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Distress signals—debt exchanges are on the rise

Corporates under pressure are negotiating distressed debt exchanges with their creditors to stave off bankruptcy. Input costs and wages continue to march upwards, squeezing margins. For some, it is too much to service their liabilities.

What can we expect in the months ahead?

1/ There may be fewer distressed debt exchanges, but they’re bigger

So far this year there have only been nine distressed debt exchanges, down from 11 last year and 25 in 2020 during the same period. But it’s the value, not the volume, of these exchanges that worrying.

The total principal exchanged year to date is US$12.5 billion, versus just US$2.3 billion last year. Diamond Sports alone exchanged US$9.3 billion this year, while the rest is split between six issuers: Wesco Aircraft Holdings Inc, Envision Healthcare Corp, U.S. TelePacific Holdings Corp, Fusion Connect, IWCO, and Peabody Energy.

2/ An exchange may give some debt holders the breathing space they need

According to Debtwire, there are at least 10 companies that have either hired advisors or shown risks of pursuing a distressed exchange, those being: Cooper Standard, Dunn Paper, Regis, Envision Healthcare, Vyaire Medical, Service King, Rodan & Fields, Diebold Nixdorf, Serta Simmons, and Hoffmaster.

These exchanges involve debt holders taking a haircut in exchange for moving up the capital structure to a senior, secured tier. That gives creditors a claim to the company’s assets should it hit the wall. For the issuer, they can push out their debt maturity to a later date and with more attractive terms rather than face the gauntlet of refinancing in a difficult credit market.

For example, auto parts supplier Cooper Standard is currently in talks with banks to extend its debt maturities and considering all options including using cash on hand to retire debt. The company has been struggling with steep material costs and high wages.

While the number of exchanges is still relatively low, there is good reason to believe that will change if price pressures persist and consumer sentiment deteriorates further.

3/ Everybody is keeping a close eye on the Fed

It’s hard to see a way out for poorly capitalized businesses, especially those that sell discretionary goods and services—Americans simply have less to spend. The personal saving rate stood at 6.2% in March 2022, the lowest level of after-tax income saved for almost 10 years.

They are also in more debt. According to the Federal Reserve, US household debt increased by US$266 billion in Q1 to more than US$15.8 trillion. That is US$1.7 trillion higher than at the end of 2019, before the pandemic, and equates to around US$47,700 of debt per American.

And interest rates are now rising, encumbering individuals’ ability to service those debts.

Everything hangs on the Fed’s next steps. On the one hand, it has made inflation the primary target of its policy decisions. But it can only tighten so far without hamstringing the government’s ability to service its own debts.

There are early indications that high prices are already destroying demand. In the US, GDP in Q1 was -1.4%. If Q2 closes in the red then the country will be in a technical recession (indeed, it may already be in one). If price growth plateaus and begins to fall, the Fed will have some wiggle room to pivot back to a less hawkish stance.

If that plays out, it may be enough to keep distressed debt exchanges from surging. Forthcoming consumer price index prints are awaited with bated breath.

Distressed debt exchanges YTD 2021

Distressed debt exchanges YTD 2022