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 Felix Salmon at Reuters asked
an insightful question about a column
I wrote in mid-June about HCA Inc.'s attempt to convince lenders to give it open-ended permission to manage its debt load by, among other things, extending maturities of the loans without limit.
In my column, I suggested that the collateralized loan obligations, which own about 66% of the bank debt in the market, were willing to contemplate HCA's request (they agreed to it, with minor revisions, on June 18) to avoid prepayments on the loans. This explanation didn't sit well with Salmon: This doesn't pass a smell test. HCA is a distressed debtor; the CLOs should be ecstatic to be repaid in full. And if they don't want to sit on low-yielding cash, there's no shortage of high-yielding leveraged loans they can buy with that cash. Are CLOs not allowed to buy loans in the secondary market, if they have excess cash? That would be very weird indeed. CLOs are indeed allowed to buy loans in the secondary market, but, as I make clear in my latest column, there's a dearth of available loans in secondary markets, especially ones that conform with overcollateralization tests that govern what kinds of loans CLOs are able to keep in their portfolios: The standardized rules that govern how loans count towards overcollateralization, or OC, tests force managers to heavily discount loans they buy at cut-rate prices. This is done on the theory that a loan trading at 60 cents in the secondary market carries greater risk of default and shouldn't be given the same OC weighting as a loan trading at par. And despite a recent rebound in loan prices, 40% loans are still trading below levels that would trigger OC discounts for the CLOs. Monday, Dwight Cass at Breakingviews via The New York Times weighs in on the issue, suggesting that lenders may be willing to give extension concessions to borrowers simply to avoid having these last default, although they might be too happy about it. Granted tweaking a loan to reduce the probability of default can be valuable for a lender, especially at a time when creditors' recoveries from bankrupt borrowers are running below their long-term average of about 40%. So borrowers are right to take a strong stand when negotiating a modification. But the prospect of making concessions during a credit drought must nonetheless stick in lenders' craws. All this, however, is overlooking perhaps the most obvious incentive for the CLOs lenders: higher fees. To bring it back to HCA, CLOs that own HCA's bank debt are now collecting LIBOR plus 225 basis point on the debt, which equals to about 2.85%. That's not a lot of money, even considering the low rates CLOs themselves are paying on the debt that financed their own funds. But, any actual extension request by HCA (it hasn't actually made such an offer, but only asked for permission to approach lenders with an offer later) would result in higher interest on the debt, resulting in more money flowing to equity holders in the CLO funds. - Vipal Monga Read Monga's latest column The extension question
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