Struggling business lenders surround carts to fend off struggling debt investors

Eaton Vance Corp.

Mutual fund manager Craig Russ is no activist, but when he learned that troubled investors were going after Serta Simmons Bedding LLC, putting his $200 million investment in the company in difficulty, he threw himself on the mattresses.

Mutual funds have long avoided fights with savvy hedge funds and other investors who specialize in troubled companies. But Mr. Russ and other fund managers battled with investors, including Apollo Global Management and Angelo Gordon & Co., and won in New York State Supreme Court last week. It’s the latest example of how big money managers are upending the balance of power on Wall Street. Mr Russ was joined by Invesco ltd.

and Credit Suisse Asset Management, among others.

These investment firms have supplanted banks over the past decade as the primary lenders to companies with questionable credit ratings by purchasing these companies’ “leveraged loans”. The companies own more than 70% of the $1.2 trillion leveraged loan market through funds known as collateralized loan obligations, or CLOs; mutual fund; and managed accounts for institutional clients.

The financial pain caused by the coronavirus pandemic is forcing loan funds to change course. Once seen as slow-moving and passive, funds are consolidating to fend off investors seeking to capitalize on financial crises by buying the debt of struggling companies and using it to take ownership of their businesses.

“The game has changed,” said Stephen Ketchum, founder of Sound Point Capital Management LP, which primarily manages CLOs and holds about $18 billion in loan investments. “CLOs and mutual funds are bigger collectively and individually than they were during the last crisis in 2009, and they are more sophisticated.”

Historically, loan fund managers sold companies at the slightest default, but today many investments are too large to be withdrawn quickly. Boston-based Eaton Vance manages about $30 billion in leveraged loan investments for its clients, and the investment arm of Swiss bank Credit Suisse manages roughly the same amount in its CLOs.

“Managers who would otherwise be more conservative realize this is the new world they live in and they are more aggressive,” said Robert Gayda, partner at the bankruptcy firm of Seward & Kissel LLP.

Lending funds have spent the past few months identifying companies they lend to that might default, forming committees and sometimes hiring lawyers and financial advisers in anticipation of potential disputes, according to portfolio managers, attorneys and analysts. In some cases, the funds also commit hundreds of millions of dollars in new loans, a tool more commonly used by hedge funds.

Sound Point, for example, is teaming up with other CLO managers, including CBAM Partners, to protect investments in a roughly $1 billion loan to Cirque du Soleil, which halted performances in March and is restructuring his debt. The funds are battling private equity giant TPG for control of Cirque du Soleil by offering to convert some of their loans into equity and lend an additional $300 million to help the company through widespread shutdowns caused by the coronavirus pandemic. pandemic, people familiar with the matter. noted.

Regulators and ratings agencies have warned for years that record purchases of leveraged loans by investors are allowing risky companies to borrow excessively, exposing lenders to above-average losses in the next economic crisis. Yield-hungry loan funds have also allowed private equity firms that own many businesses to strip key lender protections, exposing themselves to other dangers.

Loan investors’ biggest fear — that private equity firms will use a controversial tactic of moving assets such as intellectual property out of lenders’ reach — became a reality this spring. Owners of companies such as Serta, Cirque du Soleil and cosmetics maker Revlon Inc.

used or considered using the technique to protect their holdings at the expense of loan holders, sometimes obtaining financial support from other private equity and hedge funds such as Apollo, Angelo Gordon and Ares Management Corp.

Advertisements for Cirque du Soleil in Las Vegas in mid-March, just before the company announced it was suspending shows worldwide due to Covid-19.


Ethan Miller/Getty Images

Serta had been struggling for several years, and after the U.S. economy shut down in March, the loan funds that held its debt asked private equity owner Advent International what it intended to do. said people involved in the case. Advent was negotiating through Serta’s financial advisor, Evercore Group LLC, to borrow enough money from others, including Angelo Gordon and Apollo, to keep the company going. Advent offered to pledge about $1 billion of the mattress maker’s intellectual property to distressed debt funds, but it said nothing to the deal’s loan funds, the people said.

Borrowing from distressed debt funds might have allowed Advent to protect its stake in Serta, but the distressed debt funds would be the first to collect the intellectual property, before the loan funds, if Serta were to file for bankruptcy. .

“They were threatening to fuck us up,” Eaton Vance’s Mr. Russ said.

Lending funds learned of the plan in May, when Advent was already close to reaching a deal with the troubled investors, who had also purchased about $600 million of Serta’s existing loans at discounted prices. very advantageous. The loan funds quickly offered a new $200 million loan and an agreement to swap approximately $1.3 billion of Serta’s existing loans they held into $875 million of new loans that would take precedence over the debt. that the distressed debt funds had purchased.

“Evercore conducted a process on behalf of Serta and Advent in which Angelo Gordon, Apollo and Gamut Capital were among several parties specifically invited to structure an IP transaction,” an Apollo spokeswoman said. “Our group’s proposal was fully consistent with the credit agreement and recent precedents and was less aggressive than Evercore’s own proposed term sheet. Serta chose a much more aggressive transaction that we believe violates the law and loan agreements and, as analysts have noted, effectively strips nonparticipating lenders of nearly all of their collateral.

Advent and Serta accepted the offer of the loan funds because it offered greater debt reduction, people familiar with the matter said. Apollo and Angelo Gordon lost a case in the New York State Supreme Court to block the transaction.

Mr Russ said he hoped loan investors would start demanding stronger protections again. Until that happens, “it’s the new reality,” he said. “There’s a whole new playbook, and it’s all about maximizing recoveries.”

Write to Matt Wirz at [email protected]

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Carol M. Barragan