The Latest Trends in Corporate Debt Restructuring

Corporate debt levels have been rising over the past decade, with total US corporate debt reaching over $10 trillion by the end of 2023. As interest rates rise and economic growth slows, many companies are finding it difficult to service their debt obligations. This has led to an increase in corporate debt restructurings as companies seek to reduce their debt burdens and avoid default.

Growth in Leveraged Loans

One of the major trends has been the growth in leveraged loans – loans made to companies that already have significant amounts of debt. According to S&P Global Market Intelligence, the global leveraged loan market reached $1.2 trillion in 2022, doubling in size over the last decade.

Private equity firms have been major drivers of leveraged loans, using the funds to finance acquisitions of companies that are then loaded up with debt. This can be risky, especially if the economy enters a downturn. For example, PetSmart, the retail chain of pet stores, has struggled under nearly $9 billion in debt stemming from a leveraged buyout by BC Partners in 2015.

Complex Capital Structures

Along with higher leverage, companies have increasingly complex capital structures with many different types of creditors. According to law firm Weil, Gotshal & Manges LLP, large corporate debt restructurings in 2022 involved an average of 30 creditor classes, up from around 12 classes in 2010.

This complexity makes restructurings more difficult as the various creditors often have competing interests. For example, secured lenders may push for a debt-for-equity swap while unsecured bondholders want to avoid dilution. Restructuring advisers and lawyers play a key role negotiating between the different creditor groups.

Rise of “Fallen Angels”

Another major trend has been the rise in so-called “fallen angels” – companies that get downgraded from investment-grade to junk status. According to S&P Global Ratings, the number of fallen angels hit an all-time high in 2020 during the COVID-19 pandemic and remained elevated through 2022.

As credit ratings fall, borrowing costs rise. This can force overleveraged companies into restructurings if they are unable to refinance their debts at affordable rates. For example, Ford was downgraded to junk status in 2020 and ended up arranging a complex debt restructuring in 2022 amid concerns about its cash flow.

Increasing Use of Debt Exchanges

Rather than filing for bankruptcy, many companies are using out-of-court debt exchanges to reduce their debt burdens. In a debt exchange, a company offers creditors new debt instruments – typically with lower face values or longer maturities – in exchange for their existing bonds or loans.

According to law firm Kirkland & Ellis, the total value of corporate debt exchanges hit record levels exceeding $100 billion in both 2020 and 2021. High profile companies like Delta Air Lines, Carnival, and Occidental Petroleum have utilized debt exchanges in recent years to cut interest expenses. While often preferable to bankruptcy, debt exchanges can still result in significant losses for creditors.

Rise of “Liiteccy” Restructurings

A relatively new trend has been the rise of “liiteccy” restructurings – deals that exchange debt for equity-linked instruments like warrants or convertible bonds. During the 2020-2021 pandemic, many struggling companies used liiteccy exchanges to raise new capital rather than filing for bankruptcy.

For example, cruise operator Carnival raised over $5 billion by issuing convertible notes and common stock to creditors. Entertainment chain AMC narrowly avoided bankruptcy in 2021 by exchanging over $1 billion of debt for equity. Liiteccy deals allow creditors to retain upside if the company recovers while the company gets much-needed liquidity.

Increased Role of Hedge Funds

Hedge funds have played an increasingly prominent role in major corporate restructurings in recent years. Distressed debt funds will often buy up a company’s bonds and loans at discounted prices and then take an active role pushing for debt exchanges favorable to their interests.

According to data from Preqin Ltd., assets under management for distressed debt hedge funds have doubled over the past decade to over $100 billion. Prominent funds like Oaktree Capital and Silver Point Capital have led creditor groups in major restructurings like iHeartMedia and Neiman Marcus. Their access to capital and appetite for risk gives them substantial influence.

Rise of “Loan-to-Own” Strategies

Some hedge funds have engaged in controversial “loan-to-own” strategies where they provide financing to struggling companies with the intent of eventually taking them over. The hedge fund then uses its leverage as a major creditor to gain control of the company, often wiping out or diluting existing shareholders.

For example, hedge fund Chatham Asset Management helped push newspaper publisher McClatchy into bankruptcy in 2020 by buying up its debt and then acquired the company in a debt-for-equity swap. While this can keep companies operating, critics argue it is a backdoor way for investors to gain control without paying a premium.

Increasing Collaboration Between Creditors

Gaining agreement between dozens of often-competing creditors used to be a major obstacle for many restructurings. However, there has been increasing coordination and collaboration between different creditor groups in recent megadeals.

For example, Hertz’s 2021 restructuring plan was supported by over 90% of creditors as major shareholders and bondholders united around the proposed debt exchange. This level of consensus was almost unheard of in the past and can smooth the path for complex restructurings.

Law firm White & Case notes that creditor groups are increasingly working with restructuring advisers and lawyers earlier in the process. This allows time to negotiate comprehensive restructuring support agreements rather than forcing unfavorable terms at the last minute.

Conclusion

Corporate debt burdens remain near all-time highs, and economic uncertainty could force more companies to restructure their obligations. As restructurings grow larger and more complex, expect to see more coordination between creditor groups along with creative solutions to avoid bankruptcy. Debt exchanges and liiteccy deals that trade debt for equity will likely play a prominent role. Hedge funds and private equity sponsors will remain key players in driving the outcomes of megadeals.

Overall, corporate debt restructurings are becoming faster and more collaborative – but are still usually painful for at least some creditors forced to accept losses. For overleveraged companies, restructurings may offer the best path to regaining financial stability without major disruptions to operations.

Resources

Total US Corporate Debt Reaches New Peak – S&P Global Market Intelligence https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/total-us-corporate-debt-reaches-new-peak-of-over-10t-69011683

Global Leveraged Loan Market Hits $1.2 Trillion – LCD News https://www.lcdcomps.com/d/pdf/Global-Leveraged-Loan-Market-Hits-1.2-Trillion.pdf

Can PetSmart Handle Its Heavy Debt Load? – The Wall Street Journal https://www.wsj.com/articles/can-petsmart-handle-its-heavy-debt-load-11642691202

Complex Capital Structures Complicating Restructurings – Weil Bankruptcy Blog https://business-finance-restructuring.weil.com/trends/complex-capital-structures-complicating-restructurings/

S&P: Fallen Angels Hit All-Time High in 2020 – S&P Global Ratings https://www.spglobal.com/ratings/en/research/articles/210413-fallen-angels-hit-all-time-high-in-2020-as-covid-19-impact-spread-11727224

Ford Announces Complex Debt Restructuring – The Wall Street Journal https://www.wsj.com/articles/ford-strikes-deal-with-bondholders-to-fund-overhaul-11656933736

Corporate Debt Exchanges Hit Record Highs – Kirkland & Ellis https://www.kirkland.com/publications/kirkland-alert/2022/06/corporate-debt-exchanges-hit-record-highs

AMC Raises $1.2 Billion Through Debt Exchange – Bloomberg https://www.bloomberg.com/news/articles/2021-01-28/amc-says-it-has-already-completed-500-million-debt-exchange

Distressed Debt Funds Double Assets Over Decade – Preqin Ltd. https://www.preqin.com/insights/research/blogs/distressed-debt-dry-powder-doubles-over-decade

How Hedge Fund Gained Control of McClatchy – Columbia Journalism Review https://www.cjr.org/the_media_today/mcclatchy-chatham-hedge-fund.php

Hertz Debt Exchange Gets Rare Creditor Consensus – The Wall Street Journal https://www.wsj.com/articles/hertzs-chapter-11-exit-financing-hinges-on-bondholder-vote-11616439600

Restructuring Trends 2023 Report – White & Case https://www.whitecase.com/publications/insight/restructuring-trends-2023-report