The Loan Market Response to Dropdown and Uptier Transactions

Two innovative methods of subordinating first-lien lenders to newly issued debt—so-called dropdown and uptier transactions—have become important options when a restructuring looms. We weigh concerns about borrowers’ power and the loan market’s capacity to produce efficient contracts by examining the extent to which the terms of newly originated loans changed after two salient transactions: J. Crew’s dropdown, in 2016, and Serta Simmons’s uptier, in 2020. Our primary result is a contrast. Loans originated after the Serta transaction became much more likely to block uptier transactions, which suggests that loan contracts can adjust rapidly to curtail borrowers’ flexibility.

Conversely, the frequency of loans susceptible to a dropdown transaction changed little after the J. Crew transaction, which suggests that giving borrowers flexibility to repledge collateral may be valuable. In a range of loans, the optimal contract may permit borrowers to subordinate lenders by one means but not the other.