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- [00:02]
PGIM Fixed Income
Bonds are back and so is all the credit. PGIM Fixed Income's monthly podcast series. From the latest trends to long term perspectives, you'll get timely fixed income insights from leading economists, research analysts and investment professionals. Whether you're new to bonds or a seasoned investor, tune in to all the credit wherever you get your podcasts. This podcast is intended solely for professional investor use. Past performance is not a guarantee of future results.
- [00:30]
Matt Levine
The forces shaping markets and the economy are often hiding behind a blur of numbers.
- [00:35]
Tracy Alloway
So that's why we created the Big Take from Bloomberg podcasts to give you the context you need to make sense of it all.
- [00:42]
Matt Levine
Every day in just 15 minutes, we dive into one global business story that matters.
- [00:46]
Tracy Alloway
You'll hear from Bloomberg journalists like Matt Levine.
- [00:49]
Matt Levine
A lot of this meme stock stuff is, I think, embarrassing to the SEC. Follow the Big Take podcast on the iHeartRadio app, Apple Podcasts or wherever you listen.
- [01:03]
Tracy Alloway
Bloomberg Audio Studios Podcasts Radio hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
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Joe Weisenthal
And I'm Joe Weisenthal.
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Tracy Alloway
Joe, what do you know about creditor on creditor violence? I don't know anything other than it's. It's a very punchy term.
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Joe Weisenthal
It's a great. That's literally it. It's come up a few times in. All right. It's come up a few times in episodes we've done about credit. And I get the impression that, you know, lenders to a firm have different status and some are higher up in the rank than others and that they would like to probably use the technicalities of the legal code to improve their rank in some sense when money gets paid out to lenders.
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Tracy Alloway
Yes. So it has come up in a number of.
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Joe Weisenthal
It's not really violence, is it?
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Tracy Alloway
Well, some of the fights get pretty nasty. Okay, okay. Okay. Well, so when I think about it, I think back to when I covered the leveraged loan market at the FT and this was sort of like 2013, 2014. And I remember writing stories about how leveraged loans, more of them were becoming cov light so weaker covenants for lenders or investors. And what that means is companies basically had more leeway to restructure their assets if they were trying to raise new capital or stave off bankruptcy or whatever at the expense of those lenders slash investors. And back in 2014, I think the proportion of the leveraged loan market that was covlight was something like 30% and that was, was like a big deal that was already higher than the leverage buyout boom in 2007.
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Joe Weisenthal
Yeah.
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Tracy Alloway
Now, the vast majority of leveraged loans, I think something like 90% could be called cov light. So the entire market is basically cov light at this point, which fits into the creditor on creditor violence theme. So I feel like we need to, we need to dive into this what it is.
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Joe Weisenthal
I just, my impression is that if I'm going to be a firm that buys leverage loans, I need a good lawyer to look over the contract.
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Tracy Alloway
Well, I kind of wonder, I guess I wonder relatively how important like legal expertise is versus valuation expertise.
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Joe Weisenthal
This is what I am wondering as well.
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Tracy Alloway
All right, so let's get into it. I am very pleased to say we have the perfect guest. We're going to be speaking with Sujit Indap. He is of course the Wall street editor over at the ft, my former colleague who used to double byline on at least one piece. I think he is also the author of the excellent Caesar's palace coup book, which if you haven't read, I would highly recommend, especially on that point about distressed debt fights getting kind of nasty. Sujit, thank you so much for coming on. All thoughts.
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Matt Levine
Hi, Tracy Ho, Joe. It's great to be here.
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Joe Weisenthal
Thank you.
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Tracy Alloway
So I guess my first question is, you know, we see these headlines about creditor on creditor violence or, you know, someone will be writing about the private credit market and there'll be an aside about creditor on creditor violence and how it's becoming more of a thing. Can you give us some context around whether or not this is becoming a bigger trend? I feel like it is, but it's not like there's a violence index that we can look at.
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Matt Levine
Yeah. So the idea of violence in corporate restructuring and private equity deals is not a new idea. Imagine the business that's been bought by the private equity firm is just less valuable. Over time. The pie has shrunk. There's going to be a fight over who gets what piece and how big those pieces are. The creditor on creditor violence phenomena, though, is a little bit more nuanced and novel. And that's the idea that imagine you, Joe, you, Tracy and me, we are all holders of the first lien term loan. Let's say you own 500 million, Joe, you've got 300 million. Let's say I'm poor because I work the FT and only have 15 million. But there would be the view that since we're all in the same security, governed by the same document, that our rights are the same and we are all going to be treated equally in this fight with the private equity firm and maybe the junk bondholders below us, the creditor on creditor violence nuance now is that in fact we are not equal. And you two as large holders can do things to me smallholder that are not equal in treatment, arguably unfair, arguably impermissible.
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Joe Weisenthal
Just to be clear, in this theoretical setting in which all of us are equal in the firm's liabilities, did we all have the exact same language? Did we all enter into the same contractual language when we purchased the debt or when we lent money to the company? And furthermore, if we did all have the same language, what are the tools that we use to change our change our priorities?
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Matt Levine
Yeah, so we do. We all are governed by the first lien credit agreement. Maybe you bought in the original LBO and maybe your clos and I'm. Or you are a distressed debt hedge fund which bought in later at a different price. But we're all governed by the same document and in concept have the same rights and protections.
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Joe Weisenthal
So then where. How do I do something to you guys if we're. What are the basic tools at my disposal if I want to somehow gain an advantage for me that doesn't accrue to you?
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Matt Levine
Yeah. So let's talk about like why that scenario would first arise. And imagine the company is running into trouble. There's a maturity coming up and there's some liquidity challenge of as you said earlier, these documents now since the financial crisis are covenant light or no covenant. So there's a lot of flexibility for the borrower, which is the company and the private equity firm that owns the company. And rather than, you know, just declaring bankruptcy and going to bankruptcy court and fighting out there, which is messy, it's time consum it has its own restrictions on what you can do. And the private equity firm will typically, if you're the equity holder, will get wiped out. Bankruptcy is like not an attractive option for those reasons. And so what you can try to do is raise new capital. And you're going to raise new capital, often from the existing lenders. Those lenders, in exchange for giving you more money, are going to ask for some things. What are they going to ask you for? First, the company itself is probably going to want to reduce the principal balance. So they want people to take haircuts. So there's going to be some haircuts involved. And then there's going to be this new money brought in, that new money. However, if I'm giving you new money into this troubled company, I'm going to want some things to do that.
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Joe Weisenthal
Got it.
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Matt Levine
And those things I'm going to want is the most senior priority, which called super priority. Okay. That's all sort of standard. That's not new. The nuance is the company itself has some amount of value it can pass out as cookies to these in this new financing process. And in the old world, what they would do is let's say I've got $100 million and I'm making that number up a value to allocate in this new transaction that I'm going to raise new money in. Rather than splitting that up pro rata amongst the three of us, I'm just going to give it to two of you. And so why is that? From the company's point of view, it's $100 million. How the three of us divide it up they don't really care about. But you two care about getting as much as you can since you own the most. Well, we all care about it. But you guys have the, the possibility of being, let's say a 51% group and saying I can take all the cookies for me and leave sujit behind. And that is the the idea of creditor on creditor violence. We are theoretically pari pursue. We are in the same place with the same document. But you, because you choose to and the sponsor wants to, doesn't really care. The sponsor will just go to you. It's easier to deal to cut since there's two of you, not three of us to negotiate with. And that is the nuance of creditor on creditor violence. You two theoretically standing with me with the same document can impose pain on.
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Tracy Alloway
Me simply because you're bigger super priority. Kind of reminds me of double secret probation, right? I wonder, can you have super, super priority? I guess you could keep doing it forever pretty much. Or at least until all the collapses.
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Matt Levine
Well, yeah, you see these kind of like 1.5 lean that's kind of put between first and second and then there's been double creditor on creditor violence cases. So there is this spiral and kind of like through the looking guess violence squared.
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Tracy Alloway
So one thing I don't really get about the creditor on creditor violence is its connection with private credit. And I've seen people talk about private credit as a response to creditor on creditor violence in the sense that, you know, maybe it's easier to be a single lender to a company. You're higher up in the payment waterfall. You don't have to worry about getting into fights with a bunch of other investors. But then I also see headlines saying that creditor on creditor violence is becoming more of a thing in private credit too. So basically I'm confused.
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Matt Levine
Yeah. So let's, let's just take a step back and just think about that. I think there's two factors that are behind the generalized creditor and creditor violence concept. One is what we hit on before, which is just the technical aspect of these credit agreements, which is the legal contract that governs like a leveraged loan. And then you know, what are the restrictions or covenants that are in that document that prevents of this kind of creativity and refinancing and exchange offers. And there is a real legal dispute about whether these changes can be done with or without unanimity, whether you need 100% of the group, all three of us, to agree to a change in interest rate or principal maturity. Those are called the so called sacred rights, if you will. And that's a legal question that's been litigated and we can talk about that more if you want. But then there's also the social aspect. And the social aspect is the idea that me, private equity, private equity firm X, they may have the legal ability for this mischief, but they ultimately wouldn't pursue that and they wouldn't do that because they are a repeat player in the leveraged finance markets. And if they get a reputation as a firm that gets too cute, that will cause them to borrow at higher interest rates down the line and the next deal, the deal after that, the different partners who are not in this deal are going to face the consequences. So there's a social aspect and also within the deal itself, if you ultimately antagonize your creditors down the road, you may need to restructure again. And if they remember you as the person who was rough with them, they're not going to be so kind when you need their help.
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Tracy Alloway
And yet Argentina exists.
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Matt Levine
Exactly. So that brings us to the private credit point. And you were obviously a leveraged finance reporter and a leveraged loan maven. And you know how that market works, which is it's really big. It involves banks who underwrite these deals and then they sell them on in the syndication process. And that's a whole kind of machine. And you know, in a, in a big leveraged loan credit, there's going to be dozens of clos and regular way mutual funds and then hedge funds and it's like a wide, widely dispersed kind of group. And that dynamic affects how the document is negotiated and just, you know, all the kind of interactions down the line. And a private credit deal where you truly have like a club or maybe even a single lender where there's four or five or three or two, maybe one firm that's providing a loan to a private equity backed company, that group is just much smaller. The negotiations around that document are much more intimate. And again, for those social reasons, there was the idea that in a private credit deal, the private equity firm sponsor who owns the company is not going to declare war or go to Defcon 5 or Defcon 1, whichever the highest one is to pursue their own ends. It's going to be much more of a collaborative, collaborative and kind, friendly kumbaya relationship. And so this again, go now we go to the examples of the creditor on credit violence that has arisen now in the private credit market and the examples are relatively sparse so far because private credit is relatively new. And two, I do think this kind of social dynamic actually is true. There's this case called pluralsight which Bloomberg has covered, the FT has covered, where in fact there was one of these aggressive kind of refinancing transactions that happened using kind of a loose document. And the private credit syndicate, which was four or five firms, was reportedly indignant that this had happened. In fact, this creditor and credit violence situation was extremely mild. It was like one very small refinancing to make an interest payment. And then ultimately what happened was the sponsor handed the keys to the private credit firms to take ownership in a very bloodless way. And in fact I wouldn't even link that and I wouldn't even put this even close to the real like headline grabbing violence cases.
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Sujit Indap
Direct lending has been one of the most dynamic areas of the private alternative space these last few years, having grown massively as a source of capital for both corporate borrowers, but also financial sponsors that have kept going from strength to strength and have needed that private capital to foster the growth that they've been experiencing.
- [14:39]
PGIM Fixed Income
For leading alternative investing insights, listen to Speaking of Alternatives from pgim Got a business problem? There's a TED Talk for that. Stay updated on Everything Business on TED Business, a podcast hosted by Columbia Business School professor Modupe Akinola. Every week she'll introduce you to leaders with unique insights on work, answering questions like how do four day work weeks work do? Will a machine ever take my job? Get some surprising answers on TED Business wherever you listen to podcasts.
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Joe Weisenthal
So let's say I am, I don't know, a small, there's some sort of club deal or there's some sort of Deal. And I am a small holder and I am aware of the existence of creditor on creditor violence as a risk. I perceive me as being the one who might get screwed, so to speak, at some point in the future. What am I doing along with my law firm to write that document in such a way so as to reduce my odds of finding myself in that position.
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Matt Levine
If you're a small player in the leveraged finance market now and or a clo, which is basically a passive instrument, as you guys know, these things that just accumulate loans and turn into securities and you're not like a shark hedge fund, this leveraged loan market has changed quite a bit. And so if we just take a step back, leveraged loans are the most senior part of a capital structure, even a little levered company. And so what that means is even if things go south, the recovery rates and leveraged loans historically have been very high, like 80, 90, 100%. And so the people who hold these are relatively risk averse institutions. And so two things have happened of like one, is this creditor on creditor violence. Common concept, but also as you alluded to earlier, this market is huge now. Leveraged loans exploded in the last 10 years and there are a lot of loan only companies. There is nothing below the leveraged loan other than the equity. There's no high yield bond. And so the recovery rates have become lower because there's less loss absorption below you. And this idea that conservative buyer over a leveraged loan have bought the safest security and you have the first lien, the first claim on the assets, that idea has been eroded and that's actually very profound. And this market has become much riskier than it used to be for the technical reasons and the social reasons. So getting your question on what you should do about it, one, you have to actually ask yourself, do you want to be in this business? There's a lot of people who now, you know, unless they're like one of the handful of really big players that can impact a distress situation and actually be in the negotiating room, they're thinking long and hard about being in this business. And two, you do hope that the documents themselves are being tightened over time. And there are ebbs and flows in the market. You know, there's supply and demand and you know, there's, there's waves of when the documents are tight and when they're loose. And now you hear these terms about there's a J.
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Tracy Alloway
Crew pushback now.
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Matt Levine
Yeah, there is. And there are these like blockers, blockers like the J. Crew blocker. The sort of blocker.
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Joe Weisenthal
And what are they? What's it. What does that mean?
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Matt Levine
And that just means that in the. In the document, the lawyers will negotiate tighter terms and restrictions that. That prevent the J. Crew transaction, the cert transaction. And we can talk about this more in detail if you want. There is again this push and pull about, you know, the documents and how tight or loose there are and how people push back. So, you know, but the thing is though, like, everyone tends to be a price taker in these markets and you kind of take the document that is the market at the time. And if you are a firm that tries to push back in the negotiations, they can just pass you over. Right.
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Tracy Alloway
There's plenty of others.
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Matt Levine
Yeah. Someone else will take the bad document when you won't. And that is just. That's the difficult dynamic right now.
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Tracy Alloway
So there's this great bit in your book where the lawyers are arguing over the meaning of and in a contract. That's.
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Matt Levine
And.
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Tracy Alloway
Or.
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Matt Levine
Yes.
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Tracy Alloway
And. Or like whether and means a bunch of conditions have to be met. Or maybe only some of them.
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Joe Weisenthal
You know, I've always thought in language this is a weird term because it's exactly right. It's often. Anyway. Yes. I didn't. I've always thought this is a weird term. Sorry, keep going.
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Tracy Alloway
So, personal aside, but my husband is a former corporate lawyer and it takes him ages to send a text message. Like, he will spend 20 minutes writing a text message that's like two sentences. And he blames it on his legal background and the fact that you really have to consider the meaning of every single word. The thing I don't get about covenants and indentures and things like that is I would have thought a lot of it nowadays is like standard boilerplate. But I mean, the fact that these, like, issues arise and that there can be arguments over them suggests that maybe it isn't. So I guess my question is, like, how much of this is standardized versus customized for particular companies?
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Matt Levine
Yeah, I mean, I think if we just take a step back and think about just like the industrial organization of these markets. And to your point, I think there was a sense that these documents are standardized and there's some kind of, like, template which you download. And they're all kind of the same, more or less. What's happened is there has been now this arms race amongst the law firms and the investment banks to read these documents really carefully and then in their laboratories in the basement come up with crazy transaction structure. So the big creditor on creditor Violence techniques. There's something called the dropdown, there's something called the uptier exchange, there's something more exotic called the double Dipari plus. And these are like designed by these law firms and these investment banks. And when you do one of these transactions, you're not just checking a box. I want to do up to your exchange and something like it just happens. There's like five crazy things you have to do which are kind of unnatural and combined together create an up tier exchange or a dropdown and the result is all the same, which is you, senior lender suddenly in the left behind group. Collateral that you owned now is somewhere else and is not reachable to you. And what I've described are different techniques to do those things. And so people realize not only are the documents sort of looser, but the creativity that lawyers and bankers try to exploit has been accelerated and ratcheted up. And there's this idea that we are going to ask for forgiveness, not permission. We'll do the transaction. If someone wants to sue, we'll see them in court. That'll go on forever. And what you're ultimately trying to do in all these cases is create negotiating leverage for the actual settlement where everyone will come into a room and, you know, sort it out. But in fact, who has the leverage is determined by who's in the group and who's not. So the actual transaction may or may not be important, but what it does is, does set the parameters for the ultimate negotiation.
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Tracy Alloway
So we've been talking a lot about behavior on the borrower and the lender side, but there is a sort of third party here, which is the court itself and the judges. And speaking of great books on credit, there's a great book on the Argentina restructuring that came out relatively recently called Default the Landmark Court battle over Argentina's $100 billion debt restruct. And one of the takeaways that I got from reading that book is so much depends on the judge that is put in charge of a particular case. And there are moments in that book where like the judge is just really tired and fed up with everyone. And so he kind of like does things kind of hastily, I guess. But what's been the response from the courts to more aggressive creditor on creditor infighting?
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Matt Levine
So that's a great question. And not just the actual writing of the document the lawyers are doing is part of what the service they're offering. They're offering an entire kind of choreography on how this chess match is going to. Each chess move is going to Unfold, we're going to the document to the actual creditor on creditor violence transaction and then ultimately the litigation. And how can we game out each of these moves?
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Tracy Alloway
So we'll be in this jurisdiction, we can expect maybe to get this particular judge and the company or the other lender will respond this way.
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Matt Levine
Yeah. And so these documents are all, now almost all of them are written under New York state law. But that doesn't mean they always end up in New York state court. Sometimes they end up in New York state court, sometimes they end up in federal court, where the federal court is interpreting New York state law. And then sometimes they end up in bankruptcy court, which is a federal court as well. And you know, has its own like very kind of unique powers and they end up interpreting the document. And there's a whole again art and science deciding, you know, how you think it's going to evolve. The the state court and the federal courts are relatively slow. Bankruptcy courts are relatively fast. So like one case it's really interesting and I followed closely is this case so to Simmons from a couple of years ago, which was. Which is one of the emblematic creditor on creditor.
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Tracy Alloway
Oh yeah.
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Matt Levine
And so this is a mattress company, obviously we all heard of it got into trouble during the pandemic. They, in an effort to raise more capital, essentially went to their existing lenders and said we need more money, who can give us a deal? And this is a fun case because there end up being two competing groups and they each propose their own deal. One is an up tier exchange, one is a dropdown, essentially accomplishing the same things, which is new capital in the company, an exchange of debt for a discount. And the company essentially had an auction for new capital. They picked one. So one group won, one group lost.
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Tracy Alloway
Wait, was it the up tier or the.
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Matt Levine
So the up tier exchange group won. And there's side about this where the dropdown group, which is Apollo and Angela Gordon, very aggressive smart firms that are in this market all the time, think the actual up tier structure is something that actually is actually legally offensive in a way a drop down is not. And that's a rabbit hole we can go down. But that's sort of in that point is actually very interesting.
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Tracy Alloway
But they both essentially add like a new layer of debt to the capital stack.
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Matt Levine
Yeah, they both do the same thing. You end up in the same place. There's this whole question of whether the up to your exchange is something that's actually contemplated in the original document, the dropdown kind of is or not. And that we can go down that rabbit hole if you want. But the point is, eventually CERT had to file for bankruptcy. The Apollo Angelo Gordon Group had sued in New York state court. I can't recall if that ended up in federal court or not for jurisdiction reasons. But anyway, there was some lawsuit kind of going through the courts. There are multiple lawsuits about the transactions. Once the company went into bankruptcy, the company and the winning group sought to have the bankruptcy court declare the transaction permissible. And the court. Bankruptcy court, which moves very fast, the Houston court at the time, very, very fast, blessed the transaction. The deal, the bankruptcy deal got done, and the people in the winning group ultimately kind of took control of the company. The people left behind, you know, got hosed for dimes on the dollar. So. Yes. So to answer your question, yes, the whole kind of legal game theory, the judicial is actually very important. And these questions are kind of often left outstanding and hanging because what happens is people ultimately settle out before you get final rulings.
- [25:59]
Joe Weisenthal
Well, to add on to Tracy's question, has there been an evolution over time? So, okay, lawyers are racing to come up with new ideas and new interpretations of words, but in the dream world, you do transactions without ever really having to redound to the document itself. Right. Everyone is operating good faith. We know what all these things mean. Hopefully you don't have to spend a lot of time looking at where commas are or what andor actually means. Has there been an evolution among judges in court in terms of the degree to which they say, look, we know what all. We know what these words mean. Why are you guys trying to redefine words versus, I guess, like a more literal. Like, what do these words mean in the English language as described in the original document?
- [26:46]
Matt Levine
Yeah, that actually brings up an interesting point. If you read the actual complaints that, like, the losing group will write in their lawsuit, so they'll go through all their contractual points that you can't actually do this up to your exchange, and the five crazy things to get it done. And the very last count that they'll add to their. To their complaint is something called the covenant of good faith and fair.
- [27:05]
Joe Weisenthal
Yeah, yeah.
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Matt Levine
And that is the idea that. Let's just put the words aside. What did these actually parties mean when they struck this transaction? Like, what was the actual intent? What was the spirit of the document? Right.
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Joe Weisenthal
Because in the end, we don't want to have to live in a world. Right. I assume many investors, Lawyers might, but investors probably don't want to live in a world where every comma and word is being challenged as its definition. And I'm curious if there's been some erosion of norms about the degree to which we sort of accept good people, investors accept. Yeah, we all knew what this meant. Good faith.
- [27:39]
Matt Levine
Yeah. And I think there is some level of exhaustion and you know, there have been some subsequent rulings where a court frowns upon the creditor on creditor violence transaction. There's this now this idea of also cooperation groups which is this idea where the creditors instead of like doing this 5149 kind of fight, they all sign a contract to say we're going to be one single block and we will negotiate as a group with the company and there can be no credit on credit violence because often what will happen in these deals is the sponsor will find the 51% group and they're in cahoots to do this thing. Right now they're saying, you financial sponsor, don't do that because we're all one group. And you can't pick any.
- [28:18]
Joe Weisenthal
You can't separately from the. Separately from the bond doc or the loan.
- [28:21]
Matt Levine
Yeah, we'll say, well we are not going to sign into a deal for the next six months or a year or till the maturity. And if the company wants to negotiate, they negotiate with all of us as a block. So that's one thing. And there is now an effort to actually do what are called so called pro rata transactions where there is a refinancing but the entire group, Tracy, Joe, Sujit, all get a chance to participate.
- [28:47]
Tracy Alloway
What happened to the leveraged lending guidance? Because you alluded to how big this market is earlier and it's huge and it's been booming since like the 2010s. And I remember at one point regulators seemed concerned and so they issued these guidelines of how to do leveraged loans and you know, like what kind of leverage you should have. And I remember a bunch of bankers freaking out about them at the time, but it doesn't seem to have had much of an impact.
- [29:19]
Matt Levine
Yeah, so that was just the idea that a bank couldn't extend a leverage loan where the debt to EBITDA ratio was more than six times. And that was because it's a bank and they can't do risk. They shouldn't do these risky deals. So a couple things happen. One, there's just a whole non bank market. Two, there's some banks like Jefferies that are not subject to these guidance lines. Three, there's this private credit which is a whole different world which is obviously not regulated, regulated by banks. And four, I think banks found ways to push the limits or change the definition of ebitda. But even six times, if you go up to six, that's a lot of leverage. And even if you're doing it, six banks themselves. I think there's a story somewhere about Citibank or Citigroup, which hasn't been a big player in leveraged loans. It's been usurped in market share, now suddenly has a new guy from JP Morgan. There's a story yesterday in the Journal, I think, about how he's going to push to get more into the leveraged loan market. There's a reason City is not like aggressive in this because, you know, it's risky, right? So we'll see how that works out for them. So yeah, there is the actual idea of, you know, how much leverage is there total, and then, you know, then these kind of interpersonal dynamics once the loan is extended.
- [30:43]
Sujit Indap
Direct lending has been one of the most dynamic areas of the private alternative space these last few years, having grown massively as a source of capital for both corporate borrowers, but also financial sponsors that have kept going from strength to strength and have needed that private capital to foster the growth that they've been.
- [31:00]
PGIM Fixed Income
Experiencing for leading alternative investing insights. Listen to Speaking of alternatives from pjym, Got a business problem? There's a TED Talk for that. Stay updated on Everything Business on TED Business, a podcast hosted by Columbia Business School professor Modupe Akinnola. Every week she'll introduce you to leaders with unique insights on work, answering questions like how do four day work weeks work do? Will a machine ever take my job? Get some surprising answers on TED Business wherever you listen to podcasts.
- [31:36]
Joe Weisenthal
As a former banker again, you mentioned the law firms come in, they have new ideas, up tier exchange offers, asset drop downs, etc. They have the whole choreography of how it's going to play out, et cetera. These are skills that they bring to the table that are something different from valuation and debt dynamics and so forth. Is that visible in the pie? There's a certain amount of money that gets spent every year on services for transactions by companies, by borrowers or lenders, etc. Has there been a shift in the tilt of the pie of like, how much goes to lawyers versus how much goes to the dealmakers?
- [32:19]
Matt Levine
Yeah, that's a great point too. So you've now all seen these stories about the law firm wars, the lawyers getting paid 20, $30 million a year and they're shifting firms like baseball players or like hedge fund guys typically do, and that's unusual because historically, if you started a law firm as an associate and you made it to partner, you stayed at that firm your whole career, and it was prestigious, and you got a huge pension. You made a few million dollars a year. It was less than being a banker and less than being, you know, a hedge fund star, but it was a stable and respectful. So now there is this, like, warfare because there are a set of lawyers who matter in this world and who specialize in private equity and are thought to be, you know, the big brains around these crazy contracts. So that is something that's happened. And also. And this is also the accompanying point, which is really interesting. The hedge funds and the private equity firms and the investors in this market, the people who actually put money to capital, they are increasingly horrified. How much lawyers cost?
- [33:13]
Joe Weisenthal
Oh, yeah.
- [33:14]
Matt Levine
How much bankers cost? How much the whole kind of process costs. Like in bankruptcy, if you do end up filing for bankruptcy, there is transparency because your fees are approved by the court. And you can see now there's lawyers who are charging $2,500 an hour. There's bankers who are getting success fees for a pretty standard deal for like 50 million. Like, we work, for example, a relatively small company. At the end of the case, $750 million, there was something like $100 million in fees.
- [33:38]
Joe Weisenthal
Wow.
- [33:39]
Matt Levine
And there is real money in these kind of professional services in a way that is relatively new. And the costs are so much that it's affecting the returns of these funds. And they're thinking kind of proactively, how can we limit the damage? Because it's affecting, you know, how much we're going to make in the deal ourselves.
- [33:56]
Tracy Alloway
If I'm a distressed investor in the current environment, would it be better to be really good at valuation and math or be really good at reading legal documents?
- [34:06]
Matt Levine
Yeah.
- [34:06]
Joe Weisenthal
I mean, I was going to wonder, it's like if our lawyer, you know, makes sense, why doesn't a lawyer just start a hedge fund? Anyway, Keep going.
- [34:12]
Matt Levine
There are a lot of lawyers who start hedge funds. I do think, though, that this kind of the legal creativity that is becoming a little bit commoditized. And ultimately, if you're going to make a lot of money, it's going to be less on a technical factor. And the technical part, I think, is defensive. Ultimately, to make money, I think you have to be an entrepreneur and have a thesis around how is this business going to turn around? And if I end up owning it, how do I grow the market share and have more customers? And that really kind of Commercial business aspect. And there are cases like Hertz, I think is a great story. That was a big bidding war during the bankruptcy and there was two competing private equity firms with different plans for growing the business. And that stuff I think ultimately is important. The gamesmanship again, truly defensive and it's hard to differentiate yourself consistently. It is interesting now in this market to see in one deal, XYZ Famous Hedge Fund is on the outskirts. The other one, they're in the Inn. And that's kind of coin flip. And for that reason, you know, you just don't know how it's going to. You think you're in the winning group and then you wake up and you see the press release and you're not. That's a hard way to make a living. It's a hard way to sleep. And I don't know how long that will continue.
- [35:35]
Tracy Alloway
I'm going to ask a devil's advocate question, but one of the arguments that used to come up with the rise of Covlight loans was this idea that, well, maybe it's actually a good thing for companies because they get more flexibility and there are more options available to them in terms of raising capital. On the other side, you know, maybe there is like a long term cost associated with like rank legal wrangling over every single deal. What Joe was kind of alluding to, where do you fall on, on that argument? Is this ultimately good for companies or is it a bad thing? Because maybe it makes people feel a little bit different about capital markets.
- [36:17]
Matt Levine
Yeah. So if we go back to like the certificate case, which I think is a good example, again, you've got two competing groups, two aggressive transactions, and someone's going to win, someone's going to lose, and someone's feelings are going to be hurt and there's going to be litigation. But from the company's perspective, you have an auction and you're trying to get the lowest cost of capital for the $100 million that you need. And who wins or who loses to you doesn't matter. And this whole kind of distributional point, who wins, who loses, why do any of us care if Famous Hedge Fund X is on the outs in this deal, in that deal and the winning side of that deal, that doesn't really matter. But if a company can raise capital at the best terms and avoid bankruptcy, that seems like a social positive. The points to temper that are, I think are two things. One, does the overall cost of capital go up because.
- [37:13]
Joe Weisenthal
Well, if the investors are getting less returns because they have to factor in their Legal fees. That sounds like higher.
- [37:19]
Matt Levine
Yeah. Less returns. And you're just. There's some chance you're just going to get. You hold a senior loan and you're going to be at the bottom, bottom of the totem pole. And that, that. And you're just a boring clo that's going to be like. Seems bad. And then two, if the company. This is a. This is something that we're seeing a lot of. If the company ultimately does file for bankruptcy and ends up in bankruptcy court, you end up with this like, Frankenstein capital structure where you have super senior first lien, 1.5 lien third out, and the bankruptcy court and the bankruptcy process has to figure out what the actual order is. There's probably litigation.
- [37:55]
Tracy Alloway
That happened with Caesars, right?
- [37:57]
Matt Levine
It did. I mean, Caesars. There is a little bit of creditor on creditor violence, which again, is the idea of inter or intra conflict of Caesars is more the classic case where you have a fight between the equity holders, the junk bond holders and the senior loans. And there are people who are holding all.
- [38:11]
Tracy Alloway
But I just mean in terms of having a capital structure that was so complicated that like, the bankruptcy court was struggling to understand it and deal with it. Like, exactly.
- [38:20]
Matt Levine
That's how. Yeah, you, like, the company before bankruptcy, is trying to lower its cost of capital by selling all these, like, bespoke securities for this particular type of investor. And it seems like a good idea at the time, and it maybe is. But then when you're actually trying to divide up a shrunken pie that is a mess, and that process ends up being, like, very costly. And we've seen cases where there is a creditor on creditor violence, refinancing, and then six months later, the entire company is in bankruptcy. And the bankruptcy is much more complicated, T plus six months, rather than if they had just decided to do it on day zero.
- [38:56]
Joe Weisenthal
This is always the crazy thing when I think about, like, distressed stuff is like, man, there's just a risk that at all. Like, everyone is trying to, like, eke out their extra pennies or extra dollars, but you could really just like collapse the whole thing.
- [39:08]
Matt Levine
Yeah, you're picking up pennies in front of the steamroller and that is bad.
- [39:13]
Tracy Alloway
So, speaking of Caesars, there's one more question I wanted to ask you, which is, what's the deal with Apollo? Like, can you just explain Apollo to me? Because they seem to be everywhere nowadays. I see like, headline after headline about what Apollo is doing, what they're thinking about doing.
- [39:29]
Matt Levine
What's your take Yeah, I mean, I think they're the most interesting example of like the broader theme in either alternative assets. Assets. Alternative assets or just private capital generally. And that there are a set of firms that started as. Started out as in the 80s or 90s as like leveraged buyout firms. They bought whole businesses or carve outs of big businesses. As an equity player, they borrowed a bunch of money, they owned the company, they managed it, and they sold it five years later, ideally at a big profit. That's a great business. You can make a lot of money. Pretty risky, but it created a lot of billion dollar fortunes. But there is a limit on how many companies you can buy. And these firms have realized that they have such expertise in negotiating, valuation, understanding businesses and business models, and just being creative generally, that the credit markets are just much bigger. And you couple that with the idea that the banking sector has undergone massive systemic changes post financial crisis, and those businesses are much more constrained and complicated and not equipped maybe for the modern capital market. So they have, for lack of a better phrase, used regulatory arbitrage to encroach into every aspect of lending. And that is allowing them to become trillion dollar managers. And that is like a sea change, whether it's good or bad. Too soon to say. But you know, Apollo is the clearest example, you know, firm whose heritage is in credit, coming out of Drexel. But in fact, you know, credit markets are much deeper, much wider, and there's just much more opportunity to build a massive firm. And that's what they're doing.
- [41:07]
Tracy Alloway
All right, Sujit, thank you so much for coming on ots. Truly the perfect guest. And I cannot recommend your book enough so everyone who's listening definitely go check that out if you haven't already. Jo, I thought that was so good, and I feel like I have a lot more clarity about what's going on now. I did think that the. The social aspect that Suji brought up is really interesting because like I. Okay, obviously Cov lights became more of a thing, and then you had higher interest rates in recent years. And so more companies were under pressure and maybe they got more creative in how they're raising capital. But I do think like, the difference or the change in social behavior on the part of investors is also a big part of the story. And so I guess the question is whether or not it could change again, to Sujit's point about maybe having investors team up and have their own contracts, about how they're all gonna work together and things like that.
- [42:14]
Joe Weisenthal
No, I thought there were some really Interesting social questions arising out of that. And you know, I'm not a lawyer, but it does not. So I'm biased cause I'm not the beneficiary of this trend. But it does not seem great to have a ton of human hours devoted towards the definition of andor or things that we all thought we knew the definition of, et cetera. But actually, technically, if you look at. And then the second one has to be in there, because that's how I've always read it too. But maybe we thought it meant something else, or maybe we just thought it meant.
- [42:51]
Tracy Alloway
And whatever, hire Joe for your litigation.
- [42:55]
Joe Weisenthal
I'm glad you brought this up. This has always bothered me and it's interesting to think it's actually eating into the returns, these legal costs, that it actually even setting aside an incident of credit on creditor violence, or even setting aside an incident of bankruptcy that it would eat into returns just because of how much you're paying the law firms to go over every one of these legal documents.
- [43:18]
Tracy Alloway
It is crazy also just to think about, like, the amount of brain power that's being spent on debating this. And again, that's something that comes through in Sajit's book, like how much people are thinking about this, and it certainly comes through in the Argentina book just how like, mentally taxing and time consuming sorting this stuff out is.
- [43:40]
Joe Weisenthal
I thought it was also a really interesting point about the sort of. I don't know if it's like diseconomies of scale from capital efficiency. Right. So you have all of these different instruments, you have equity, you have junk bonds, you have all the, you know, super plus, whatever. And individually, each one of these transactions is designed to be the most capital efficient, to align the company's borrowing needs with the investors needs. But then you end up with this sort of, you know, Frankenstein's monster of a capital stack. And in the event that that has to be unwound, that is, it's like a tail risk. Right. That emerges that in the event that that has to be unwound, it'll be a much costlier process than had it simply been equity and bonds or something like that.
- [44:24]
Tracy Alloway
Yeah, I mean, there can be like a parent company, an operating company, like convertible bonds, the loans, preferred stock. Like it can go on and on and on. And someone has to go through all of that. Okay, well, on that note, shall we leave it there?
- [44:38]
Joe Weisenthal
Let's leave it there.
- [44:39]
Tracy Alloway
This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me at.
- [44:44]
Joe Weisenthal
Tracy Alloway, and I'm Joe Wiesenthal. You can follow me at the Stalwart Follow our guest Sujit Indepth. He's Indepth and check out his book he is the co author of the Caesars Palace Coup came out in 2021. Follow our producers Carmen Rodriguez, CarmenArman, Dashiell Bennett at Dashbot and Cale Brooks at Cale Brooks. Thank you to our producer Moses Ondam. For more Odd Lots content, go to bloomberg.com oddlots where we have transcripts, a blog and a new daily newsletter and you can chat about all of these topics 24. 7 in our Discord Discord GG odd.
- [45:19]
Tracy Alloway
Lots and if you enjoy Odd Lots, if you like it when we dig deep into creditor on Creditor violence, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, in addition to getting our new daily newsletter, you can also listen to all of our episodes absolutely ad free. All you need to do is find the Bloomberg Channel on Apple Podcasts and follow the instructions there. Thanks for listening.
- [46:13]
Matt Levine
The forces shaping markets and the economy are often hiding behind a blur of numbers.
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Tracy Alloway
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