Bankers Craft Workaround to Refinance Billions for Riskiest Borrowers

Investment bankers in Europe have found a way to circumvent a key obstacle to junk-rated companies extending the maturity on billions of euros of risky debt.

(Bloomberg) — Investment bankers in Europe have found a way to circumvent a key obstacle to junk-rated companies extending the maturity on billions of euros of risky debt.

The workaround, known in the market as “Snooze Drag,” allows a borrower to pull its existing lenders into a new, longer loan – even if some of them are technically unable to participate. It’s controversial, and it’s something many people in the market aren’t eager to talk about publicly.

The maneuver is at least a partial solution to the tough environment for borrowers, many of whom face looming debt maturities. Surging interest rates and slowing economies have made it more perilous for a heavily indebted company to try to raise all-new financing. And the buyout firms that own many of those businesses and loaded them up with all that debt have been unable to sell them on to other buyers, because dealmaking has ground to a halt. 

So the obvious route is a so-called amend and extend, when a company agrees with existing lenders to push out the debt maturity, in return for more favorable terms. The snag: Many of those leveraged loans are held by collateralized loan obligations, which package them into securities of varying levels of risk that are sold on to institutional investors. Many of those CLOs have come up against investment deadlines and therefore can’t participate in an amended loan — in theory.

When companies need to push out their debt maturities, they have to go to their lenders to ask permission. If CLOs are able to stay invested, they can vote yes to extend. But if they have run out of time to buy new loans or to extend existing ones, they tend to vote no.

Bankers pitching amend-and-extend deals are telling those CLO managers who want to remain invested but technically can’t to remain silent – to “snooze” during the vote, according to people familiar with the transactions. If they do so, the CLOs can then get “dragged” into the longer loan, the people say.

“CLO managers investing in leveraged loans are generally happy to do Snooze Drag because they may not be able to actively agree to the maturity extension but very much want to stay in certain credits,” said Jane Gray, head of European research at Covenant Review. “It’s a win/win situation for the borrower and CLO manager.”

Two of the early deals to use the Snooze Drag option were Apax Partners-owned Safetykleen’s reworking of its term loans in January and KKR & Co.-owned Spanish amusement park operator PortaVentura’s amendment of its €620 million ($681 million) loan in the same month, according to people familiar with those transactions.

Spokespeople for Apax Partners and KKR declined to comment.

Bankers say Snooze Drag has appeared in almost every single amend-and-extend that has come to market in Europe this year. They say it’s not being used as a back-door means of getting more investors to extend – it’s spelled out in consent letters to investors and any take-up is purely optional. 

Buyout firms and their portfolio companies have the option to do Snooze Drag thanks to the easy-money era that followed the global financial crisis of 2008 and the euro zone debt crisis of 2010-2012. Investors were so hungry for yield, any yield, that private equity sponsors could and did put language into loan documents that gave borrowers greater flexibility. From about 2018 on, many loans specified that lenders who didn’t respond to a request to amend a loan could be dragged into the process. 

Controversial Move

Snooze Drag is somewhat controversial because CLOs — the biggest buyers of leveraged loans — are designed to have finite lives and ensure that investors get paid back on a timely basis. About a third of those vehicles already are unable to invest in new loans, according to Bank of America Corp., and that number is rising.

Yet Snooze Drag appeals to managers of CLOs that are nearing the end of their reinvestment periods because it allows them to stay invested in companies they’re already lenders to, and maintain assets under management in a market where new leveraged loan supply has been scarce. 

The option has ruffled some feathers because it has the potential to benefit some CLO investors more than others.

For example, Snooze Drag threatens to make losers of buyers of the least risky CLO securities – those rated AAA – who may prefer to be repaid instead of rolled into a new deal. But at the other end of the stack, investors in the so-called equity slice — which is the first to absorb any losses — get compensated for the extra risk with the higher margins that the amend-and-extend offers. 

However, AAA investors are inclined to be understanding – and are giving CLO managers flexibility – because they understand leveraged loan issuers are having problems refinancing their debt, and they don’t want to see downgrades to pick up in their portfolio.

“CLO managers are required to act in the best interests of investors in all tranches of a CLO,” said Boris Okuliar, co-head of global liquid credit for Ares Management Ltd. “They need to be taking investors across the capital stack into account. It really comes down to the manager style, but managers are usually speaking to debt holders, and should be making sure they’re creating the right balancing act between debt holders and equity holders.” 

So far, only some CLO managers have opted to get dragged into amended loans – one banker estimated fewer than 10% of accounts are doing so – while other managers have declined to. But the option is expected to gain steam. 

“If the CLO manager thinks that remaining in the credit through the amend and extend is beneficial because it is a good credit, it still has to make sure the actions it takes are in line with its standard of care, which requires it to consider the interests of all of the noteholders from AAA down to the equity, even if the CLO manager is more inclined to make decisions that favor a better equity return,” said Alex Martin, a CLO and finance partner at law firm Latham & Watkins.

–With assistance from Lisa Lee.

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