Ready for restructuring

White & Case LLP


  • Rising interest rates and reduced refinancing options are increasing the likelihood of restructuring and financial distress in the next 12 months
  • Cov-lite debt packages have given borrowers breathing room, but may conceal underlying distress
  • Issuers in stable sectors have negotiated amend-and-extend (A&E) deals to push out maturity cliff edges, but not all borrowers have that option

Borrowers and lenders have dusted off their hard hats and rolled up their sleeves in anticipation of an increase in restructuring and distressed debt situations in 2023.

For the first time in more than a decade, European leveraged finance markets, private equity (PE) sponsors and management teams are feeling the pressure from rising interest rates on capital structures, introduced to stem the steady rise in inflation.

The build-up of cash during more benign market conditions in the past 18 months, coupled with the fact that borrowers took advantage of buoyant debt markets in 2021 to refinance and extend maturities, shielded credits from the immediate impact of rising interest rates in 2022.

In 2023, however, market conditions have worsened materially as the full impact of the cost of living crisis and the ongoing war in Ukraine begin to bite. Higher interest payments are now taking a toll on cashflow and the option to refinance out of a tight spot is no longer on the table, with leveraged loan and high yield bond issuance earmarked for refinancing down by 51 per cent and 79 per cent respectively in 2022. High yield funds, meanwhile, have faced significant outflow through the course of 2022, limiting the capital available for refinancing.

According to Refinitiv Lipper, in the first nine months of 2022, the outflow from global bond funds had already reached its highest level in 20 years, at US$175.5 billion.

As these headwinds intensify, many borrowers that were once in a relatively comfortable position when it came to servicing capital structures may find themselves stretched. And borrowers that are running out of cash can no longer bank on raising new financing with relative ease.

Exploring options

Debt packages issued in the past five years have few or no covenants, so lender protections that might have triggered an early warning are not in place, thereby concealing underlying problems

As pressures mount, the first ripples of distress are already being felt. Bankruptcies and corporate insolvencies in the EU and the UK recorded double-digit increases in 2022 and, according to forecasts from Allianz, the UK, France and Germany may see business insolvencies climb by 29 per cent, 10 per cent and 17 per cent respectively in 2023.

According to Fitch Ratings, meanwhile, European credit defaults are expected to more than double in 2023, with high yield defaults forecast to rise from 0.7 per cent in 2022 to 2.5 per cent by the end of 2023, and leveraged loan defaults set to climb from 1.3 per cent to 4.5 per cent during the same period.

There is also likely to be a cohort of borrowers that do not appear to be in obvious distress but may be feeling the squeeze behind the scenes. Debt packages issued in the past five years have few or no covenants, so lender protections that might have triggered an early warning are not in place, thereby concealing underlying problems. As a result, some borrowers may not immediately seek out covenant waivers and facility amendments from their lenders. But when challenging market conditions really take hold, those same borrowers will be facing even more critical concerns as facility maturities approach and cash begins to run out. Restructuring under those circumstances will likely be more difficult and the financial pain suffered by borrower and lender alike could be significant.

The fact that most borrowers took the opportunity to refinance and do not have to meet covenant tests, however, has given them some breathing room. Many are now exploring their options proactively to avoid a potential full-blown restructuring or insolvency down the road.

Borrowers facing maturities in the next 12 to 24 months are already undertaking exchange offers and amend-and-extend deals that offer a mix of higher coupons, refreshed call protection, improved covenant packages, better collateral protection, equity injections and debt paydowns in return for extending maturity runways. PE-backed generic pharmaceuticals group Stada and consumer finance group NewDay were among the first borrowers to bring forward amend-and-extend options, followed by a string of companies taking the same path.

Some PE sponsors may also agree to put additional capital into a portfolio company, but ideally only if that capital can go in at the top of the capital structure as super-senior debt. Lenders are adopting a similar playbook when injecting additional funding into businesses following debt-for-equity swaps.

Barings and Farallon Capital Management, for example, swapped a portion of the debt they held in UK cinema chain Vue for equity, and injected an additional £75 million of cash into the business in the form of a super-senior term loan.

Distressed debt investors ready to step in

Borrowers that move early to head off restructuring risk early will likely be in the best position to renegotiate debt packages consensually with lenders. The timing may be ideal, as many lenders will be open to supporting liability management plans rather than crystallising losses or facing the reputational risks that come with enforcing a restructuring.

Given the relatively borrower-friendly terms in recent debt documents, it is possible to imagine a wave of "stage 1" restructuring processes in 2023 where lenders agree to a degree of short-term relief. This may include limited debt service relief or injecting new capital on a senior basis in return for more traditional lender protections being re-inserted in the debt documents. These may include financial covenants or allow lenders to trade their debt more freely.

Not all credits, however, will be able to undertake amend-and-extend (A&E) deals. To date, successful A&E transactions have been brought forward by companies that are performing well and based in stable sectors, such as healthcare, infrastructure and TMT. An A&E deal brought forward by French medical diagnostics company Sebia, for example, was well received by existing and new lenders.

Borrowers also must ensure that any amendments to pricing and terms are attractive enough to get lenders onboard. For example, Debtwire Par reports that one lender decided against getting behind an extension deal brought forward by UK sports betting company Entain because the pricing was deemed to be too tight.

PE firms, meanwhile, are expected to triage portfolios and only invest resources in liability management exercises when portfolio companies are expected to return to growth in the medium-to-long term. There will be limited appetite from sponsors to inject equity and time resources into companies that are unlikely to improve in the year ahead. Parties are also grappling with the challenges presented by CLO investors that are unable to extend their investment periods due to underlying constitutional restrictions.

Credits trading at deep discounts to par will also be on the radar of distressed debt investors. Many will be preparing to buy up debt at a discount with a view to selling on the paper when prices recover, or positioning themselves to transfer debt positions into equity ownership if borrowers run aground and run out of cash. Specialist players will also manoeuvre into capital structures by offering to inject more cash into a business if their capital can sit at the top of the structure.

With the likes of J.P. Morgan and Zetland Capital both closing funds focused on investments in troubled businesses in 2022 and established distressed investment players Oaktree Capital Management and GoldenTree Asset Management approaching investors for additional capital, distressed debt players are set to play an increasingly prominent role in debt restructurings in the year ahead.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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