Speaker 1: Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2: Hello and welcome to another episode of the All Thoughts podcast.
Speaker 2: I'm Tracy Alloway.
Speaker 3: And I'm Joe Wisenthal.
Speaker 2: Joe, what do you know about creditor on creditor violence.
Speaker 2: I don't know anything other than it's it's a very punch.
Speaker 4: It's a great that's literally it. It's come up a
Speaker 4: few times in all Right. It's come up a few
Speaker 4: times in episodes we've done about credit, and I get
Speaker 4: the impression that, you know, lenders to affirm have different
Speaker 4: status and some are higher up in the rank than others,
Speaker 4: and that they would like to probably use the technicalities
Speaker 4: of the legal code to improve their rank in some
Speaker 4: sense when money gets paid out to lenders.
Speaker 2: Yes, so it has come up in a number of well,
Speaker 2: some of the fights get pretty nasty. Okay. Well, so
Speaker 2: when I think about it, I think back to when
Speaker 2: I covered the leverage loan market at the Ft and
Speaker 2: this was sort of like twenty thirteen, twenty fourteen, and
Speaker 2: I remember writing stories about how leverage loans, more of them,
Speaker 2: were becoming covelight, so weaker covenants for lenders or investors.
Speaker 2: What that means is companies basically had more leeway to
Speaker 2: restructure their assets if they were trying to raise new
Speaker 2: capital or stave off bankruptcy or whatever at the expense
Speaker 2: of those lenders slash investors. And back in twenty fourteen,
Speaker 2: I think the proportion of the leverage loan market that
Speaker 2: was cove light was something like thirty percent, and that
Speaker 2: was like a big deal that was already higher than
Speaker 2: the leverage buyout boom in two thousand and seven. Now,
Speaker 2: the vast majority of leverage loans I think something like
Speaker 2: ninety percent could be called cove light. So the entire
Speaker 2: market is basically cove light at this point, which fits
Speaker 2: into the creditor on creditor violence theme. So I feel
Speaker 2: like we need to we need to dive into.
Speaker 3: This what it is.
Speaker 4: I just my impression is that if I'm going to
Speaker 4: be affirmed that buys leverage loans, I need a good lawyer.
Speaker 3: For the contract.
Speaker 2: Well, I kind of wonder, I guess, I wonder relatively
Speaker 2: how important like legal expertise is versus valuation expertise.
Speaker 3: This is what I am wondering as well.
Speaker 2: All right, so let's get into it. I am very
Speaker 2: pleased to say we have the perfect guest, we're going
Speaker 2: to be speaking with Sujet Endap. He is, of course, uh,
Speaker 2: the Wall Street editor over at the FT, my former colleague.
Speaker 2: We used to double byline on at least one piece.
Speaker 2: I think he is also the author of the excellent
Speaker 2: Caesar's Palace Coup book, which if you haven't read, I
Speaker 2: would highly recommend, especially on that point about distressed debt
Speaker 2: fights getting kind of nasty sigit. Thank you so much
Speaker 2: for coming on all thoughts.
Speaker 5: Hi, Racy Joe, it's great to be here.
Speaker 3: Thank you.
Speaker 2: So, I guess my first question is, you know, we
Speaker 2: see these headlines about creditor on credit or violence, or
Speaker 2: you know, someone will be writing about the private credit
Speaker 2: market and they'll be in aside about creditor on credit
Speaker 2: or violence and how it's becoming more of a thing.
Speaker 2: Can you give us some context around whether or not
Speaker 2: this is becoming a bigger trend. I feel like it is,
Speaker 2: but it's not like there's a violence index that we
Speaker 2: can look at.
Speaker 5: Yeah, so the idea of violence in corporate restructuring and
Speaker 5: private equity deals is not a new idea. Imagine the
Speaker 5: business that's been bought by the private equity firm is
Speaker 5: just less valuable over time, the pious shrunk, there's going
Speaker 5: to be a fight over who gets what piece and
Speaker 5: how big those pieces are. The creditor on creditor of
Speaker 5: violence phenomena, though, is a little bit more nuanced and novel,
Speaker 5: And that's the idea that imagine you, Joe, U, Tracy,
Speaker 5: and me. We are all holders of the first lean
Speaker 5: term loan. Let's say you own five hundred million, Joe,
Speaker 5: you've got three hundred million. Let's say I'm poor, say
Speaker 5: worth the ft, and only have fifteen million. But there
Speaker 5: would be the view that since we're all in the
Speaker 5: same security governed by the same document, that our rights
Speaker 5: are the same and we are all going to be
Speaker 5: treated equally in this fight with the private equity firm
Speaker 5: and maybe the junk bond holders below us. The creditor
Speaker 5: on credit of violence nuance now is that in fact
Speaker 5: we are not equal, and you two, as large holders,
Speaker 5: can do things to me small holder that are not
Speaker 5: equal in treatment, arguably unfair, arguably impermissible.
Speaker 4: Just to be clear, in this theoretical setting in which
Speaker 4: all of us are quote equal in the in the
Speaker 4: firm's liabilities, did we all have the exact same language
Speaker 4: did we all enter into the same contractual language when
Speaker 4: we purchased the debt or when we lent money to
Speaker 4: the company. And furthermore, if we did all have the
Speaker 4: same language, what are the tools that we use to
Speaker 4: change our change our priorities?
Speaker 5: Yeah, so we do. We all are governed by the
Speaker 5: firstly in credit agreement. Maybe you bought in the original
Speaker 5: LBO and maybe you're clos an i'm or you are
Speaker 5: a distressed debt hedge fund which bought in later at
Speaker 5: a different price, but we're all governed by the same
Speaker 5: document and in concept have the same rights and protections.
Speaker 4: So then where how do I do something to you guys?
Speaker 4: If we're what are the basic tools at my disposal
Speaker 4: if I want to somehow gain an advantage for me
Speaker 4: that doesn't accrue to you.
Speaker 5: Yeah, So let's talk about why that scenario was first arise.
Speaker 5: And imagine the company is running into trouble. There's a
Speaker 5: maturity coming up, but there's some liquidity challenge. As you
Speaker 5: said earlier, these documents now since the financial crisis are
Speaker 5: covenant light or no covenant, so there's a lot of
Speaker 5: flexibility for the borrower, which is the company and the
Speaker 5: private equity firm that owns the company, and rather than
Speaker 5: just declaring bankruptcy and going to bankruptcy court and finding
Speaker 5: out there, which is messy, it's time consuming, it has
Speaker 5: its own restrictions on what you can do in the
Speaker 5: private equity firm will typically if the equity holder will
Speaker 5: get wiped out. Bankruptcy is like not an attractive option
Speaker 5: for those reasons, and so what you can try to
Speaker 5: do is raise new capital. And you're going to raise
Speaker 5: new capital, often from the existing lenders. Those lenders in
Speaker 5: exchange for giving you more money are going to ask
Speaker 5: for some things. What are they going to ask you for? First,
Speaker 5: the company itself is probably going to want to reduce
Speaker 5: the principle balance, So they want people to take haircuts.
Speaker 5: So there's gonna be some haircuts involved, and then there's
Speaker 5: gonna be brought this new money, brought in that new money. However,
Speaker 5: if I'm giving you new money into this troubled company,
Speaker 5: I'm gonna want some things to do. That gota and
Speaker 5: those things I'm gonna want is the most senior priority,
Speaker 5: which calls super priority. Okay, that's all sort of standard,
Speaker 5: that's not new. The nuance is the company itself has
Speaker 5: some amount of value it can pass out as cookies
Speaker 5: to these in this new financing process. And in the
Speaker 5: old world, what they would do is, let's say I've
Speaker 5: got one hundred million dollars and I'm making that number
Speaker 5: up of value to allocate in this new transaction that
Speaker 5: I'm going to raise new money in. Rather than splitting
Speaker 5: that up pro rata amongst the three of us, I'm
Speaker 5: just going to give it to two of you. And
Speaker 5: so why is that From the companys point of youw
Speaker 5: it's one hundredllion dollars. How the three of us divide
Speaker 5: it up? They don't really care about But you too,
Speaker 5: care about getting as much as you can since you
Speaker 5: own the mo what we all care about it? But
Speaker 5: you guys have the possibility of being let's say, a
Speaker 5: fifty one percent group and saying I can take all
Speaker 5: the cookies for me and leave Sejeet behind. And that
Speaker 5: is the idea of creditor on creditor of violence. We
Speaker 5: are theoretically PARTI pursue. We are in the same place
Speaker 5: with the same document, but you, because you choose to
Speaker 5: and the sponsor wants to doesn't really care where responsor
Speaker 5: will just go to you it's easier to deal to
Speaker 5: cuts if there's two of you, not three of us
Speaker 5: negotiate with and that is the nuance of creditor on
Speaker 5: credit violence. You two theoretically standing with me, but the
Speaker 5: same document can impose pain on me simply because you're bigger.
Speaker 2: Super priority kind of reminds me of double secret probation,
Speaker 2: right like that, I wonder, can you have like super
Speaker 2: super priority that would I guess you could like keep
Speaker 2: doing it forever pretty much, or at least until all
Speaker 2: the collection.
Speaker 5: It's kind of like one point five. Yeah, I mean
Speaker 5: that's kind of put between first and second. And then
Speaker 5: there's been double creditor on creditor violence cases, so there
Speaker 5: is like this spiral, uh and kind of like through
Speaker 5: the looking guests violence squared. Yeah.
Speaker 2: So one thing I don't really get about the creditor
Speaker 2: on creditor violence is its connection with private credit. And
Speaker 2: I've seen people talk about private credit as a response
Speaker 2: to creditor on creditor violence in the sense that, you know,
Speaker 2: maybe it's easier to be a single lender to a company.
Speaker 2: You're higher up in the payment waterfall, you don't have
Speaker 2: to worry about getting into fights with a bunch of
Speaker 2: other investors. But then I also see headlines saying that
Speaker 2: creditor on credit or violence is becoming more of a
Speaker 2: thing in private credit too, So basically I'm confused.
Speaker 5: Yeah, so let's just take a step back and just
Speaker 5: think about that. I think there's two factors that are
Speaker 5: behind the generalized credit or on credit or violence concept.
Speaker 5: One is what we hit on before, which is just
Speaker 5: the technical aspect of these credit agreements, which is the
Speaker 5: legal contract that governs like a leverage loan. And then
Speaker 5: you know, what are the restrictions or covenants that are
Speaker 5: in that document that prevent this kind of creativity and
Speaker 5: like refinancing and exchange offers. And there is like a
Speaker 5: real legal dispute about whether these changes can be done
Speaker 5: with or without unanimity, whether you need one hundred percent
Speaker 5: of the group, all three of us to agree to
Speaker 5: a change an interest rate or pull maturity. It does
Speaker 5: are called the so called sacred rights, if you will,
Speaker 5: And that's like a legal question that's been liting at it,
Speaker 5: and we can talk about that more if you want.
Speaker 5: But then there's also the social aspect. And the social
Speaker 5: aspect is the idea that me private equity forms they
Speaker 5: may have the legal ability for this mischief, but they
Speaker 5: ultimately wouldn't pursue that. And they wouldn't do that because
Speaker 5: they are a repeat player in the leverage finance markets.
Speaker 5: And if they get a reputation as a firm that
Speaker 5: gets too cute, that will cause them to borrow at
Speaker 5: higher interest rates and down the line and the next deal,
Speaker 5: the deal after that, the different partners who are not
Speaker 5: in this deal are going to face the consequences. So
Speaker 5: there's a social aspect and also within the deal itself.
Speaker 5: If you ultimately antagonize your creditors down the road, you
Speaker 5: may need to have restructure again. And if they remember
Speaker 5: you as the person who is rough with them, they're
Speaker 5: not going to be so kind when you need their help.
Speaker 2: And yet Argentina exists exactly.
Speaker 5: So that brings us to the private credit point. And
Speaker 5: you were obviously a lover's finance reporter and a lover's
Speaker 5: loan mayven. And you know how that market works, which
Speaker 5: is it's really big. It involves banks who underwrite these
Speaker 5: deals and then they sell them on in the syndication process,
Speaker 5: and that's a whole kind of machine. And you know,
Speaker 5: in in a big leveraged loan credit, there's going to
Speaker 5: be dozens of clos and regular way mutual funds and
Speaker 5: then hedge funds, and it's like a wide, widely dispersed
Speaker 5: kind of group, and that dynamic affects how the document
Speaker 5: is negotiated and just you know, all the kind of
Speaker 5: interactions down the line. And a private credit deal where
Speaker 5: you truly have like a club or maybe even a
Speaker 5: single lender, whether there's you know, four or five or
Speaker 5: three or two, maybe one firm that's providing a loan
Speaker 5: to a private equity backed company, that group is just
Speaker 5: much smaller. The negotiations around that document are much more intimate.
Speaker 5: And again for those social reasons, there was the idea
Speaker 5: that in a private credit deal, the private equity firm
Speaker 5: sponsor who owns the company is not going to declare
Speaker 5: war or go to deaf Con five or deaf Cone
Speaker 5: one with whichever the highest one is, to pursue their
Speaker 5: own ends. It's going to be much more of a collaborative,
Speaker 5: collaborative and.
Speaker 2: Kind friendly come by a relationship.
Speaker 5: And so this again now we go to the examples
Speaker 5: of the credit or on credit violence that has arisen
Speaker 5: down the private credit market and The examples are relatively
Speaker 5: sparse so far because private credit is relatively new and too,
Speaker 5: I do think this kind of social dynamic actually is true.
Speaker 5: There's this case called plural Site, which Bloomberg has covered.
Speaker 5: The ft is covered, where in fact, there was one
Speaker 5: of these aggressive kind of reef financing transactions that happened
Speaker 5: using kind of a loose document, and the private credit syndicate,
Speaker 5: which was four or five firms, was reportedly indignant that
Speaker 5: this had happened. In fact, this credit or on credit
Speaker 5: of violance situation was extremely mild. It was like one
Speaker 5: very small refinancing to make an interest payment. And then
Speaker 5: ultimately what happened was the sponsor handed the keys to
Speaker 5: the private credit firms to take ownership in a very
Speaker 5: bloodless way. And in fact, I wouldn't even like that,
Speaker 5: and I wouldn't even put this even close to the
Speaker 5: real like headline grabbing violence cases.
Speaker 4: So let's say I am I don't know a small
Speaker 4: there's sub sort of club dealer, there's subsort of deal
Speaker 4: and I am a small holder, and I am aware
Speaker 4: of the existence of creditor on creditor violence as a risk.
Speaker 4: I perceive me as being the one who might get screwed,
Speaker 4: so to speak, at some point in the future, what
Speaker 4: am I doing, along with my law firm, to write
Speaker 4: that document into such a way so as to reduce
Speaker 4: my odds of finding myself in that position.
Speaker 5: If you're a small player in the leverage finance market
Speaker 5: now and or a CLO, which is basically a passive instrument,
Speaker 5: as you guys know, things that just accumulate loans and
Speaker 5: turned in securities, and you're not like a shark hedge fund.
Speaker 5: This leverage loan market has changed quite a bit. And
Speaker 5: so if we just take a step back, leverage loans
Speaker 5: are the most senior part of a capital structure, even
Speaker 5: in a levered company. And so what that means is,
Speaker 5: even if things go south, the recovery rates and leverage
Speaker 5: loans historically have been very high, like eighty ninety one
Speaker 5: hundred percent, and so the people who hold these relatively
Speaker 5: risk averse institutions. And so two things have happened. Of
Speaker 5: like one is this credit on credit of violence common concept.
Speaker 5: But also, as you alluded to earlier, this market is
Speaker 5: huge now. Leverage loansally speaking, it's exploded in the last
Speaker 5: ten years, and there are a lot of loan only companies.
Speaker 5: There is nothing below the leverage loan other than the equity.
Speaker 5: There's no high yield bond, and so the recovery rates
Speaker 5: have become lower because there's less loss absorption below you.
Speaker 5: And this idea that conservative buyer over leverage loan have
Speaker 5: bought the safest security and you have the first lean,
Speaker 5: the first claim on the assets. That idea has been eroded,
Speaker 5: and that's actually very profound, and that this market has
Speaker 5: become much riskier than it used to be for the
Speaker 5: technical reasons and the social reasons. So getting your question
Speaker 5: on what you should do about it, one, you have
Speaker 5: to ask yourself, do you want to be in this business? Okay?
Speaker 5: And there's a lot of people who, now you know,
Speaker 5: unless they're like one of a handful of really big
Speaker 5: players that can impact of a distress situation and actually
Speaker 5: be in the negotiating room, they're thinking long and hard
Speaker 5: about being in this business. And two, you do hope
Speaker 5: that the documents themselves are being tightened over time, and
Speaker 5: there are ebbs and flows in the market. You know,
Speaker 5: there's supply and demand, and you know there's there's waves
Speaker 5: of when the documents are tight and when they're loose,
Speaker 5: and now you hear these terms about there's a j
Speaker 5: CREU blockers, Yeah, there is, and there are these like blockers,
Speaker 5: these blockers, like the J crew blocker, the sort of blocker,
Speaker 5: and that just means that in the in the document,
Speaker 5: the lawyers will negotiate tighter terms and restrictions that prevent
Speaker 5: j crue transaction the sort of transaction. And we can
Speaker 5: talk about this more in detail if you want. There
Speaker 5: is again this push and pull about you know, the
Speaker 5: documents and how title loose there are and how people
Speaker 5: push back. So you know, but the thing is, though,
Speaker 5: like everyone tends to be a price taker in these markets,
Speaker 5: and you kind of take the document that is the
Speaker 5: market at the time, and if you are a firm
Speaker 5: that tries to push back in the negotiations, they can
Speaker 5: just pass you over.
Speaker 2: Right, There's plenty of others someone else.
Speaker 5: Will take the bad document when you won't. And that
Speaker 5: is just that's the difficult dynamic right now.
Speaker 2: So there's this great bit in your book where the
Speaker 2: lawyers are arguing over the meaning of and in a
Speaker 2: contracts end or like whether and means a bunch of
Speaker 2: conditions have to be met or maybe only some.
Speaker 4: Of them, you know, I've always thought in language, this
Speaker 4: is a weird term because it's exactly right, it's off anyway, Yes,
Speaker 4: I didn't, I've always thought this is a weird term.
Speaker 2: Sorry, keep going so personal aside, But my husband is
Speaker 2: a former corporate lawyer, and it takes him ages to
Speaker 2: send a text message, Like he will spend twenty minutes
Speaker 2: writing a text message that's like two sentences, and he
Speaker 2: blames it on his legal background and the fact that
Speaker 2: you really have to consider the meaning of every single word.
Speaker 2: The thing I don't get about covenants and indentures and
Speaker 2: things like that is I would have thought a lot
Speaker 2: of it nowadays is like standard boiler plate. But I
Speaker 2: mean the fact that these issues arise and that there
Speaker 2: can be arguments over them suggests that maybe it isn't. So.
Speaker 2: I guess my question is like, how much of this
Speaker 2: is standardized versus customized for particular companies.
Speaker 5: Yeah, I mean, I think if we just take a
Speaker 5: step back and think about like the industrial organization of
Speaker 5: these markets, and to your point, I think there was
Speaker 5: a sense that these documents are standardized and there's some
Speaker 5: kind of like template which you downloaded, and they're all
Speaker 5: kind of the same more or less. What's happened is
Speaker 5: there has been now this arms race amongst the law
Speaker 5: firms and the investment banks to read these documents really
Speaker 5: carefully and then in their laboratories in the basement come
Speaker 5: up with crazy transaction structure. So the big credit or
Speaker 5: on credit of violence techniques. There's something called the drop down.
Speaker 5: There's something called the up to exchange. There's something more
Speaker 5: exotic called the double dip. It's called pari plus. And
Speaker 5: these are like designed by these law firms and these
Speaker 5: investments and when you do one of these transactions, you
Speaker 5: are not just checking a boxing. I want to do
Speaker 5: up to your exchange, and something like it just happens.
Speaker 5: There's like five crazy things you have to do which
Speaker 5: are kind of unnatural and combine together create an up
Speaker 5: to her exchange or a drop down, and the result
Speaker 5: is all the same, which is you, senior lender, suddenly
Speaker 5: in the left behind group, collateral that you owned now
Speaker 5: is somewhere else and is not reachable to you. And
Speaker 5: I've described our different techniques to do those things. And
Speaker 5: so people realize not only are the documents sort of looser,
Speaker 5: but the creativity that lawyers and bankers try to exploit
Speaker 5: has been accelerated and ratcheted up, and there's this idea
Speaker 5: that we're going to ask for forgiveness, not permission. We'll
Speaker 5: do the transaction. If someone wants to sue, we'll see
Speaker 5: them in court. That'll go on forever. And what you're
Speaker 5: ultimately trying to do in all these cases is create
Speaker 5: negotiating leverage for the actual settlement where everyone will come
Speaker 5: into a room and sort it out. But in fact
Speaker 5: who has the leverage is determined by you know, who's
Speaker 5: in the group and who's not. The actual transaction may
Speaker 5: or may not be important, but what it does is
Speaker 5: does set the parameters for the ultimate negotiation.
Speaker 2: So we've been talking a lot about behavior on the
Speaker 2: borrower and the lender side, but there is a sort
Speaker 2: of third party here, which is the court itself and
Speaker 2: the judges. And speaking of great books on credit, there's
Speaker 2: a great book on the Argentina restructure that came out
Speaker 2: relatively recently called Default, The landmark court battle over Argentina's
Speaker 2: one hundred billion dollar debt restructuring. And one of the
Speaker 2: takeaways that I got from reading that book is so
Speaker 2: much depends on the judge that is put in charge
Speaker 2: of a particular case, and there are moments in that
Speaker 2: book where like the judge is just really tired and
Speaker 2: fed up with everyone, and so he kind of like
Speaker 2: does things kind of hastily, I guess. But what's been
Speaker 2: the response from the courts to more aggressive creditor on
Speaker 2: creditor in fighting.
Speaker 5: So that's a great question, and not just the actual
Speaker 5: writing of the document the lawyers are doing is part
Speaker 5: of what the service they're offering. They're offering an entire
Speaker 5: kind of choreography on how this chess match is going
Speaker 5: to like each chest move is going to in florid,
Speaker 5: We're going to the document to the actual creditor on
Speaker 5: credit of violence transaction, and then ultimately the litigation and
Speaker 5: how we game out each of these moves.
Speaker 2: So like we'll be in this jurisdiction, we can expect
Speaker 2: maybe to get like this particular judge and the company
Speaker 2: or the other lender will respond this way.
Speaker 5: Yeah, And so these documents are all now almost all
Speaker 5: of them are written under New York state law, but
Speaker 5: that doesn't mean they always end up in New York
Speaker 5: state court. Sometimes they end up in New York State court.
Speaker 5: Sometimes they end up in federal court where the federal
Speaker 5: court is interpreting New York state law. And then sometimes
Speaker 5: they end up in bankruptcy court, which is a federal
Speaker 5: court as well and has its own, like very kind
Speaker 5: of unique powers, and they end up interpreting the document.
Speaker 5: And there's a whole again art and science deciding, you
Speaker 5: know how you think it's going to involve. The state
Speaker 5: court and the federal courts are relatively slow, bankruptcy courts
Speaker 5: are relatively fast. So like one case, it's really interesting
Speaker 5: and I followed closely. Is this sort of Simmons from
Speaker 5: a couple of years ago, which was which is one
Speaker 5: of the emblematic creditor on creditor. Oh yeah, and so
Speaker 5: this is a mattress company. Obviously we all heard of
Speaker 5: it got into trouble during the pandemic. They in an
Speaker 5: effort to raise more capital, essentially went to their existing
Speaker 5: lenders and said, we need more money. Who can give
Speaker 5: us a deal? And this is a fun case because
Speaker 5: they end up being two competing groups and they each
Speaker 5: propose their own deal. One is an uptier exchange. One
Speaker 5: is a drop down essentially accomplishing the same things, which
Speaker 5: is new capital in the company, the exchange of debt
Speaker 5: for a discount, and the company essentially had an auction
Speaker 5: for new capital. They picked one so one group one.
Speaker 5: One group lost.
Speaker 3: Wait was it the up tier the so the up.
Speaker 5: Tor exchange group one. And there's a whole a side
Speaker 5: about this where the drop down group, which is Apollo
Speaker 5: an Angela Gordon, very aggressive smart firms that are in
Speaker 5: this market all the time. You know, think the actual
Speaker 5: up tier structure is something that actually is actually legally
Speaker 5: offensive in a way a drop down is not. And
Speaker 5: that's a rabbit hole we can go down. That's sort
Speaker 5: of at that point is actually very interesting.
Speaker 2: Theoretically essentially add like a new layer of debt to
Speaker 2: the capital step.
Speaker 5: Yeah, they both do the same thing. You end up
Speaker 5: in the same place. There's this whole question of whether
Speaker 5: the up to exchange is something that's actually contemplated in
Speaker 5: the original document, the drop down kind of is or
Speaker 5: not in that we can go down that rabbit hole
Speaker 5: if you want. But the point is, eventually STA had
Speaker 5: to file for bankruptcy. The Apollo angel Gordon group had
Speaker 5: sued in New York state court, and I can't recall
Speaker 5: that ended up in federal court or not for jurisdiction reasons.
Speaker 5: But anyway, there was some lawsuit kind of going through
Speaker 5: the court. There are multiple lawsuits about the transactions. One
Speaker 5: the company went into bankruptcy. The company and the winning
Speaker 5: group sought to have the bankruptcy court to declare the
Speaker 5: transaction permissible, and the court bankrupt court, which was very fast,
Speaker 5: the Houston Court at the time, very very fast, blessed
Speaker 5: the transaction, the deal, the bankruptc deal got done, and
Speaker 5: the people in the winning group ultimately the kind of
Speaker 5: took control of the company. The people left behind, you know,
Speaker 5: got hoosed for dimes on the dollar. So yes, So
Speaker 5: to answer your question, yes, the whole kind of legal
Speaker 5: game theory, the judicial is actually very important, and these
Speaker 5: questions are kind kind of often left outstanding and hanging
Speaker 5: because what happens is people ultimately settle out before they
Speaker 5: get vial ruling.
Speaker 4: Well, I'm to add on to Tracy's question, has there
Speaker 4: been an evolution over time? So okay, lawyers are racing
Speaker 4: to come up with new ideas and new interpretations of
Speaker 4: words and oh, but in the dream world, you do
Speaker 4: transactions without ever really having to like red down to
Speaker 4: the document itself. Right, everyone is operating good faith. We
Speaker 4: know what all these things mean? Hopefully you don't have
Speaker 4: to spend the time a lot of time look at
Speaker 4: where commas are or what and or actually means. Has
Speaker 4: there been an evolution among judges in courts in terms
Speaker 4: of the degree to which they say, look, we know
Speaker 4: what all we know what these words mean, while you
Speaker 4: guys trying to redefine words versus I guess like a
Speaker 4: more literal like what do these words mean in the
Speaker 4: English language as described in the original document.
Speaker 5: Yeah, that brings up an interesting point if you read
Speaker 5: the actual complaints that, like the losing group will write
Speaker 5: in their lawsuits, go through all their contrastual points that
Speaker 5: you can't actually do this up to her exchange and
Speaker 5: the five crazy things to get it done, and the
Speaker 5: very last count that they'll add to their to their
Speaker 5: complaint is something called the covenant of good faith. And Yeah,
Speaker 5: and that is the idea that let's just put the
Speaker 5: wards aside. What do these actulety parties mean when they
Speaker 5: struck this transaction? Like, what was the actual intent? Was
Speaker 5: the spirit of the document?
Speaker 2: Right?
Speaker 4: Because in the end, we don't want to have to
Speaker 4: live in a world right. I assume many investors lawyers might,
Speaker 4: but investors probably don't want to live in a world
Speaker 4: where every comma and word is being challenged as it's definition.
Speaker 4: And I'm curious if there's been some erosion of norms
Speaker 4: about the degree to which we sort of accept good
Speaker 4: people investors accept.
Speaker 3: Yeah, we all knew what this meant, good faith.
Speaker 5: Yeah, And I think there is some level of exhaustion.
Speaker 5: And you know, there have been some subsequent rulings where
Speaker 5: court frowns upon the credit or on creditor violence transaction.
Speaker 5: There's just now this idea of also cooperation groups, which
Speaker 5: is this idea where the creditors, instead of like doing
Speaker 5: this fifty one to forty nine kind of fight, they
Speaker 5: all sign a contract to say we're going to be
Speaker 5: one single block and we will negotiate as group with
Speaker 5: the company and there can be no drawing credit violence
Speaker 5: because often what will happen in these deals is the
Speaker 5: sponsor will find the fifty one percent group and they're
Speaker 5: in cahoots to do this thing. Right now, they're saying, you,
Speaker 5: financial sponsor, don't do that, because we're all one group
Speaker 5: and you can't pick and you can't.
Speaker 3: Say separately from the separately from the bond doc or
Speaker 3: the low.
Speaker 5: Yeah, we'll say, well, is that we are not going
Speaker 5: to sign into a deal for the next six months
Speaker 5: or a year or to the maturity. And if the
Speaker 5: company wants to negotiate, they negotiate with all of us
Speaker 5: as a block. So that's one thing. And there is
Speaker 5: now an effort to actually do what are called still
Speaker 5: called pro rata transactions where there is a refinancing, but
Speaker 5: the entire group Tracy, Joe, Sujit all get a chance
Speaker 5: to participate.
Speaker 2: What happened to the leverage lending guidance because you alluded
Speaker 2: to how big this market is earlier, and it's huge
Speaker 2: and it's been booming since like the twenty tens, and
Speaker 2: I remember at one point regulators seemed concerned, and so
Speaker 2: they issued these guidelines of how to do leverage loans
Speaker 2: and you know, like what kind of leverage you should have,
Speaker 2: and I remember a bunch of bankers freaking out about
Speaker 2: them at the time, but it doesn't seem to have
Speaker 2: had much of an impact. Uh.
Speaker 5: Yeah, So that was the idea that a bank couldn't
Speaker 5: extend a leverage loan where the DEBTIBA dollar issue was
Speaker 5: more than six times, and that was because you know,
Speaker 5: it's a bank and they can't do RESI shouldn't do
Speaker 5: these risky these risky deals. So a couple things happened. One,
Speaker 5: there's just a whole non bank market too. You know,
Speaker 5: there's some banks like Jeffrees that are not subject to
Speaker 5: these guidance lines. Three, there's this private credit which is
Speaker 5: a whole different world which is obviously not regulated by banks.
Speaker 5: And four I think banks found ways to push the
Speaker 5: limits or change the definition bit dah. But even six times.
Speaker 5: I mean, if you go up to six, that's like
Speaker 5: a lot of leverage. And you know, even if you're
Speaker 5: doing it six and banks themselves. I think there's a
Speaker 5: story in somewhere about City Bank or City Group, which
Speaker 5: hasn't been a big player in leverage loans, it has
Speaker 5: been kind of usurped in the market share now suddenly
Speaker 5: has a new guy from Jacone Morgan. There's a story
Speaker 5: yesterday in the journal I think about how he's going
Speaker 5: to push to get more into the leverage loan market.
Speaker 5: There's a reason City is not like aggressive in this
Speaker 5: because you know, it's risky, right, So we'll see how
Speaker 5: that works out for them. So yeah, there was the
Speaker 5: actual idea of you know, how much leverage is their
Speaker 5: total and then you know, then these kind of interpersonal
Speaker 5: dynamics once the loan is extended.
Speaker 4: As a former banker, you know, again you mentioned the
Speaker 4: law firms come in. They have new ideas up to
Speaker 4: your exchange offers as.
Speaker 3: It dropped downs, cetera.
Speaker 4: They have the whole choreography of how it's going to
Speaker 4: play out, et cetera. These are skills that they bring
Speaker 4: to the table that are something different from valuation and
Speaker 4: you know, debt dynamics and so forth. Is that visible
Speaker 4: in the pie? There's a certain amount of money that
Speaker 4: gets spent every year on services for transactions by companies,
Speaker 4: by borrowers or lenders, et cetera. Has there been a
Speaker 4: shift in the tilt of the pie of like how
Speaker 4: much goes to lawyers versus how much goes to the
Speaker 4: deal makers.
Speaker 5: Yeah, that's a great point too. So you've now I've
Speaker 5: seen these stories about the law firm war as the
Speaker 5: lawyer's getting paid twenty thirty million dollars a year and
Speaker 5: they're shifting firms like baseball players or hedge fund guys
Speaker 5: typically do. And that's unusual because historically you started a
Speaker 5: law firm as an associate and you made it a partner.
Speaker 5: You stated at that firm your whole career, and it
Speaker 5: was prestigious and you've got a huge pension. You made
Speaker 5: a few million dollars a year. It was less than
Speaker 5: being a banker and less than being you know, a
Speaker 5: hedge fun star, but it was a stable and respect
Speaker 5: So now there is this like warfare because there are
Speaker 5: a set of lawyers who matter in this world and
Speaker 5: who specialize in private equity and are thought to be,
Speaker 5: you know, the big brains around these crazy contracts. So
Speaker 5: that is something that's happened. And also, and this is
Speaker 5: actual the company point which is really interesting, the hedge
Speaker 5: funds and the private equity firms and the investors in
Speaker 5: this market that people actually put money to capital, They
Speaker 5: are increasingly horrified how much lawyers cost. Oh yeah, how
Speaker 5: much bankers cost. How much the whole kind of process costs.
Speaker 5: Like in bankruptcy, if you do end up filing for bankruptcy,
Speaker 5: there is transparency because you your fees are approved by
Speaker 5: the court and you can see now there's lawyers who
Speaker 5: are charging twenty five hundred dollars an hour. There's bankers
Speaker 5: who are getting success fees for you know, a pretty
Speaker 5: standard deal for like fifty million, Like we work, for example,
Speaker 5: a relatively small company. At the end of the case
Speaker 5: seven hundred and fifty million dollars there was you know,
Speaker 5: something like one hundred million dollars in fees. Wow. And
Speaker 5: there is real money in these kind of professional services
Speaker 5: in a way that is relatively new, and the cost
Speaker 5: are so much that it's affecting the returns of these funds.
Speaker 5: And they're thinking kind of proactively, how can we limit
Speaker 5: the damage because it's affecting you know, how much we're
Speaker 5: going to make and the deal ourselves.
Speaker 2: If I'm a distressed at investor in the current environment,
Speaker 2: would it be better to be really good at valuation
Speaker 2: in math or be really good at reading legal document?
Speaker 5: Yeah?
Speaker 3: I mean I was going to wonder.
Speaker 4: It's like, if you our lawyer, you know, makes sense,
Speaker 4: why doesn't lawyer start a hedge fund?
Speaker 5: Anyway? Keep going, There are a lot of lawyers who
Speaker 5: start hedge funds. I do think though, that this kind
Speaker 5: of the legal creativity that is becoming a little bit commoditized,
Speaker 5: and ultimately, if if you're going to make a lot
Speaker 5: of money, it's going to be less on a technical
Speaker 5: factor and that like the technical part I think is defensive. Ultimately,
Speaker 5: to make money, I think you have to be an
Speaker 5: entrepreneur and have a thesis around how is this business
Speaker 5: going to turn around? And if I end up owning it,
Speaker 5: you know, how do I grow the market share and
Speaker 5: have more customers? And that really kind of commercial business aspect.
Speaker 5: And there are cases, you know, like Hurts I think
Speaker 5: is a great story that was a big bidding or
Speaker 5: during the bankruptcy and there was two competing private equity
Speaker 5: firms with different plans for growing the business, and that
Speaker 5: stuff I think ultimately is important. The gamesmanship again truly defensive,
Speaker 5: and it's hard to differentiate yourself consistently. It is interesting
Speaker 5: now in this market to see in one deal XYZ
Speaker 5: famous hedge fund is on the outs, the other one
Speaker 5: they're in the inn, and that's kind of coin flip.
Speaker 5: And for that reason, you know, you just don't know
Speaker 5: how it's coming. You think you're in the winning group,
Speaker 5: and then you wake up and you see the press
Speaker 5: release and you're not. That's a hard way to make
Speaker 5: a living. It's a hard way to sleep. And I
Speaker 5: don't know how long that will continue.
Speaker 2: I'm going to ask a devil's advocate question. But one
Speaker 2: of the arguments that used to come up with the
Speaker 2: rise of cove light loans was this idea that, well,
Speaker 2: maybe it's actually a good thing for companies because they
Speaker 2: get more flexibility and there are more options available to
Speaker 2: them in terms of raising capital. On the other side,
Speaker 2: you know, maybe there is like a long term cost
Speaker 2: associated with like legal wrangling over every single deal. What
Speaker 2: Joe was kind of alluding to, where do you fall
Speaker 2: on that argument. Is this ultimately good for companies or
Speaker 2: is it a bad thing because maybe it makes people
Speaker 2: feel a little bit different about capital markets.
Speaker 5: Yeah, so if we go back to like the Surta case,
Speaker 5: which I think is a good example, again, you've got
Speaker 5: two competing groups, two aggressive transactions, and someone's going to win,
Speaker 5: someone's going to lose, and someone's feelings are going to
Speaker 5: be hurt, and there's going to be a litigation. But
Speaker 5: from the company's perspective, you have an auction and you're
Speaker 5: trying to get the lowest cost of capital for the
Speaker 5: one hundred million dollars that you need, and who wins
Speaker 5: or who loses to you doesn't matter. And this whole
Speaker 5: kind of distributional point, who wins who loses, Like, why
Speaker 5: do anyvists care if famous hedge fund access on the
Speaker 5: outs in this deal and in that deal and the
Speaker 5: winning sidn of that deal. That doesn't really matter. But
Speaker 5: if a company can raise capital at the best terms
Speaker 5: and avoid bankruptcy, that seems like a social positive. The
Speaker 5: the points to temper that are, I think are two things. One,
Speaker 5: does the overall cost of capital go up, because.
Speaker 4: Well, if the investors are getting less returns because they
Speaker 4: have to factor in their legal fees, that sounds like
Speaker 4: higher less returns.
Speaker 5: And you're just there's some chance you're just gonna get
Speaker 5: you hold a senior loan and you're gonna be at
Speaker 5: the bottom of the bottom of the totem pole and
Speaker 5: that that and you're just a boring clo. That's gonna
Speaker 5: be like it seems bad. And then two, if the
Speaker 5: company this is this is something that we're seeing a
Speaker 5: lot of. If the company ultimately does file for bankruptcy
Speaker 5: and ends up in bankruptcy court, you end up with
Speaker 5: this like Frankenstein capital structure, where you have super senior
Speaker 5: firstly one point five lean third out of and the
Speaker 5: banksty court and the banks process has to figure out
Speaker 5: what the actual order is. There's probably litigation.
Speaker 2: That happened with Caesar's, right, it.
Speaker 5: Did, I mean Caesars. There is a little bit of
Speaker 5: creditor on credit of violence, which against the idea of
Speaker 5: inter or intra conflict of Caesar's is more the classic
Speaker 5: case where you have a fight between the equity holders,
Speaker 5: the junk bondholders, and the senior loans. Yes, and there
Speaker 5: are people who are holding holds, but.
Speaker 2: I just mean in terms of having a capital structure
Speaker 2: that was so complicated that like the bankruptcy court was
Speaker 2: struggling to understand it and deal with it, Like, yeah.
Speaker 5: Exactly that. Yeah, you of like the company before bankruptcy
Speaker 5: is trying to lower its cost of capital by selling
Speaker 5: all these like bespoke securities for this particular type of investor,
Speaker 5: and it seems like a good idea at the time,
Speaker 5: and it maybe is, But then when you're actually trying
Speaker 5: to divide up a shrunken pie, that is a mess
Speaker 5: and that process ends up being like very costly. And
Speaker 5: we've seen cases where there is a credit on credit
Speaker 5: violent refancing and then six months later the entire companies
Speaker 5: in bankruptcy. In the bankruptcy is much more complicated t
Speaker 5: plus six months rather than if they had just decided
Speaker 5: to do it on day zero.
Speaker 4: This is always this crazy thing when I think about
Speaker 4: like distressed stuff is like, man, there's just a risk
Speaker 4: in it at all. Like everyone is trying to like eke
Speaker 4: out their extra pennies or extra dollars, but you could
Speaker 4: really just like collapse the whole thing.
Speaker 5: Yeah, you're picking up pennies in front of the steam roller,
Speaker 5: and that is bad.
Speaker 2: So, speaking of Caesar's, there's one more question I wanted
Speaker 2: to ask you, which is what's the deal with Apollo? Like,
Speaker 2: can you just explain Apollo to me? Because they seem
Speaker 2: to be everywhere nowadays. I see like a headline after
Speaker 2: headline about what Apollo is doing, what they're thinking about doing.
Speaker 2: What's your take?
Speaker 5: Yeah, I mean I think they're the most interesting example
Speaker 5: of like the broader theme in either alternatives assets, alternative assets,
Speaker 5: or just private capital generally, and that there are a
Speaker 5: set of firms that started as started out as in
Speaker 5: the eighties or nineties, as like leveraged buyout firms they
Speaker 5: bought whole businesses or carbouts of big businesses. As an
Speaker 5: equity player, they borrowed a bunch of money. They owned
Speaker 5: the they owned the company, they managed it, and they
Speaker 5: sold it five years later ideally at a big profit.
Speaker 5: That's a great business. You can make a lot of money.
Speaker 5: Pretty risky, but you know it created a lot of
Speaker 5: billion dollar fortunes. But there is a limit on how
Speaker 5: many companies you can buy. And these firms have realized
Speaker 5: that they have such expertise in negotiating valuation, understanding businesses
Speaker 5: and business models and just being creative generally that the
Speaker 5: credit markets are just much bigger. And you couple that
Speaker 5: with the idea that the banking sector has undergone like
Speaker 5: massive systemic changes post financial crisis, and those businesses are
Speaker 5: much more constrained and complicated and not equipped, you know,
Speaker 5: maybe for like the modern capital market. So they have,
Speaker 5: for lack of a better phrase, use regulatory arbitrage to
Speaker 5: encroach into every aspect of lending. And that is a
Speaker 5: lot them to become trillion dollar managers. And that is
Speaker 5: like a sea change. Whether it's good or bad, too
Speaker 5: soon to say, but you know, Apollo is the clearest
Speaker 5: example you know from whose heritage is in credit, coming
Speaker 5: out of Drexel. But in fact, you know, credit markets
Speaker 5: are much deeper, much wider, and there's just much more
Speaker 5: opportunity to build a massive firm and that's.
Speaker 2: What they're doing, all right, Suji, thank you so much
Speaker 2: for coming on all thoughts. Truly the perfect guest, and
Speaker 2: I cannot recommend your book enough, So everyone who's listening
Speaker 2: definitely go check that out if you haven't done. Right Joe,
Speaker 2: I thought that was so good, and I feel like
Speaker 2: I have a lot more clarity about what's going on now.
Speaker 2: I did think that the social aspect that Suji brought
Speaker 2: up is really interesting because, like I, okay, obviously cove
Speaker 2: lights became more of a thing, and then you had
Speaker 2: higher interest rates in recent years, and so more companies
Speaker 2: were under pressure and maybe they got more creative and
Speaker 2: how they're raising capital. But I do think like the
Speaker 2: difference or the change in social behavior on the part
Speaker 2: of investors is also a big part of the story,
Speaker 2: and so I guess the question is whether or not
Speaker 2: it could change again. To Sijit's point about maybe having
Speaker 2: investors team up and have their own contracts about how
Speaker 2: they're all going to work together and things like that, no.
Speaker 4: I thought it was there are some really interesting social
Speaker 4: questions arising out of that. And you know, I'm not
Speaker 4: a lawyer, but it does not. So I'm biased because
Speaker 4: I'm not the beneficiary of this trend. But it does
Speaker 4: not seem great to have a ton of, you know,
Speaker 4: human hours devoted towards the definition of and or or
Speaker 4: things that were We all thought we knew the definition
Speaker 4: of et cetera. But actually, technically, if you look at
Speaker 4: and or, then the second one has to be in there,
Speaker 4: because that's how I've always read it too. But maybe
Speaker 4: we thought it meant something else, or maybe we just
Speaker 4: thought it meant and whatever.
Speaker 2: Hire Joe for your litigation.
Speaker 3: I'm glad you brought this up.
Speaker 4: This has always bothered me so and it's interesting to
Speaker 4: think like it's actually eating into the returns these legal costs,
Speaker 4: that it actually even setting aside an incident of credit
Speaker 4: on credit or violence, or even setting aside an incident
Speaker 4: of bankruptcy, that it would eat into returns just because
Speaker 4: of how much you're paying the law firms to go
Speaker 4: over every one of these legal documents.
Speaker 2: It is crazy also just to think about like the
Speaker 2: amount of brain power that's being spent on debating this.
Speaker 2: And again that's something that comes through in Sidjet's book,
Speaker 2: like how much people are thinking about this, and it
Speaker 2: certainly comes through in the Argentina book. Just how like
Speaker 2: mentally taxing and time consuming sorting the stuff out is.
Speaker 4: I thought it was also a really interesting point about
Speaker 4: the sort of I don't know if it's like dis
Speaker 4: economies of scale from capital efficiency. Right, So you have
Speaker 4: all of these different instruments. You have equity, you have
Speaker 4: junk bonds, you have all the you know, super plus whatever,
Speaker 4: and individually, each one of these transactions is designed to
Speaker 4: be the most capital efficient to align the company's borrowing
Speaker 4: needs with the investors' needs. But then you end up
Speaker 4: with this sort of you know, Frankenstein's monster of a
Speaker 4: capital stack. And in the event that that has to
Speaker 4: be unwound, that is it's like a tail risk, right, Yeah,
Speaker 4: merges that in the event that has to be unwound,
Speaker 4: it'll be a much costlier process than had it simply
Speaker 4: been equity and bonds or something like that.
Speaker 2: Yeah, I mean there can be like a parent company,
Speaker 2: an operating company, like convertible bonds, the loans, preferred stock,
Speaker 2: like it can go on and on and on, and
Speaker 2: someone has to go through all of that. Uh, Okay. Well,
Speaker 2: on that note, shall we leave it there?
Speaker 3: Let's leave it there.
Speaker 2: This has been another episode of the All Thoughts podcast.
Speaker 2: I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 4: And I'm joll Wisenthal. You can follow me at the Stalwart.
Speaker 4: Follow our guest Sujit in Depth. He's at s in
Speaker 4: Depth and check out his book. He is the co
Speaker 4: author of The Caesars Palace Coup, came out in twenty
Speaker 4: twenty one. Follow our producers Carmen Rodriguez at Kerman Erman
Speaker 4: dash Ol Bennett at Dashbot and Calebrooks at Kale Brooks.
Speaker 4: Thank you to our producer Moses Ondam. More Oddlots content,
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