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A New Kind of Hedge-Fund Activism Has Arrived

Anjani Trivedi

(Bloomberg Opinion) -- In the coronavirus era, even the most aggressive hedge funds have had to relent and refrain from asking companies to speed up dividend payouts and share buybacks. But it could make way for a new kind of activism. 

Covid-19 is shifting the balance of power between borrowers and lenders to the latter. Creditors are asking for more as they come to the negotiating table: In the U.S., bonds backed by collateral are rising. Last month, investment-grade cruise ship operator Carnival Corp. issued $4 billion of bonds at 11.5% for three years – terms befitting junk-rated debt  – backed by $28 billion of ships and assets. In Europe, sports-car maker McLaren Automotive Ltd. is sparring with its bondholders over security for new emergency funding. 

In Asia, the trends are similar. Restructurings are picking up and covenant quality – or the level of investor protection in bonds — is improving after deteriorating for much of the past decade. Singapore-based mining company Geo Energy Resources Ltd. is asking creditors to waive certain clauses. China’s Dr Peng Telecom & Media Group Co. secured a year-and-a-half extension on its bonds due in 2020 by paying investors over 2 percentage points more, along with returning the principal in installments. That’s just the beginning — there will be more.  Investors in companies’ capital structures now have more opportunities to push for operational efficiency and stronger corporate governance, as well as to hold debtors accountable. Unlike their equity-side activist peers, creditors love firms sitting on cash and want to keep companies alive by boosting their value.Gregory Nini, a finance professor at Drexel University, says companies have to make their lenders happy, especially now, noting that “incumbent creditors have a fair amount of power.” His research has found that, on average, firms improve their operations and performance after negotiations. They typically aren’t willing to slim down until pressured to do so. Creditor intervention can amount to activism – after all, they don’t seek returns now, and wish to protect their claims. Cash management is their forte and they don’t want companies to go bust.

Largesse after the 2008 financial crisis offers a lesson this time around. In the U.S., over 80% of the syndicated leveraged-loan market is covenant-lite, or without financial maintenance requirements, according to Moody’s Investors Service Inc. Debt cushions, or junior obligations that absorb losses first, shrank to 18% last year from 33% pre-crisis. Because heaps of such debt already exist, recovery from the Covid-19 disaster will be far slower, the rating agency expects.Nini notes that a big concern now, given the terms that investors signed up for in recent years, is that companies will — and can — stumble along until a conversation is forced upon them. The flip side, as leveraged loan defaults rise sharply, is that creditors are presented with an opportunity. They don’t have to deal with debt-for-debt exchanges or shifting of collateral outside their control, or potentially risk ending up in a subordinated position in the capital stack. Especially in times like these, even if they sympathize and give waivers, lenders can put in stringent covenants on capital spending and asset sales. That’s a start. 

Another takeaway from post-2008: Don’t kick the can down the road. As companies struggled, they missed a chance to crisis-proof their capital structures, relying on out-of-court distressed exchanges of debt and the like, instead of bankruptcy proceedings and restructurings. Moody’s analysts looking at the past three decades say that more than 40% of the time, such exchanges don’t save troubled firms from another default. Meanwhile, investors accepted terms, because liquidity was flush and rates were low, that didn’t insulate them from future difficulties. Now, recoveries will struggle on the legacy of such debts. No one imagined a global pandemic.

When businesses will be able to move on from the one-time impact of the coronavirus is anyone’s guess. But it’s clear that they need to be prepared for their new reality. Creditors, this may be your time.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Anjani Trivedi is a Bloomberg Opinion columnist covering industrial companies in Asia. She previously worked for the Wall Street Journal.

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