The New Rules of Debt Are Totally Cutthroat

At the foundation of credit markets is one very basic idea: If I lend you money and you can’t pay me back, I’ll seize your assets and pay myself. That bargain is written into debt terms known as covenants that have long been regarded as iron-clad. But two things have happened over the past decade: Covenants grew weaker, as investors frustrated by the low interest rates prevailing in most of the market competed more fiercely than ever to lend to riskier companies that paid more in interest. And companies facing credit squeezes came up with a bag of tricks to get around some covenants, often by pitting one set of creditors against another.

Now interest rates are up sharply and a growing number of companies are feeling financial pain. One result has been a surge in such end-runs and the ruckus they bring, dubbed by some as “creditor-on-creditor violence.” Some investors are fretting that hardball tactics will undermine the $3 trillion market for what is known as high-yield or junk debt — and become a threat elsewhere, too. Even in the clubby $1.7 trillion world of private credit, where lenders and borrowers have historically joined forces to keep trouble at bay, covenant wars have now come to the door.