The practice certainly still seems very widespread and not just among private equity sponsors, if the data the Bloomberg article cites is true:

Data gathered by Xtract Research show that 77 percent of all loan deals in the third quarter included provisions giving borrowers the ability to block individual lenders, up from 51 percent at the end of last year. The lists can often be updated to add new investors whenever a borrower wants.

Now, in most facility agreements (particularly the LMA documentation used as the starting point for many European facility agreements), the starting point is usually that a lender can transfer all or a portion of the debt it holds to another bank, financial institution, or to a trust, fund or entity which is regularly engaged in or established for the purpose of making, purchasing or investing in loans, securities or other financial assets.

This is a very broad category of acceptable transferees, and reflects the starting position of the lenders. They have an interest in being able to sell or “syndicate” debt to as broad a range of institutional investors as possible.

This starting point would often be negotiated extensively by the borrower and lenders and their legal counsel. The final product would always be bespoke and reflect the strengths of the borrower and lenders and market conditions at the time the facility agreement was negotiated.

In most of the facility agreements I saw, there would be a specific list of firms that were excluded, usually including firms falling into the categories of:

• Hedge funds and other investment funds that specialized in acquiring distressed debt
• Rival private equity firms that had investment strategies that allowed them to acquire debt securities ahead of a hostile bid
• Competitors in the same or adjacent industries that might use their access to confidential information disclosed to lenders to gain a competitive advantage
• Investment banks and investment funds that are active in the syndicated loan markets but have developed reputations for being “difficult” to work with when the borrower is experiencing financial distress
• Institutional investors that are “disliked” by the private equity sponsor for other idiosyncratic reasons

What do I think of the practice?

It depends on where you’re sitting, of course. From the perspective of the private equity sponsor (or corporate management), the restrictions make a lot of sense. You do not want to have an investor base that may actively benefit if the borrower experiences financial distress, e.g. a hedge fund or private equity fund that is accumulating a position in the debt in the hopes of becoming the new owners in a bankruptcy scenario. You also don’t want to have lenders that are competitors and can potentially use the confidential information provided to lenders to assist them in gaining a competitive advantage. You also, for the sake of your own sanity, do not want to have to deal with “difficult” lenders; life is short and nasty enough already.

From the perspective of a lender, it can be risky to participate in a syndicated loan subject to such a “blacklist”, particularly if there a lot of names on the list. A thin market limits your liquidity and can leave you holding onto debt that you no longer want to hold because you cannot locate a buyer that is not the “blacklist”.

And from the perspective of the capital markets, the practice leaves much to be desired. First, it creates very thinly traded markets where market inefficiencies can persist. Second, it limits the utility of debt instruments as a method of disciplining management, since potentially hard-negotiating lenders may be excluded from participating in the primary and secondary markets.