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Moody’s: Distressed Retailers Protecting Assets at Lenders’ Expense

If you’re a retailer that’s leveraged beyond reason, your options for gaining liquidity or buying yourself a little breathing room are limited.

That’s the unenviable position several fashion retailers find themselves in today. To solve the problem, or at least lessen its impact, chains like J.Crew, Neiman Marcus and Claire’s have found a way to fence off their most valuable assets. However, what might be good for them, threatens their secured lenders, according to Moody’s Investors Service.

All three of these retailers have take the rare step of moving their most assets into unrestricted subsidiaries that are outside of their investors’ reach. Once transferred, these assets can be used as collateral for more debt. In March, Neiman Marcus shifted its MyTheresa and several stores to an unrestricted subsidiary. In the other two cases, the assets have been intellectual property. In 2016, Claire’s used its IP as collateral to obtain a $130 million loan. Similarly in the case of J. Crew, the company announced plans to back a note exchange using J. Crew IP in March.

(Read about how debt is the real culprit in the retail meltdown: How a Lack of Liquidity is Tanking Retail—And Who’s to Blame)

“The new debt can be used to reduce total leverage via a debt exchange by negotiating an exchange offer (as in the J. Crew case) or buying debt in the open market at a significant discount,” Moody’s states. “The proceeds can also be used to take out a near-term maturity, or simply to get a cash infusion in order to fix a temporary liquidity problem.”

The problem is it undermines secured lenders because it creates a new class of secured debt that would take precedence in a bankruptcy claim. Some unsecured lenders may also find themselves in a similar position.

Further, the move would affect ratings as well. Moody’s says in a situation like this it would “reassess the existing instrument ratings to reflect impaired recovery value.” In the case of a distressed debt exchange, the firm would assess ratings on the capital structure post transaction.

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(Read more about J. Crew’s attempt to protect its IP: J.Crew Can’t Afford to Keep its Intellectual Property Protected, Say Lenders)

Moody’s warns investors there could be more instances like this on the horizon for two reasons. First, of the companies the credit agency rates that have a B3 negative or below rating, 83 percent permit a transfer like this. Only Sears Holdings, Bon Ton Stores, Tops Holding and one other private company were restricted from doing so.

Second, though most retailers don’t have hard assets outside of inventory, some have very strong brand names that could use to their advantage. Retailers that fall into this category include Cole Haan, Vince and Toms Shoes, according to Moody’s.

But because IP is valuable—demonstrated by the recent acquisitions of Sports Authority by Dick’s, Nasty Gal by Boohoo, and American Apparel by Gildan which all centered around the companies’ brand names and intellectual property—lenders may not be content to stand by as this collateral is stripped out of their deals.

In J.Crew’s case the move fence off its IP has resulted in a legal battle between the retailer and its senior lenders, who are trying to block the transfer. And it looks like they might be successful, according to the New York Post. Either that, the paper says, or the lengthy court case could stretch out beyond the retailers’ ability to avoid bankruptcy.