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High-Yield Investors Could Suffer as Companies Raise Virus Funds

High-Yield Investors Could Suffer as Companies Raise Virus Funds

(Bloomberg) -- European high-yield investors risk becoming less protected from the destruction wrought by the coronavirus pandemic as the companies they invest in seek to raise funds to weather the crisis.

As firms struggle to raise cash, their private equity owners are exploring how to support them. Besides revolver draws and equity injections, issuing new secured debt on top of existing loans or bonds -- a process known as priming -- presents an opportunity, according to Alexander Robb, a partner at international law firm Ropes & Gray LLP.

However, the practice poses a potential risk for high-yield and leveraged loans investors, which may get bumped down the line of a company’s creditors if it runs into problems.

There are signs of that happening in Europe. Travelodge Hotels Ltd., for example, recently received a 60 million pounds ($75 million) super senior revolving credit facility from its shareholders. The new debt ranks at the same level as its senior secured notes for payment obligations, according to a statement, but would rank ahead of them in terms of repayment claims.

A Travelodge representative declined to comment on the new debt.

Priming debt can be beneficial to private equity sponsors because they may avoid having to put cash into a company through new equity, said Robb.

“They can effectively look to the debt markets and say ‘I can give you access to these particular assets ahead of my existing secured creditors if you layer in debt at this level of the structure,’” he said in a phone interview. “That could be a more attractive alternative, and cheaper than junior ranking debt options.”

Ropes & Gray expects an increase in such financing structures through the third quarter. That’s because looser protections in credit agreements in recent years have given more flexibility to companies to issue new debt, even as existing bondholders get left behind.

“There’s not a whole lot they can do if their covenant package is weak and allows the issuer to take these steps without consent,” Robb said. “Unless of course what the sponsor is looking to do is debatable or based on a bullish interpretation. At that point they could challenge a sponsor and consider litigation.”

©2020 Bloomberg L.P.