even more credit market analysis
and insight. Read all of Aiden's great work on the
Bloomberg terminal. Bloomberg Intelligence is part of our research department,
with five hundred analysts and strategists working across all markets.
Coverage includes over two thousand equities and credits, plus outlooks
on more than ninety industries and one hundred market industries,
currencies and commodities. Please do subscribe to the Credit Edge
(42:52):
wherever you get your podcasts. We're on Apple, Spotify, and
all other good podcast providers, including the Bloomberg Terminal at
b pod go. Give us a review. It helps other
people find us, Tell your friends, or email me directly
at jcromb eight at Bloomberg dot net. I'm James Crombie.
It's been a pleasure having you join us again. Next
week on the Credit Edge,
Host
James Crombie
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