Investment bankers have discovered a way around a major obstacle that prevents companies with junk ratings from extending their maturity date on risky debt worth billions of euro.
This workaround is known as “Snooze Drag” in the market. It allows a borrower, even if they are technically not able to participate, to get their existing lenders to join a longer, new loan. This is a controversial issue that many in the market don’t want to discuss publicly.
This is a partial fix to the difficult environment that many borrowers are in, as they face imminent debt maturity. The soaring interest rates and the slowing economy have made it harder for heavily indebted companies to obtain new financing. The buyout companies that have piled up all this debt on these businesses are unable to sell the businesses to other buyers because dealmaking has slowed down.
The obvious solution is to amend and extend the loan maturity. This involves a company working with its existing lenders in exchange for better terms. A problem arises: many of these leveraged loans are held in collateralized loan obligation, which packages them into securities with varying degrees of risk and sells them to institutional investors. These CLOs are often past their investment deadlines, and can therefore not participate in an amended lending — at least in theory.
If a company wants to extend the maturity date of its debt, it must ask their lender for permission. If CLOs can stay invested, then they will vote to extend. If they are out of time for new loans, or have exhausted their existing loan portfolios, they will tend to vote against extending.
People familiar with these transactions say that bankers who pitch amend-and extend deals tell CLO managers, who want to stay invested but are technically unable to do so, to remain silent during the voting – “snooze”. People familiar with the transactions say that if they do this, CLOs could be “dragged” by the longer loan.
Jane Gray, Head of European Research at Covenant Review said that “CLO managers who invest in leveraged loan are generally happy to Snooze Drag” because they might not be able actively to agree to the maturity extensions but want to remain in certain credits. It’s a win-win situation for both the CLO manager and borrower.
According to sources familiar with the transactions, two of the first deals to use Snooze Drag were Apax Partners’s Safetykleen’s reworking its term loan in January and KKR & Co.’s Spanish amusement park operator PortaVentura’s amending its €620,000,000 ($681,000,000) loan that same month.
Apax Partners’ and KKR’s spokespeople declined to comment.
Bankers claim that Snooze drag has been used in nearly every amend-and extend product in Europe in the past year. The bankers say that Snooze Drag is not used to get more investors to extend. It’s explained in the consent letters sent to investors, and any extension taken up by them is entirely optional.
The easy-money period that followed the global economic crisis of 2008, and the eurozone debt crisis from 2010-2012 has given buyout firms and portfolio companies the option of doing Snooze Drag. Investors were so desperate for any kind of yield that private equity sponsors put language in loan documents to give borrowers more flexibility. Many loans from about 2018 specified that lenders could be brought into the process if they didn’t respond when asked to amend a mortgage.
Snooze drag is controversial, because CLOs – the largest buyers of leveraged loan – are designed to be finite and pay investors on time. According to Bank of America Corp. about a third of these vehicles are unable invest in new loan, and this number is increasing.
Snooze Drag is appealing to managers of CLOs who are approaching the end of their reinvestment period because it allows them stay invested in companies that they already lend to and maintain assets under manager in a market with a limited supply of new leveraged loans.
Some people have been upset by the option because it could benefit some CLOs more than others.
Snooze Drag, for example, could make losers out of buyers of CLO securities that are rated AAA and the least risky. They may prefer to get repaid rather than rolled into a brand new deal. At the other end, investors who are in the equity slice — the first to take on any losses — can be compensated with higher margins by the amend-and extend offer.
But AAA investors tend to be more understanding and give CLO managers some flexibility because they know that leveraged loan issuers are having difficulty refinancing debt and don’t wish to see their portfolios downgraded.
Boris Okuliar is co-head for global liquid credit at Ares Management Ltd. He said that CLO managers must act in the interests of all investors, regardless of the tranche. Manager style is key, but managers usually speak to debt holders. They should ensure they are creating the right balance between debt holders and shareholders.
Only a few CLO managers are opting to be dragged in to amended loans. One banker estimates that less than 10% of CLO accounts do so. Other managers, however, have refused to. The option is expected gain popularity.
The CLO manager may be more inclined to favor a higher equity return, but it must still adhere to its standard of care. This means that it has to take into account the interests of each noteholder, from AAA to equity.