Loan Note: The growth of ‘super senior'; covenant breaches on the up
One way to gauge this bifurcation of the American economy is by looking at the results of some major credit card companies. The customers of Capital One, Discover Financial and Synchrony have historically been those with lower credit scores, while American Express typically serves the wealthiest and well-to-do. At Synchrony Bank, the largest issuer of retail co-brand credit cards, the charge-off rate jumped from 3.5 percent to 5.6 percent in a year. Meanwhile, roughly 4.7 percent of Synchrony customers are 30 days or more behind on their bills, which is also up from a year ago. One way to gauge this bifurcation of the American economy is by looking at the results of credit card companies like American Express, Capital One, Discover Financial and Synchrony Financial. In the unfortunate event of default, conflicting goals among different tranches can escalate into costly and time-consuming legal battles, commonly known as “tranche warfare.”
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- If ABC Company were to go bankrupt, the senior lenders (Bank A) would get paid back first from the liquidation of assets before the subordinated lenders (Private Equity Firm B).
- It has priority over other debt obligations and claims on assets in the event of default or bankruptcy.
- Gross domestic product surged in the second half of 2023, the economy added a flush of new jobs and the unemployment rate has clung near a 55-year low at 3.7%.
- Subordinated debt has become a relatively easy way for banks to meet capital requirements without having to dilute their shareholder base by raising capital.
It involves dividing a pool of cash flow-generating assets, such as mortgages or loans, into different slices or tranches that cater to the preferences of specific investors. Each tranche represents a different level of risk and reward based on factors like maturity and yield. In summary, seniority level, interest rates, and collateralization all distinguish senior debt from subordinated offerings. Senior lenders closely analyze project feasibility, cash flows, collateral value, and the borrower’s ability to service debt. They require strict covenants and oversight to ensure loan repayment over periods often lasting years.
How Senior Debt Works
This has serious implications for the senior debtholders’ post-default recovery prospects. The introduction of a large tranche of super senior debt above the senior debt is likely to materially reduce the amount of cash that the senior debtholders recover. Discover’s customers are carrying $102 billion in balances on their credit cards, up 13 percent from a year earlier. They attract conservative investors like institutional investors and pension funds, contributing to market liquidity.
Delinquency rates on single-family homes remain at near historic lows and home prices have continued to climb. Even in economically uncertain times, paying down debt quickly—and contributing to emergency funds—must be a top priority, Bankrate advises, lest a loss of income throw a wrench in your plans. And it’s possible to multitask; just over a third of the study’s respondents said they’re currently prioritizing paying down debt and saving money in equal measure.
The company provides regular principal and interest payments to lenders based on a preset schedule. Most European leveraged finance transactions in recent years have provided very limited security to the senior debtholders. Typically, this security takes the form of share pledges, charges over bank accounts, intergroup receivables, guarantees from some operating companies, and not much else. It’s unlikely that Americans will see any relief from the banks or interest rates any time soon that would allow them to refinance these high interest debts. The Federal Reserve signaled Wednesday that its first interest rate cut is likely months away.
Senior debt is often secured by collateral on which the lender has put in place a first lien. Usually this covers all the assets of a corporation and is often used for revolving credit lines. High-profile cases of senior super senior debt debtholders being unexpectedly “primed” have risen in recent years. Priming occurs when one lender surpasses the priority status of another with the introduction of new debt that effectively becomes super senior.
However, there are dangers in revisiting precedent deals and applying the intercreditor principles from those deals to future transactions in which the intercreditor dynamics and the characteristics of the underlying credit may vary significantly. The ICAs we have reviewed do not appear to restrict the raising of new super senior debt. The SFA generally sets out limitations on the raising of additional senior debt, specifying the size of relevant baskets, for example, although the location of these limitations within the document varies. It is entirely possible that, for each transaction, there is explicit language in the SFA that mitigates the flexibility the ICA provides. Economists at the moment feel the financial strain felt by these lower income Americans is not likely to spill over broadly into the broader economy, at least at the moment. But economists and experts see these rising delinquencies as one of the growing risks to the economy this year, especially if student loans become too much for younger, debt-burdened Americans to handle.
The previous month, President Barack Obama signed into law a bill providing a debt restructuring process, which stopped any litigation that would have resulted from the default. One area of discussion on various recent deals has been whether the definition of Permitted Financial Indebtedness should be something that is only capable of amendment with all lender / majority super senior lender consent. The proportion of mid-market leveraged (and increasingly corporate) deals done on a super senior / unitranche basis has increased dramatically over the last few years.
Mr. 80 Percent
The increasing competition between private debt funds and banks has brought further debate into an already-troubled dynamic. While market commentary has been quick to point out the decline, FOLO days may not be over yet. These tranches offer higher stability and security than subordinate tranches due to their seniority in the payment hierarchy, ensuring a greater likelihood of recovery in case of default. The varying risk, reward, and maturity characteristics of tranches within the same offering can make it challenging for investors to assess and compare different investment options accurately. The complexity of tranching transactions often requires detailed and specific documentation to ensure that the desired characteristics, such as the seniority order of tranches, are maintained under different scenarios. Lawsuits were also filed by investors holding junior tranches, alleging that their yields were affected by low-priced sales of foreclosed properties.
Restrictive covenants in employment—a guide to our materials
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In recent years, the UK mid-market has seen a proliferation in the number of sponsor-backed (and increasingly event-driven corporate) transactions which are financed on a super senior – unitranche basis. Such structures typically involve provision of non-amortising term debt by a credit fund (the ‘unitranche’ provider), with such facility ranking junior (in a post-enforcement scenario) to ‘super senior’ facilities. These are typically either a standalone RCF or a combination of working capital, capex and/or drawn term debt (the so-called ‘first out’ facility) provided by a clearing bank. In summary, the preferential treatment of senior debt in repayment and collateralization is pivotal in enabling businesses to raise capital efficiently while balancing risk and return for lenders.
While tranching offers flexibility and customization in structuring financial products, it has inherent complexities and risks. Relying on historical performance data for modeling tranched https://personal-accounting.org/ transactions has also raised concerns. The increased complexity of tranching can make it difficult for less sophisticated investors to comprehend and make informed investment decisions.
DIP loans are risky, with high interest rates, but can lead to profitable returns. As existing lenders refuse to lend more, new lenders provide liquidity through DIP loans to drive restructuring. Similar to the DSCR, the interest coverage ratio specifically looks at EBIT relative to interest expenses on debt. A lower ratio implies higher risk of missing interest payments if income declines.
Certain jurisdictions, such as Germany and Belgium, have been able to continue to offer lower pricing and therefore to benefit from the advantages of FOLOs without being under-compensated for their risk. It remains to be seen if there will be some return to this lower-risk style of lending in a post-COVID-19 environment. It becomes evident that no single agent is acting as a fiduciary for the entire structure, further complicating the decision-making process and potentially undermining the overall efficiency of the tranching arrangement. Balancing the incentives and interests of these stakeholders becomes essential to prevent conflicts that may arise from acting in favor of one investor class at the expense of others.
For example, in 2020, Swiss aviation services company Swissport Group S.a.r.l was able to access the plan via a contribution deed from a guarantor, as was Swiss airline caterer gategroup Holding AG, via a deed poll and contribution payment agreement in 2021. Note that credit analysts, rather than lawyers, undertook this review, and no single legal agreement forms the basis of it. Rather, it is a synthesis of multiple transactions across multiple jurisdictions, although many of the intercreditor agreements (ICAs) we reviewed are subject to English law. It is both noteworthy and helpful that different legal firms use similar, often identical, wording for the key paragraphs.