J.Crew Considers Bankruptcy. It Already Has a Controversial Debt-Market Legacy.
J.Crew is the latest retailer to reportedly consider bankruptcy. It could file as soon as this weekend and is in discussions about a loan that would keep it operating during a bankruptcy process, according to news reports.
It is one of several retailers that are reportedly preparing to restructure after more than a month of store closures to prevent the spread of coronavirus. Neiman Marcus, Lord & Taylor and J.C. Penney (JCP) are all reportedly considering filings.
Unlike its peers, however, J.Crew already has a large and contentious presence in debt markets. The company declined to comment.
The privately owned company’s influence extends far beyond the $1.7 billion in debt it had at the end of last year—a hefty burden for the retailer, which had only $26 million in cash, but not large for the more-than-$2-trillion high-yield debt market.
J.Crew’s name has become synonymous with a debt-market maneuver that raised eyebrows in 2017. The company used a loophole in its debt contracts to transfer a substantial amount of its intellectual property and brand value into a subsidiary.
That put it out of the reach of senior lenders, who are supposed to have the strongest claim on company assets. It then used that subsidiary to negotiate a debt exchange with a group of junior bondholders.
Similar maneuvers have been used by other stressed retailers, such as Claire’s Stores and Neiman Marcus. But investors and analysts still call it the “J.Crew trapdoor.”
So it may not come as a surprise that credit analysts pushed back against some terms of a J.Crew plan to pay down its debt with the proceeds of an initial public offering of Madewell, a brand it launched in 2006. Both S&P Ratings and Moody’s said in December that the terms initially proposed for the Madewell transaction would constitute a default on the company’s loans, rather than a repayment.
“We think the indicative terms...indicate lenders would receive less than what was originally promised,” S&P said. “We would likely view this as tantamount to a default.”
J.Crew decided to shelve the Madewell IPO in March, according to a company filing, a move that has led it to reportedly consider bankruptcy.
No matter how any restructuring or bankruptcy process goes—restructuring, liquidation, or something in between—J. Crew’s legacy will probably persist for some time in debt markets.
For example, take a bond offering last week from Gap Inc. (GPS), a retailer facing some financial pressure itself. As Gap marketed the deal, which ended up totaling $2.25 billion, investors insisted on a contractual provision known as a “J.Crew Blocker,” according to Covenant Review, a firm that analyzes debt contracts.
The Blocker provision is meant to prevent the type of asset transfer that J.Crew carried out roughly three years ago.
“Gap was likely the first deal in the time of COVID-19 to include a J.Crew Blocker” because retail-sector debt investors had a front-row seat to J.Crew’s maneuver years ago, wrote Ross Hallock, an analyst with Covenant Review. “However, we think this kind of investor protection is appropriate in any deal [where such a transfer is possible], regardless of the sector.”
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