Novel protection could curb loopholes in junk debt deals, Moody's says

By Matt Tracy

(Reuters) - Stressed junk-rated companies were coming up with new ways to restructure their debt which benefited some creditors over others but protections to close loopholes in deal documentations that enabled them are starting to emerge, said a Moody's report.

Some debt issuers used a simple majority from existing creditors to raise more debt that was sold exclusively to lenders who will provide consenting votes.

Armed then with a supermajority (usually two-thirds majority of consenting creditors), these companies then got approval for debt restructurings that helped them prevent a default, the report said.

This group of new consenting lenders now had a bigger claim on the company's assets at bankruptcy before other creditors. And given their enhanced position, they were more willing to provide additional liquidity making such transactions a crucial tool among stressed companies who need to restructure, it added.

"This 'engineered' consent, where majority lenders punch above their weight for voting purposes, allows issuers to execute certain forms of restructurings even where they fall short of the required supermajority control," the report said.

Some creditors were now demanding an extra level of protection which stops companies from issuing more debt and lower their claim on the company's assets during bankruptcy.

The new protection was recently included in the modified credit agreement for City Brewing Company's distressed exchange, which could be the start of a new trend, Moody's said.

"The move to adopt such features has lagged the emergence of new risks, but the trend towards increasing adoption has been consistent over the last few years and reflects how seriously creditors take these concerns," the report's authors wrote.

(Reporting by Matt Tracy)