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Private Credit 

Bill Weisbrod

Will Caiger-Smith

At the end of a long cycle for corporate credit, lenders are searching for schematics.

Lately, an old narrative has once again begun circulating among credit investors: deals backed by certain private equity sponsors should be avoided, as these firms will go to extreme lengths in order to protect their equity. 

In other words, they’re dusting off the naughty list. 

Some firms have only recently found their way onto this register (KKR for Envision Healthcare, Platinum Equity for Incora). Others have been on it for a while (the backers of J. Crew, TriMark, Serta and Boardriders); others still have been a fixture for years (Apollo).

Putting names aside for a second, it’s understandable that lenders are worried. As economic headwinds rise, higher interest rates are squeezing free cash flow. The cycle is turning, and many companies that borrowed during the low-rate boom have extremely loose debt covenants. 

Conditions are ripe for an increase in what is colloquially known as lender-on-lender violence: priming debt, asset-stripping, manufactured defaults, and any other maneuver that might make debt investors a) wish they had read the docs more closely or b) go to court to argue that their reading is the correct one.

For years, the erosion of lender protections — driven by smart sponsor lawyers, and enabled by portfolio managers that kept letting it slide — has given PE firms increasingly powerful weapons with which to protect their equity capital. As the cycle turns, they may want to finally pull the trigger. 

Recently, many credit investors have successfully pushed for some of the most contentious covenant loopholes to be closed. But even in credit agreements that might seem impregnable, potential openings can often still be found. 

The next logical step is to figure out where the violence is most likely to erupt, and this naturally leads people to make lists of the sponsors that seem to attract the most trouble. Can it really be that simple?

As debt investors begin to sort PE firms between naughty and nice, some are casting an increasingly skeptical eye towards debt issued by KKR portfolio companies, multiple industry sources told 9fin.

This is largely prompted by what some credit professionals view as unfair treatment by Envision Healthcare, the KKR-backed physician staffing company that riled lenders last year when it dropped its AmSurg division into a non-recourse subsidiary and used it as collateral to raise new debt.

This move came after negotiations around a more conventional restructuring collapsed; those initial talks followed a dramatic slump in Envision’s earnings, sparked by a US government bill that outlawed the lucrative but controversial practice of ‘surprise’ medical billing.

Envision is now reportedly on the verge of another restructuring that could give creditors full ownership of the company. 

As such, the ultimate outcome of the Envision drama is not yet clear. But the fallout of last year’s dropdown restructuring has sparked internal debates at several credit funds over whether to limit exposure to KKR-backed credits, out of fear that the sponsor might use similar tactics again. 

Portfolio managers often grouse about counterparties they feel have wronged them, or have policies not to invest in certain sectors or alongside certain sponsors. Having strong opinions is part of the job. But for some, the questions around exposure to KKR deals are coming directly from LPs that have been following the Envision debacle from afar. 

“It was a question that came up from investors at ABS West,” said one portfolio manager, referencing the annual Las Vegas securitization conference that many CLO issuers use as an opportunity to meet with the investors that buy their bonds and equity.

In Europe — where lender-on-lender violence is less common — debt investors in KKR portfolio companies Genesis Care (distressed) and Upfield Flora (not particularly distressed) are also on alert for possible liability management exercises. 

All of the lenders we spoke to took pains to emphasize that, in their opinion, the Envision restructuring represented a significant shift from their previous perception of how KKR conducts itself. Other outlets have made the same pointin their coverage.

Some sources we spoke to were genuinely dismayed at the idea that lenders had soured on the sponsor. A lawyer told us it was “painful” to hear that KKR was viewed as anything other than a “classy” operator; a banker pointed to the firm’s track record, calling Envision an “abnormality”.

“KKR do good deals,” the banker said. “People make money on their deals.”

It’s also worth noting (again) that Envision executed the AmSurg dropdown only after previous negotiations with lenders fell apart, and that such maneuvers are not a free option for sponsors: they cost a huge amount of time and money, and carry the risk of reputational damage. 

For its part, KKR declined to provide comment for this story. 

Platinum Equity is another name on many lenders’ lists of sponsors that should be approached with caution.

From its flashy headquarters in Beverly Hills, the firm — headed by billionaire Tom Gores, who also owns the Detroit Pistons basketball team — has masterminded some of the most aggressively levered buyouts in recent history. 

It has an impressive track record of making them work, often by tapping the credit markets for debt-funded dividends. This blueprint was laid in early 2014, when Platinum recouped its entire equity investment in BlueLine Rental within just two months of acquiring the company. 

Making the most of loose covenants around dividend capacity, the sponsor funded the payout with a PIK toggle note. It sold BlueLine to United Rentals four years later, by which point BlueLine’s valuation had nearly doubled.

Two more examples, both from early 2020: Cision, when the sponsor took a dividend within days of closing its buyout, and Husky Injection Molding, whose bonds were finally inching back towards par after several tough quarters, only for Platinum to announce another PIK-toggle payout.

Those deals are among the reasons that one of the buyside teams we spoke to for this article has had a “no Platinum” policy for several years. But in recent months, the sponsor has attracted renewed scrutiny after its restructuring of Incora, the aerospace supplier it formed in 2020 by merging Wesco Aircraft and Patonnair. 

The controversy stems from a priming transaction last year (just before the Envision Healthcare drama kicked into high gear, in fact). The deal staved off a liquidity crunch, but gave a group of new investors including Silver Point and Pimco preferential treatment over existing lenders. 

The new debt diluted the claim that the original creditors would have on Incora’s assets in any future restructuring or bankruptcy. Crucially, those lenders were not offered the chance to participate in the new funding provided by the Silver Point and Pimco group. 

When sorting sponsors based on those most likely to take an aggressive stance towards lenders, Platinum is “one of the obvious ones”, said a source familiar with the firm; another said they admired the firm’s equity returns but couldn’t get on board with their treatment of lenders. 

“They do a very good job for their clients, but they're not a sponsor we’re ever going to partner with given how they view bondholders,” the second source said. “Loose covenants are one thing, but using them in the way Platinum does is another.”

We approached Platinum’s media relations contact for comment multiple times. They didn’t respond. 

There are mounting fears among lenders that as interest rates rise and liquidity becomes more scarce, other private equity-backed companies may be emboldened by the examples of Envision and Incora.

But to be fair, KKR and Platinum aren’t the first to do this. They followed trails that were blazed by pioneers like TPG and Leonard Green, whose J. Crew dropdown transaction was so shocking (not to mention ultimately successful) that it eventually became a verb. 

Likewise, any sponsor that pursues an uptiering maneuver will be standing on the shoulders of Advent, Centerbridge and Oaktree, the firms that masterminded the restructurings of Serta, TriMark and BoardRiders.

More will surely come. In recent weeks, ClubCorp — owned by Apollo, which for years has had a reputation for aggressive dealmaking but is actually on the losing side of the Serta uptiering deal — has taken steps towards a dropdown ahead of a 2024 debt maturity (Apollo declined to comment). 

Lenders have been scrutinizing new loan agreements to guard against other such transactions. But several sources told 9fin that these days, it feels like pretty much any sponsor could attempt such a move, often regardless of what the documentation says. 

“The credit agreements I thought were tight, are still at risk,” said a portfolio manager. “Uptiering, dropdowns, and collateral stripping will probably be more prevalent. Most sponsors are probably looking at it as an option these days.”

That cuts against the idea that the risk of these maneuvers can be measured by simply ranking debt covenants or blacklisting certain sponsors (as an aside, we should note that PE firms themselves often maintain lists of lenders they won’t transact with).

Here are three more reasons to be skeptical of such sponsor schematics:

Firstly, the legal landscape is hard to read. Much as lenders protest, these kinds of deals may turn out to be completely legitimate — or they may not. 

Last month, a Texas bankruptcy court ruled that Serta did not violate its credit agreement when pursuing an uptiering transaction that excluded some lenders (that decision is being appealed). Envision lenders held talks with lawyers, but do not appear to have pursued litigation.

On the other hand, TriMark ultimately chose to settle a suit from minority lenders over its uptiering deal. And in a possibly promising sign for lenders, a New York Supreme Court judge denied most of Boardriders’ and Oaktree’s motions to dismiss lenders’ claims against them. 

Secondly, these deals are not all the same. Just as uptiering, dropdown and collateral-stripping transactions can be conducted in ways that lenders might feel are unfair, they can also be done in more equitable ways. 

“If it’s offered pro rata to the whole group, I don’t view it as lender-on-lender violence,” said the aforementioned portfolio manager. Another potential example is Lycra, which recently did a dropdown deal structured in a way that is unlikely to be seen as controversial. 

Thirdly, the world has changed. New loopholes are being discovered, and new blueprints written; ultimately, sponsors have a fiduciary duty to protect their investors’ capital and maximize returns, and they will use whatever tactics are available to do so.

To that point, some sources argue that discriminating against sponsors because of past behavior is a distraction. When all is said and done, they say, solid underwriting wins the day.

“There are some sponsors we are looking at that have taken a lot of risk, and because of that they are in difficult positions,” said a private equity source. “They played the game thinking valuations would be high forever.”

The more capital sponsors have on the line, the more ferociously they will guard it. In such situations, the rules of engagement naturally get tested; you can choose to hate the player, or you can choose to hate the game. 

“It’s my view that you have to expect these things and that anyone could do it,” said one of the investors we spoke to, referring to Envision and KKR. “I would still lend to them.”

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