Struggling Companies and Lenders Hit the Negotiation Table

According to data from PitchBook, corporate bankruptcy filings in June lifted the default rate of the Morningstar LSTA US Leveraged Loan Index to 1.71%, up from 1.58% in May. That marks an increase of 143 basis points from where the index stood a year ago. Broadly speaking,
the number of bankruptcies that end up in court is still relatively low, thanks to a bigger focus on workouts and refinancings. Still, there have been a few high-profile cases in the headlines, including Bed Bath & Beyond, Serta Simmons Bedding and Cyxtera Technologies.

Sources say that bankruptcies and restructurings are impacting a wide range of industries, although there are some with more activity than others. Retail, aerospace and healthcare have all been hotspots recently. Because of secular trends, retail and healthcare tend to run nominally higher in terms of the number of filings, regardless of economic conditions.

Amend and Extend

When it comes to process, Ann Pille, a partner at law firm Reed Smith who focuses on restructuring, says that companies and lenders are trying to exhaust other options before going to court. “It depends on the appetite of the lender, but a forced sale can be very expensive,” she explains. “If you’re going to court over a bankruptcy— unless there is a clear plan going in—it can be very expensive and there are a lot of things that are out of everyone’s control at that point. You’re leaving a lot of business decisions up to third parties and a bankruptcy judge.”

If a company has a pathway through trouble, Michael Krakovsky, managing director in investment banking at Stout, says amending and extending loan agreements is still possible. In this situation, borrowers may be able to extend the maturity of a credit agreement by several months. All or part of the loan may also be repriced to current market rates. These transactions are offered in lieu of refinancing and may give borrowers some breathing room.

“Lenders are willing to go along if there’s a story right now,” Krakovsky says. Apart from the cost of a forced sale, he adds that “there’s not much of a market to sell into right now if you want to maximize the value of that sale.”

Lenders are willing to go along if there’s a story right now.

Michael Krakovsky

Stout

Pille notes there is also a public relations aspect to lenders’ math. “If you look at recent cases, judges have been siding with borrowers if it’s not a substantial default,” she says. “Lenders also don’t want to look like they are the ones shuttering businesses. That’s been true since COVID; there is much more willingness to try and be flexible where they can.”

Some issues may not always warrant harsh legal remedies, Pille adds. She is seeing more covenant defaults, for example, in which a borrower defaults on loan terms but not on loan payments. When a company defaults on covenants, that can often be a precursor to a default on payments and may prompt lenders to ask for additional disclosures or a second look through financials to understand whether the covenant default might lead to something bigger. However, in many cases, companies can fix a covenant default without going into bigger financial trouble. Lenders, in turn, must balance how aggressive they want to be about pursuing remedies.

In Bed Bath & Beyond’s case, for example, the company announced in regulatory filings that its failure to meet its financial covenants with JP Morgan triggered a default.

In another example from June, a group of creditors reportedly sent a notice of potential default to Swedish property group SBB, saying it failed to meet one of its covenants requiring the company to cover interest payments, which could trigger a default if not resolved. The company issued a statement shortly after, saying it had met its consolidated coverage requirements.

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The ability of a company to make payments often indicates its ability to repay the entirety of the loan. Typically when a covenant is breached, a lender will issue a notice of the breach. At that point, the company is required to resolve the issue, come up with a plan to resolve it, or notify the lender that the default indicates a bigger problem.

“We’re seeing lenders make new calculations in the face of covenant defaults,” Pille says. “They’re looking at what options are available, and it may be difficult for a company to extend loan maturity if they have defaulted on a covenant or if there are messy financials. It’s still happening, but companies may not always like the terms that lenders ask for.”

Robert Del Genio, senior managing director in restructuring for FTI Consulting, agrees. He notes that rising rates are putting extra pressure on companies. “The total cost of capital is higher, obviously,” he says. “But if you were to look back at loans several years ago, lenders would’ve wanted borrowers to hedge that debt. A lot of the debt right now is unhedged, so the rise in rates is having a bigger impact.”

Del Genio adds that many companies have less runway than they did before rates increased. “We’re seeing companies come to us for restructuring advice that have a couple of months of liquidity—sometimes it’s just a few weeks. That really limits a company’s options when they go into a restructuring negotiation,” he says.

Indeed, this is one of the issues emerging in trucking company Yellow Corp.’s bankruptcy filing. As of August, the company is considering bankruptcy loans from a number of lenders, a move that came as a surprise because there was a loan offer on the table from Apollo Global Management. Apollo had already loaned Yellow $501 million before it filed for bankruptcy. However, according to reports, Apollo’s proposal gives Yellow 90 days to wrap up its asset sales and move forward—a timeline the company says isn’t long enough. Apollo is also seeking veto rights on those sales, which could make it harder to comply with the 90-day time limit.

Yellow says it hopes that by entering into a competitive financing process, it can come away with better terms, according to a report from Reuters.

Other Lifelines

For privately held companies, the pathways to restructuring or bankruptcy look similar to those of public companies, although general partners may have additional options for a company that’s under pressure but not distressed just yet.

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Brian Forman, partner and chair of the investment funds and advisors practice at law firm Morrison Cohen, notes that there has been a rise in single-asset vehicles housing performing assets that sponsors may not want to sell into a challenging market. He is also seeing a rise in net asset value lines, which GPs can use to distribute cash back to investors if they haven’t exited assets or paid distributions. These lines may also be used to cover other expenses.

“We’re seeing sponsors consider all of the options before them right now,” says Forman. “Some investors are still dealing with the denominator effect and would like to see some cash back. That can be difficult when exits begin to slow.”

Steven Cooperman, chair and co-managing partner in Morrison Cohen’s corporate department, notes that he’s heard from one sponsor asking about ways to extend the life cycle of a fund without resorting to either of these options. “That pathway is less clear,” he says. “When the manager finds out that they might not get a management fee during that period or there will be a lot of negotiations with investors to approve the extension, they may not want to go that route.”

Bailey McCann is a business writer and author based in New York.

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