Tatton Teaser
Posted 12 September 2024
Creditor-on-Creditor Violence
The surge in “liability management exercises” (LMEs) — where companies manipulate their creditor dynamics to extract concessions — has intensified, with a staggering $155 billion of debt hanging in the balance.
This post-Covid default cycle is unique. It’s driven primarily by prohibitive debt costs for highly levered companies, particularly in non-cyclical sectors, rather than a specific “problem sector” or poor earnings. This less cyclical “tail” in credit suggests that slower growth may not translate into sharply higher defaults. Additionally, defaults have been more skewed toward restructurings/distressed exchanges than bankruptcies and liquidations. This dampens the transmission of stress from credit to the broader economy. While bankruptcies wipe out equity holders and liquidations often lead to significant job losses, distressed exchanges tend to be less disruptive to existing business operations and the labour market.
Private equity firms, grappling with shrinking returns (down to ~6% in 2023) and a subdued M&A landscape, are increasingly resorting to LMEs to preserve their investments. These tactics, often involving preferential treatment for select creditors, can offer a lifeline to distressed companies like Altice USA, Rackspace Technology, and Incora, but leave others holding the bag.
The consequences are far-reaching. Companies engaging in LMEs face elevated re-default risks (4x higher), and investor recoveries suffer. Data paints a bleak picture: recoveries in bankruptcies involving LMEs averaged a mere 47% last year, compared to 60% for those without. The ripple effects extend to the broader high-yield market, creating uncertainty and impacting investor confidence, as seen in the case of iHeartMedia where lenders are organising in response.
In response, investors are forming alliances, but even these are vulnerable to fracture, as witnessed in the PetSmart restructuring where Apollo broke ranks. The Carvana case, where Apollo and PIMCO successfully thwarted a coercive exchange, offers a glimmer of hope, but the overall landscape remains fraught.
As creditor-on-creditor violence, where debt investors elbow ahead of each other to drive negotiations with the sponsor and capture a greater share escalates, the distressed debt market is evolving into a complex game of strategy and survival. Investors must remain vigilant, adapting their approaches to navigate this turbulent terrain. The rise of LMEs underscores the shifting balance of power between companies and their creditors, highlighting the need for sophisticated risk management and a keen understanding of the evolving dynamics in this space. Will this trend dampen the stress or feed through to the broader economy? The answer likely lies somewhere in between. While the prevalence of distressed exchanges may mitigate immediate economic fallout, the lingering uncertainty and potential for re-defaults cast a long shadow. The battle for control in the distressed debt market is far from over, and its full ramifications are yet to unfold.
Thank you Anthony Graham for the analysis.
