Rescue financings have evolved considerably in the past twenty years since the last true cycle of corporate distress in 2000-2003. Gone are the days when a CFO’s desperate search for one last liquidity solution, a silver bullet so to speak, would inevitably lead to a discussion with rescue lenders named after a mythological three-headed dog guarding the gates to the underworld or those foreshadowing major change. Through a prolonged Fed induced environment of low interest rates and easy credit, what was once a feared group of counterparties has become a much more benign (even friendly) group of lenders of last resort. But has this evolution in rescue financings been helpful to borrowers, or could it have become too much of a good thing? Importantly, in today's more volatile credit market, how should borrowers and their advisors evaluate this landscape of rescue lenders?
How We Got Here – The Financial Crisis and the Evolving Rescue Lender Profile
Prior to the Financial Crisis (2007-2008), every restructuring professional knew when a borrower had run out of options and was on its last chance. What would follow was inevitably a reset of the balance, coupled with a bankruptcy filing – likely led by its new lenders, which were hedge funds that had purchased the borrower’s debt at steep discounts to par and were offering to provide new financing conditioned on the restructuring of their debt liabilities. But, the era of easy credit and the low interest rate environment that followed the Financial Crisis, also impacted the world of rescue lenders. Ever looser debt documents, growing competition from other sources of capital, and the high costs of bankruptcy have led rescue lenders today to evolve into more friendly forms of capital. Such lenders have been rewarded with higher yielding returns on their structured financings than would otherwise have been available, without (to date) the offset of higher levels of defaults or bankruptcies related to such financings. As such, the amount of capital focused on this asset classes’ higher prospective yields has grown rapidly. Today, the world of private credit is a sector with over $1.3 trillion of assets under management. The year 2022 was in particular a banner period for new credit fund raises. Direct lenders such as Neuberger Berman, Crescent Capital, and The Carlyle Group all raised new multi-billion dollar credit funds that were significantly larger than their predecessor funds. Others such as JP Morgan Chase started 2023 by setting aside $10 billion to target direct lending opportunities.
From ‘Good Companies with Bad Balance Sheets’ to ‘Any Company with Good Debt Documents’ – How Rescue Financings Have Evolved
The rescue financing playbook today remains largely similar in form to its earlier predecessor, namely, to combine a highly sophisticated understanding of capital structures with an offering to inject liquidity into a distressed borrower. But today’s rescue lender playbook comes with a repositioned target client strategy. While rescue lenders of the past era were primarily focused on ‘good companies with bad balance sheets’, today’s competitive dynamics have led rescue lenders to embrace average companies with ‘good debt documents’. In rescue lender terminology, ‘good debt documents’ means that a borrower has the flexibility to add incremental financing to an already highly levered balance sheet in a protected manner. This flexibility is typically the product of debt documents that allow for a borrower to transfer assets, create new subsidiaries, or sell existing assets (to name a few) with limited or no requirement for consents from existing lenders. As such, ultimate downside protection for the rescue financing through equity ownership (likely via Chapter 11) has become less desirable, if not wholly unwanted. The evolved rescue lender playbook has also come with updated branding, with the image of a three-headed dog guarding the gates to the underworld being replaced by friendlier images of capital providers in the form of trees, minerals and birds (to name a few). But this playbook change has also come with unintended consequences for borrowers, namely, to allow some to ignore their overall leverage profiles and structural business issues for far too long.
Today’s Rescue Lender Playbook at Work
Certain words have become synonymous with rescue financings today. What were once primarily up-tier financings, priming existing lenders within the same collateral pool, are now transactions known as Liability Management Exercises or ‘LMEs’ which also go by names such as IPCos, BrandCos, and other asset transfers into unrestricted subsidiaries that are then financed directly by the rescue lender. The associated corporate names that have pursued these types of financings are long and distinguished, including J. Crew, Bed, Bath & Beyond, Party City, and Revlon, among others. For a rescue lender today, the fact that the borrower may already have too much debt does not necessarily equate to being a bad lending opportunity - given the ability to carve-out and ringfence collateral for the new financing. In some instances, the rescue financings have been coupled with debt exchanges, to further incentivize the economics of the transaction. For troubled borrowers, these transactions have provided a lifeline of liquidity, through an asset on their balance sheets (namely weak credit documents) that was likely not on their radar until approached by savvy rescue financing institutions. These savvy lenders seek to identify opportunities to put capital to work at attractive rates and with structural protections that the broader debt markets have overlooked. But, have these transactions been silver bullets for borrowers? The answer is largely situation specific.
Liability Management Balance Sheet Fixes – Through Rescue Financing Alone
Given the environment of easy credit (and flexible debt documents), recent liability management transactions have largely avoided the need to negotiate with existing debt holders to a borrower. These transactions differ from typical balance sheet fixes involving new capital, where the new capital acts as a catalyst for restructuring the leverage profile of the borrower’s balance sheet. Such transactions, better known as out-of-court recapitalizations or new-money plans of reorganizations, require significant and at times acrimonious negotiations with lenders, equity holders and other constituents within a capital structure. But the end result of these transactions is typically a borrower with not only new liquidity but also a lower overall debt-burden. Not so with today’s liability management transactions. While the liability management transactions for Revlon (2020), Envision Healthcare (2022), and Bed Bath & Beyond (2022) all included rescue financings / new liquidity to the borrower, they also added to the overall leverage profile of each. Leaving aside the litigation risks, following the completion of these rescue financings each of the businesses was left with an even larger debt balance to grow into. Other recent rescue financing / liability management transactions have provided some level of overall debt reduction, but clearly not enough for the businesses to survive - as both J Crew (2017) and Party City (2020) each filed for Chapter 11 within three years following their transactions.
Evaluating the Rescue Financing Landscape Today
Today, almost every borrower that is perceived to face a liquidity or balance sheet challenge will be the recipient of inbounds from friendly capital providers offering structured rescue financing solutions. The post Financial Crisis era has created such an environment from both the perspective of flexible debt documents and an abundance of private credit. Whether a rescue financing alone is a silver bullet to a borrower is today much less of a question about the ability to obtain such capital, but rather whether that capital by itself is adequate for the business to survive. The answer to that question is not one provided by today’s rescue lenders, who have their own financial motivations, but instead one for Boards, management teams and advisors to independently evaluate. After all, just because collateral can be carved out for a new financing does not necessarily mean that a borrower can afford to carry more debt.