High yield bond and leveraged loan issuance for restructurings across the United States and Western and Southern Europe has climbed 65% year-on-year, up from US$29.1 billion for the first nine months of 2019 to US$48 billion over the same period this year.
The first three quarters of 2020 also represent the three biggest quarters for restructuring issuance, in terms of value, across North America and Western and Southern Europe since Debtwire Par began tracking the data in 2015.
The uptick in restructurings has tracked similar increases in bankruptcies and defaults throughout 2020.
In the US, the number of Chapter 11 bankruptcies climbed 26% in the first half of 2020 and global credit insurer Coface is forecasting a double-digit percentage increase in insolvencies across Europe’s largest economies this year and into 2021.
Ratings agency Fitch, meanwhile, sees US loan default rates holding at 5% annually until at least 2022 and expects European loan defaults to rise to 3.8% for the year, up from pre-pandemic forecasts of 2.5%.
Mixed picture
Despite these increases, the rise in restructuring activity and corporate distress has not been as extensive as anticipated when COVID-19 lockdowns began.
Government stimulus packages, central bank action, plentiful pockets of capital in the credit markets and the relative patience of many lenders have offered businesses some protection from the worst of the COVID-19 fallout. The fact that many borrowers had negotiated debt on permissive terms pre-pandemic—cov-lite institutional loan issuance has accounted for around three-quarters or more of annual US loan issuance since 2017—also softened the impact of COVID-19 on borrowers with the luxury of long-dated maturities.
In certain situations, lenders have also been reluctant to push for a restructuring when the exit route or recovery prospects from a workout scenario are highly unclear. Additionally, lenders to certain sectors have been hesitant to take over the operation of assets. In aircraft leasing, for example, lenders have been cautious about foreclosing given that there are currently limited options for redeploying aircraft assets.
Distress and restructuring activity has centered primarily on a cluster of sectors directly impacted by lockdowns, such as retail, transport, automotive and oil & gas, rather than the entire economy. According to Debtwire Par, close to a third (31%) of US restructuring cases in September were in the oil and gas sector, with transportation (8%), automotive (7%), retail (7%) and food and beverage (7%) the next highest ranked.
Some credits, such as J.C. Penney in the US and Debenhams in the UK, were already in difficulty pre-pandemic and were tipped over the edge by COVID-19. There are also instances where credits in the same industries, under the same pressures, have faced vastly different levels of distress and, consequently, have differing restructuring needs.
Large restructurings over the past year or two, meanwhile, tend to have been characterized by ad hoc or one-off circumstances of the credits—e.g., the Windstream chapter 11 filings commenced following an adverse federal court ruling, and the PG&E chapter 11 filings commenced following a series of harmful wildfires.
Clarity on valuations crucial
Overall, most distressed situations have been bespoke. Where businesses have been able to secure shareholder or government support and credit or forbearance, there has been space to avoid restructuring proceedings.
In cases where it has been impossible to avoid a restructuring, however, many companies have been able to buy enough time to get their affairs in order and put a recovery plan in place before filing for bankruptcy protection.
In September, for example, fewer than half of the 26 bankruptcy proceedings tracked by Debtwire Par’s Restructuring Database were free fall situations, where a liquidity event forces a debtor immediately into bankruptcy. In most situations, debtors were able to arrange pre-pack plans, pre-arranged plans or pre-filing processes, all of which involve borrowers negotiating the terms and plan for recovery with their main stakeholders before filing.
Auto parts manufacturer Garrett Motion, for example, filed for chapter 11 this fall after agreeing to a US$2.1 billion “stalking horse” sale agreement that it intended to serve as a reserve bid to underpin a competitive sale process during the bankruptcy proceedings.
Establishing business values in restructurings, however, is a challenge in volatile markets and can restrict workout options and heighten litigation risk. Until a clearer picture emerges of how company earnings are likely to fare post-COVID-19, restructuring proposals are likely to be subject to an enhanced degree of scrutiny from junior creditors.
J.C. Penney’s plans to split into an operating company and property company, for example, have been challenged by one of its lenders, Aurelius Capital. Aurelius holds 5.6% of the company’s debtor-in-possession claim and just under a fifth of its first-tier debt. Following months of negotiations between creditor groups, Aurelius is still not satisfied with the attribution of value in the recovery plan.
Even if valuations do settle and workouts can progress, ultimately overall restructuring volumes will only slow if revenue rebounds to pre-pandemic levels. In the event of additional waves of COVID-19 and further lockdowns, even credits that have been able to survive these initial rounds of dislocation may struggle.
