Left with thin protections, lenders are helping themselves

M&G's credit team wrote on July 7th about Arxada, a capital structure the market had been pricing for LME optionality, but that optionality wasn't what determined the outcome. The group and its creditors landed on the consensual route: secured and unsecured debt extended at par, Bain and Cinven put fresh money in junior to the secured creditors, and the amended documents reduced future LME optionality in exchange for consent.

Covenant capacity set the table for that negotiation rather than driving it. Arxada needed its creditors to extend, and creditors who held together were able to price that consent - par treatment, sponsor money junior to the secureds, and a package with less flexibility in it than the one they started with.

Arxada's creditors had leverage because the transaction had to come through them. First Brands is the other end of that: financing that never needed anyone's consent, because it never engaged the covenants at all.

The estate is now heading toward Chapter 7 conversion for every debtor other than Premier Marketing Group, with an exclusivity hearing on July 9th and a plan voting deadline of July 20th, against roughly $9.3bn of obligations. Of that, around $2.3bn was financed through SPVs off the balance sheet, on receivables that were allegedly backed by fake invoices and pledged more than once.

Receivables financings, factoring lines and supply chain programs often fall outside the definition of Indebtedness, and the definition of Asset Sale, in a standard leveraged finance covenant package. They're carved out as ordinary course working capital. This means a leverage ratio in a compliance certificate can be entirely accurate and still tell a lender close to nothing about where the group's cash is coming from or what's been promised against it.

A leverage test isn't the provision most likely to reveal that. Reporting, verification and usage limits are - program size, obligor concentration, and verification against the underlying invoices rather than the borrower's spreadsheet of them.

The market expects private credit to come under greater regulatory scrutiny, according to Loan Market Association research published on July 10th, drawn from more than 230 senior EMEA market participants. Nearly half expect regulatory tightening of non-bank lenders and private credit funds, with a split by institution: 55% of banks expect stricter rules against 33% of non-bank lenders. Respondents also put economic slowdown and rising defaults (54%) ahead of regulatory intervention (39%) and sector concentration (38%) as the constraint on growth.

Where the tightening would focus is a separate question from whether it's coming. My expectation is that disclosure and oversight tighten, providing lenders with something arguably more valuable than a contractual leverage limit. Banks and non-bank lenders are 22 points apart on whether it's coming at all.

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