Despite a push in recent years to revise the indenture language of collateralized loan obligations (CLOs) to provide them with more flexibility to invest in distressed corporate restructurings, a limited analysis by Fitch Ratings found that a lack of such language did not obstruct their participation.
The push arose from concerns about the increasing number of liability-management transactions that occur in distressed restructuring situations typically outside of bankruptcy where one party of creditors gains seniority over another. By adding CLO documentation specifying that that CLOs can participate in liability management restructurings, CLO managers sought to "level the playing field" with other non-CLO investors, Fitch says.
The rating agency analyzed two such transactions and found that creditors participating in the new debt retained higher bid levels on their debt holdings than those that didn't--important if a manager wants to sell the debt.
We don't really think they need this new language providing the flexibility to participate in the examples we dove into.
In one example, Fitch points to two CLOs participating in restructured Mitel Networks debt that saw the average bid prices on their new holding in the high 60s over Libor, while a CLO that did not participate saw the market value of its existing exposure fall below 30. Creditors that did not participate in restructurings last year of Envision debt, the other Fitch example, were similarly disadvantaged.
While that outcome is unsurprising, the CLOs did not appear to require the more flexible language in their indentures to participate in the restructurings.
"The punchline is: We don't really think they need this language providing the flexibility to participate in the examples we dove into," said Derek Miller, managing director at Fitch, despite "a lot of effort and energy focused on negotiating these terms and focusing on this particular issue."
An example of restrictive documentation language, according to Christine Yoon, a senior director at Fitch and one of the report's authors, is that a CLO typically has eligibility criteria that requires new assets to be rated 'CCC-' or above. While participants in the CLO may want to be at the table to negotiate the restructuring, she added, the CLO manager may renounce the effort because the new debt fails to meet that threshold.
In the Mitel restructuring, the Fitch report says, CLOs were able to participate in the restructuring even without indenture language specifically allowing them to participate in liability management transactions by defining the investment in the new debt as an allowable transaction, such as a maturity extension.
"Even those CLOs that didn't have the very specific language that we're seeing in new CLO documentation were still able to find some way to participate," Yoon said.
Liability management strategies started raising concerns several years ago with capital restructurings by J. Crew, Serta Simmons and others. Nevertheless, the transactions still remain relatively limited. Yoon said that of the 25 defaults Fitch logged in 2022, just 28% of them fell into liability-management category, and among the 26 default events so far this year, only three.
