And now, back to a familiar crisis…

Now selling like hotcakes at Saks Fifth Avenue: ringside seats to a creditor-on-creditor cage match. You may have seen Saks Global’s announcement last week that it was able to raise a fresh $600 million from its existing bondholders, many of the very same people who have suffered a 65 percent loss on bonds they bought just last December. And you may have asked yourself: Why in the world would anyone who has already lost 65 percent of their money owning part of a $2.2 billion bond, used to finance Saks’s purchase of Neiman Marcus Group, want to put up more money to rescue Saks Global from its dire financial predicament? Why throw good money after bad?

This is where things get interesting, and it’s just the latest example of how very loose bond indentures, which are so common today, allowed one group of creditors to salvage their money by throwing in another $400 million or so. And there’s nothing the creditors losing out can do about it.

This complex play is truly fascinating, and indicative of how much things have changed for creditors since I did my restructuring work at Lazard in the 1990s. You’ll recall that a month ago, Saks announced that it had arranged for a new $350 million asset-based financing with SLR Credit Solutions, a subsidiary of SLR Investment Corp, which was founded in 2006 by Michael Gross, one of the original employees of Apollo Global Management. As I wrote, Gross’s money does not come cheaply, as you would expect from someone with an Apollo pedigree. And that expensive pricing—whatever it was (Saks won’t say)—gave other sources of capital an opening, as Saks Global was probably hoping it would. Perhaps SLR was a stalking horse for other providers of financing, or it could have been Saks’s only choice. According to people familiar with what happened, as the SLR deal was in the process of closing, a group of Saks bondholders contacted the company through its financial and legal advisors, PJT Partners and Kirkland & Ellis, and said, in effect, We can do better than what SLR did. We can offer you more.

This is when and where the creditor-on-creditor violence began. A group of bondholders that collectively controls 54 percent of the outstanding bonds, represented by Lazard and Paul Weiss, got organized. Some were par buyers—they owned the bonds at 100 cents on the dollar—and others had bought the bonds at distressed prices during the past six months. In any event, these bondholders agreed to provide the new financing, and to exchange their existing bonds for up to $1.5 billion of new 11 percent bonds, which will be senior to the remaining 46 percent of the bonds not represented by Paul Weiss and Lazard. (The 46 percent are being represented by Greenhill Partners and Glenn Agre, a litigation boutique.)

The privileged 54 percent have also ginned up the opportunity to invest the new money in Saks Global at market terms—which, believe it or not, appeals to some of the bondholders. (As usual, this is not investment advice.) They also tightened up the bond indenture, to their benefit.

So, to summarize: The majority of the Saks bondholders got a bunch of special benefits while making sure what they did to their fellow bondholders won’t happen to them in the future. And that 11 percent interest rate is lower than what SLR was going to charge the company for the new money. The company also got the bondholders to put in the new money without so-called “discretionary reserves,” or the ability to limit the availability of credit to Saks. Pretty clever, right?

How can that happen, you may ask? It turns out that the original indenture related to the December bond deal allowed for a simple majority of bondholders to make these changes, which give some creditors a serious advantage over others. Of course, for the 46 percent of the bondholders, it stinks. “I’m sure they would have loved to have been part of the 54 percent,” one person close to the action told me. “They were just too late to the party. There’s more value for the 54 percent of the lenders to keep their group as close to a majority as possible. And so in these types of transactions, where bondholders are protecting themselves and elevating their position vis-à-vis other bondholders, there is more value for those bondholders to be gained by keeping their group as close to whatever the requisite voting percentage you need in this deal.”

In this case, the majority only needed the agreement of 50.1 percent of the bondholders to pull this off. No surprise, they got a bit more than they needed, at 54 percent. This group has already agreed to lend Saks the fresh $300 million and then, when the exchange offer is completed in about three weeks, another $100 million. The final $200 million to be lent is contingent on certain thresholds, although the company declined to disclose them.

There’s a coercive element to the exchange offer. The minority group of bondholders will miss out on getting to the top of the security stack after the exchange offer is completed. But some, although not all, of the benefits that the majority will get from the exchange will be available to the minority group of bondholders— if they participate in the exchange and swap their bonds, albeit at some sort of discount, for new bonds, and also agree to fund their pro-rata portion of the new money going into Saks.

However, if the minority group of bondholders doesn’t participate in the exchange, and doesn’t provide their pro-rata share of the new money for Saks—and I can understand why they wouldn’t, after this whole charade—they’ll really get screwed. Not only will they be last in priority—in a bankruptcy, other creditors would get paid 100 cents on the dollar before they get anything, at least in absolute sense—but the few covenants in their existing bonds will be stripped out, and the majority bondholders could continue to layer them with new money, pushing them further and further into credit oblivion.

Of course, the architects of this exchange recognize its coercive elements. But they also ostensibly believe there are enough sweeteners for most of the minority group to go along, even if they’re not happy about it. “We offer them something that is worth more than what they have today, and so they are economically incentivized to participate, because what they have today now is a bond with no covenant protections at the bottom of the stack,” said one of the people involved in the deal. “We are going to offer them the ability to move those bonds up at a discount. But when you take into account everything that they are getting, including benefiting from the covenant protections that they'll have in the new bonds, those bonds should be more valuable than what they have now, even giving effect to the discount.”

Last year, there were around 50 transactions like this one, and PJT Partners and Kirkland were involved in about half of them. What might have seemed outrageous and unfair to a substantial minority of bondholders is, however, increasingly just another accepted fact of life in the ever-changing and ever-expanding world of private and public credit. “This has become such an important part of the playbook for companies in the leveraged loan and high yield markets, I think people are used to this,” explained one longtime restructuring professional. “This isn’t a unique transaction really in any respect. The company paid for flexibility in its bond indenture to do exactly this deal, and it did it. And so people investing in those bonds knew, or should have known, that this was a possibility. There is, I think, a general acceptance in the high yield and leveraged loan market that this is one of the risks that you have. That’s a real change over the last five years, as these types of transactions have become significantly more common.”

If Saks Global is to be believed, the new financing from its bondholders will give it some runway to operate, hopefully through the all-important Christmas season, when another $120 million interest payment will come due on the bonds, whether exchanged or not. The company made the first $120 million interest payment on the $2.2 billion of bonds on Monday. (There was concern on Wall Street that they would be NCAA bonds—no coupon at all.) It will make the overdue payments it owes to vendors in July, as agreed as part of the previously discussed Valentine’s Day Massacre. I’m told negotiations are underway, and going well, with regard to the $500 million commercial mortgage-backed security that needs to be refinanced or repaid in August.

It seems that Saks Global has taken steps to solve its immediate corporate finance challenges. I suspected that when PJT Partners and Kirkland were hired, there would be some outcome along these lines. But none of this fancy Wall Street jujitsu will matter one whit if Saks’s underlying business doesn’t recover. And that’s on Marc Metrick, the Saks Global C.E.O., and his team.

Marc is confident that the business will perform and that the revenue, EBITDA, and synergies promised to creditors in the December bond indenture are being achieved. The market, though, is still digesting the news of the new financing and the exchange offer. Last Thursday, the bonds traded as low as 34.73 cents on the dollar. On Monday, the bonds traded up to 37.81 cents on the dollar, a 9 percent increase. Today, they are at 35 cents. But the bonds are still yielding more than 44 percent. As for the bonds that used this tricky maneuver to get to the senior-most position in the sad Saks Global capital structure? They are only trading at 60 cents on the dollar now—an indication, to me anyway, that there is still plenty of skepticism out there that Metrick will be able to make the original Saks-Neiman Marcus deal a financial success.

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