Distressed exchanges to hit all-time high of $50bn this year
“Distressed exchange” volume is on track to hit a record high this year, as covenant-lite lending has paved the way for more liability management exercises (LMEs).
Covenant-lite lending has become more prevalent in the upper-middle market, as private credit managers compete with the broadly syndicated loan market for larger deals.
Steve Tesoriere, co-portfolio manager of Oaktree Capital’s value opportunities strategy, said that covenant-lite debt “allows these LMEs to happen”.
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“So oftentimes, when we say covenant-lite debt, we’re referring not only to the covenant itself, but the actual broader language of these credit agreements today that allows companies to take assets that are theoretically secured and move them away from the current creditors,” he said. “So the LMEs are occurring because of the looseness of the documents as a whole.”
Distressed exchanges are an alternative to companies restructuring their debts in a bankruptcy court, whereby the firm will negotiate a new deal with creditors, typically at a reduced value to existing debt to prevent default.
Tesoriere noted that the average default rate in the high-yield, leveraged loan market is around 1.5 per cent, which is low compared to a historical average of three per cent.
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But if you include distressed exchanges in that number, today’s default rate is around 4.25 per cent, which Tesoriere said is “actually above normal, what you might expect in a high interest rate environment.”
“So we are seeing companies today utilize distressed exchange much more frequently than in past times,” he added.
Tesoriere cited data which showed the market is reflecting around $35bn (£26.8bn) of distressed exchange volume this year to date, which is the equivalent to 2008 during the global financial crisis, and is pace to reach $50bn this year – an all-time high.
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Additionally, Tesoriere noted that one third of LMEs happening this year are from previous LMEs.
“So we’re seeing LMEs on LMEs, and I think again, the relative strength of the economy and the easy access to capital with credit spreads near all-time lows is allowing these to happen,” he added. “As you see credit spreads widen, you see less access to capital, you see more Chapter 11s [bankruptcies] over LMEs into the future.”
