Private Credit: Pulling Rank and the Game of Senior Preferreds in LMEs

Secured lenders have long looked to “Disqualified Stock” provisions in credit documentation to protect them against cash leakage on account of junior ranking instruments. However, lessons from a recent private credit liability management exercise (LME) raised questions regarding the perceived benign nature of permitted junior ranking hybrid instruments.

Key Takeaways

A recent LME transaction widely discussed in media reports did not exhibit qualities of lender-on-lender gamesmanship, although the transaction does provide a new template for value-shifting transactions.
A review of a random sampling of credit documents highlights another avenue where stressed borrowers can leverage document terms to shift some value away from credit parties, a matter that is becoming a bigger discussion point in private credit deal negotiations.
Preferred equity—commonly viewed as nonthreatening to senior lenders—can pull rank if the document allows it, and it appears most…