2023 and the start of 2024 presented challenging economic conditions to the market, with debt costs at a historic high. Following a series of increases over the last two years, the Federal Reserve’s federal funds rate is currently 5.25% to 5.50%, its highest levels in decades. Between regional bank failures in the spring of 2023, the current election cycle, and tighter credit conditions, borrowers and lenders are approaching an uncertain market by entering into more loan workouts, rather than entirely new loan deals.
Refinancings, repricings, and “amend and extend” transactions—otherwise known as “pray and delay” transactions—dominated the loan market in 2023. In 2023, institutional refinancing transactions increased by 141%, while amend and extend transactions reached $175.9 billion (reflecting an increase of more than $65 billion over the previous record of $110.1 billion set in 2021).[1] Amend and extend transactions saw a similar trend over the past year: Given higher debt costs in the current environment, borrowers are requesting more extensions in their repayment schedules than usual. In amend and extend deals, borrowers and lenders agree to push out maturity dates on an existing loan in exchange for certain loan modifications, usually covenant changes and/or increased fees. In total, repayment schedules have been extended on $114 billion worth of U.S. loans in the past year—the highest since 2009.[2]
On the other hand, loan default volumes reached $50.5 billion and corporate bankruptcies soared in 2023. The leveraged loan default rate rose from 1.6% in 2022 to 3.04% in 2023, according to Fitch Ratings. And according to S&P Global Market Intelligence, 642 companies filed for bankruptcy in 2023, reflecting an increase of 72.5% from 2022 and more than in any of the last three years.
The increase of bankruptcy filings also ushered in more debtor-in-possession (“DIP”) financings beginning from early 2023 through the end of the year. DIP loans are an avenue in which companies in chapter 11 bankruptcy may seek post-petition financing to continue their operations. In return, the DIP lender receives certain protections under the Bankruptcy Code, such as being granted a senior position on liens on the debtor company’s assets ahead of previous lenders, earning a premium interest rate, and insight into a distressed company’s operations through a court-authorized budget, along with any additional comfort measures approved by the bankruptcy court.
Outlook for 2024 and Beyond
Rates are expected to hold steady for the time being, with many economists predicting a rate cut no earlier than September of this year.[3] Lenders should expect a continuation of opportunistic-type transactions described above, such as borrower requests to enter further amend and extend and refinancing transactions.
For lenders considering loan accommodation and workout arrangements with existing clients, below are a few considerations it may choose to leverage:
- Added Support: Consider requiring the addition of new guarantors, as well as additional collateral support to secure the extended, amended, or new facility;
- Lien Searches: Secured lenders should conduct lien searches prior to extending new facilities to ensure any new collateral support would not be primed;
- Loan Document Review: Review original loan documents for any errors in documentation as well as for more substantive deficiencies, such as ensuring provisions regarding remedies are in order (e.g., revising the loan agreement and the security documents to cross-default and cross-collateralize the facilities);
- Covenant Refresh: Amend financial covenants to increase reporting, or add new covenants entirely, such as requiring engagement of financial advisors or consultants if necessary;
- Fees and Repricing: This is a natural juncture to consider repricing of facilities and requirement of amendment fees;
- Insurance: Confirm that all required insurance coverage is in effect and will remain in place through any renewal period;
- Repairs and Maintenance: For depreciating collateral, the borrower should demonstrate adequate cash flow or reserves to address necessary collateral repairs or improvements during any extension; and
- Business Plan/Continuity: Carefully consider the borrower’s projections and business plans for operations during the renewal period with an eye toward any risks that may erode loan-to-value ratio.
In light of current trends, lenders should seek legal counsel familiar with loan workouts to ensure its business decisions are legally sound and loan documentation is airtight, particularly when dealing with a series of modifications in a credit facility. In other cases, loan restructurings may involve bankruptcy proceedings, in which case legal professionals will be essential in assisting lenders through the bankruptcy process to protect their rights and interests. Lenders should also seek counsel familiar with creditors’ rights to ensure they are lawfully navigating the bankruptcy process and that they are maximizing their chances of a successful outcome in the case.
[1] Amid accommodating investor market, leveraged loan amendment activity soars anew – PitchBook
[2] “Pray and delay” is back as debt costs soar | Semafor
[3] When will Fed cut interest rates in 2024? Here’s what 100 economists say in Reuters polls | Reuters
