Debt Wars: The Rise of Creditor-on-Creditor Violence Rocks Corporate Finance

Creditor-on-Creditor Violence: The Rising Trend in Corporate Debt Restructuring

In recent years, a concerning trend has emerged in the world of corporate finance: creditor-on-creditor violence. This phenomenon, characterized by lenders aggressively competing against each other to recover debts from distressed borrowers, has been on the rise since 2015 and shows no signs of abating.

Imagine a struggling restaurant chain, "Tasty Burgers," owes money to several parties: a bank that financed their kitchen equipment, a food supplier, and a business loan company. As Tasty Burgers falls behind on payments, the bank swoops in and seizes all the kitchen equipment, hoping to recover their investment. This leaves the restaurant unable to operate. Meanwhile, the food supplier, fearing they won't get paid, stops delivering ingredients and demands immediate payment for past deliveries. The business loan company, seeing this unfold, quickly files a lawsuit to freeze Tasty Burgers' bank accounts. Each creditor's actions, while intended to protect their own interests, collectively force Tasty Burgers into bankruptcy faster than necessary. The result? The restaurant chain collapses, workers lose their jobs, and ironically, all creditors end up recovering less money than they might have if they had worked together to keep the business afloat.

The trend is particularly prevalent in cases involving private-equity-owned companies and distressed debt investors. As economic headwinds continue to push more businesses into financial distress, lenders are resorting to increasingly extreme measures to protect their interests. These actions often come at the expense of other creditors and can ultimately lead to worse outcomes for all parties involved, including the debtor company.

Key Takeaways:

1. Creditor-on-creditor violence is expected to persist in the near future, driven by ongoing economic challenges and diverse lender objectives.
2. Common aggressive tactics include "up-tiering" and "drop-down" transactions, which can disadvantage certain lenders.
3. The trend has led to higher secured credit spreads and increased investment in distressed debt by hedge funds.
4. Lenders are taking proactive measures, such as entering into cooperation agreements earlier in the restructuring process.
5. The phenomenon is having broader impacts on the economy, including increased borrowing costs and potential reductions in overall lending activity.

Deep Analysis:

The rise of creditor-on-creditor violence is a complex issue with far-reaching implications for the financial markets and the broader economy. On one hand, it can lead to increased investment and potentially higher ex-ante firm values by enabling debt reductions in high default cost scenarios. However, it also creates significant inefficiencies and can result in suboptimal outcomes for distressed companies.

The trend is largely driven by the diverse objectives and risk tolerances of different lenders within a syndicate. As distressed debt investors enter the picture through secondary market transactions, they often bring different approaches and goals compared to original lenders. This diversity can lead to conflicts and aggressive actions that ultimately harm all parties involved.

One of the most concerning aspects of this trend is the lack of regulatory mitigation. While lenders are taking proactive steps to protect themselves, such as entering into cooperation agreements earlier in the restructuring process, there are currently no specific regulatory measures in place to address the issue directly. This regulatory gap leaves the market vulnerable to continued aggressive tactics and potentially destructive outcomes.

The impact on the broader economy is also significant. Increased borrowing costs, reduced lending activity, and inefficient capital allocation can all result from the rise of creditor-on-creditor violence. Moreover, the trend may spur innovation in financial products and legal structures as market participants seek to protect themselves from potential conflicts.

Did You Know?

1. The term "creditor-on-creditor violence" is often euphemistically referred to as "liability management exercises" by private equity firms.
2. Hedge funds are capitalizing on this trend, wagering tens of billions of dollars on taking advantage of the mayhem in distressed debt markets.
3. The Revlon case, which involved complex creditor conflicts, led to Citibank's infamous $900 million mistaken payment incident in 2020.
4. The trend of creditor-on-creditor violence has its roots in the excesses of the cheap money era, particularly in the leveraged loan market.
5. While cooperation agreements between lenders are becoming more common, there is still a need for legal and contractual innovation to address the challenges posed by this phenomenon.

As the corporate debt landscape continues to evolve, lenders, investors, and regulators will need to remain vigilant and adapt their strategies to navigate the ongoing challenges posed by creditor-on-creditor violence. Without regulatory intervention or significant market changes, this trend is likely to remain a dominant force in corporate debt restructuring for the foreseeable future.