Despite many similarities, high-yield bonds remain liquid instruments that are freely transferable in accordance with US securities law, whilst leveraged loans are becoming increasingly difficult to trade, particularly during periods of stress, affecting secondary market liquidity. For some time now, the private debt space has imposed tight transfer restrictions on lenders as borrowers, and sponsors expect a “take and hold” approach from their lenders. Such provisions are now equally seen in the large cap space. As the debate continues around when (or if) the secondary markets will fully open to allow for high trading levels, and whether such market will be open for a longer period of time than was seen at the start of the pandemic, we summarise a few of the key transfer items to consider when looking at buying and selling loans.
Borrower consent is generally required for transfers and assignments subject to a set of exceptions where no consent is required. Transfers between affiliates, existing lenders and related funds is a very common exception. Similarly the majority of European credits include a “white” list or “approved lender” list: a pre-agreed list of banks and funds that can buy the loans. This differs from the disqualified lender list (DQ List) concept seen in the United States, which expressly sets out those institutions that cannot become lenders. Recently, larger credits have included a combination of these two concepts, with the DQ List applying only to specific dollar tranches being marketed in the United States. Lenders should conduct a regular review of the white list, given borrowers’ typical ability to remove a limited number of names from the list on an annual basis.
Among the more contentious points is the treatment of events of default. Historically, a loan became freely transferable during any continuing event of default. Now, as borrowers look for greater certainty over their syndicate in periods of stress, such freedom is limited to a sub-set of defaults, namely non-payment and insolvency (and insolvency-related) defaults. This precludes lenders from buying or selling loans at very early signs of stress or for minor breaches. On deals with a financial covenant, it is a subject for debate as to whether a breach of that covenant should be included. In some cases, delaying investors’ ability to buy into loans until such limited times is not in the best interests of any stakeholder, as waiting to such point means that the value of the group will likely have already begun to erode.
Recently there has been a trend towards requiring lenders to provide notice of transfers to the borrower irrespective of whether consent was required and, in some cases, for such notice to be given in advance of the transfer taking effect. This further highlights the desire to have information and control over a syndicate to maximise its option value in any periods of distress or even in a restructuring.
It is customary for consent not to be unreasonably withheld or delayed, and most documents will include a time period after which deemed consent is given, albeit this has fallen away on some credits.
Blanket Prohibitions and Other Restrictions
Certain groups of transferees may be blocked from ever holding commitments. Business competitors and their shareholders are one group, and the market has accepted that competitors looking to hold debt would only do so with nefarious intent. Private equity houses holding the loans may also be included in this group.
Loan-to-own investors are a second group that borrowers and sponsors are focussed on excluding to reduce the risk of precipitous or disingenuous fabrication of defaults and/or ultimately looking to take the equity. How such loan-to-own investors are defined is a critical point of negotiation, to properly ensure that performing credit funds and CLOs are not restricted from buying into the debt. Whether this prohibition continues to take effect whilst an event of default (or the sub-set of events of default as above) is continuing is a point of commercial negotiation, but analysis of the transfer provisions should be undertaken to confirm.
Recent developments include restrictions on any individual lender (and affiliates) owning more than 10% (or 20%) of the total commitments. This restriction has generally been reserved for jumbo transactions, which make it unlikely for any lender (particularly institutional investors with concentration limits) to get close to this number, but it does act as a barrier to potential stake building. It may also make it more difficult to agree a restructuring with a large number of lenders.
In certain credits, lenders also are required to represent that, through any interest in a total return swap, credit default swap or other derivative contract, they are not a net short lender. Failure to make (or to correctly make) such representation may lead to such lender’s commitments being disqualified or voted in the same proportion as non-net short lenders. Alternatively, loans may permit such transfers but expressly disenfranchise such lender from voting. It is unlikely that the “net short” disqualification would work meaningfully in high-yield owing to the underlying mechanics of global notes versus loans, but this does not appear to have been tested in the courts to date.
The ability to take loans through some form of voting sub-participation is now commonly regulated in line with transfers. Non-voting sub-participations are generally permissible provided voting rights are not transferred in the present or future, and representations by lenders may be required. To the extent such new lender is considering a sub-participation, the terms of the loan agreement should be carefully reviewed by such lender to see what restrictions could apply.
In any trade, it is worth paying regard to minimum hold amounts (including ensuring that such hold amounts are aggregated amongst affiliates and related funds) and minimum transfer amounts, as well as any rating requirement for revolving commitments. Many true revolving credit facilities require lenders to have an investment grade rating in order to ensure counterparties will accept letters of credit issued by such institutions. For those looking to transfer into a revolving credit facility owing to its seniority in the capital structure, this may operate as a blocker to distressed investors. Finally, given large number of lenders that will lend from levered funds, it is also prudent to check that lenders can create security, in favour of those leverage providers, over their rights under the finance documents.