The Loan Market Response to Dropdown and Uptier Transactions

Abstract

Hardball recapitalizations have emerged in recent years as an important feature in the landscape of corporate financial distress. Since 2016, borrowers have sought to incur super-senior debt, priming existing first-lien lenders, on the strength of aggressive though plausible interpretations of their loan contracts. The two principal transaction forms borrowers have used—the “dropdown” and the “uptier”—can cause significant losses to creditors, suggesting to some that borrower power has run amok and casting doubt on the loan market’s capacity to generate efficient contracts. We weigh these possibilities by examining changes in loan contracts after salient dropdown and uptier transactions, J. Crew in 2016 and Serta Simmons in 2020.

Our primary result is a contrast. In the year following the Serta transaction, the frequency of loans that block uptiers increased from about 40% to about 75%, suggesting that syndicated loan contracts can adjust rapidly to curtail borrower flexibility if market participants perceive it to be value-destructive. Conversely, the frequency of loans that block dropdowns—and the magnitude of vulnerability in loans that do not—changed little in the years following J. Crew. The muted reaction to J. Crew suggests that the contractual flexibility underlying the dropdown transaction may be valuable on net, even if it can be used to prime first-lien debt. In a range of loans, the optimal contract may permit borrowers to subordinate lenders by one means but not the other.

Keywords: priming, subordination, uptier, dropdown, leveraged loans, syndicated loans, bankruptcy, refinancing, unrestricted subsidiary, sacred rights

JEL Classification: G32, G33, K12, K22