Rising rates and weaker trading sound like a toxic recipe for heavily indebted corporates, but debt advisory specialists say an expected wave of restructurings has so far been averted, thanks to a string of opportunistic refinancings.
“Levels of distress have perhaps been lower than expected at this point,” said Christian Savvides, global co-head of debt advisory at Rothschild & Co. This was partly because many borrowers remained on fixed-rate agreements for now.
“The impact of rising rates on debt issuers has been staggered. Many borrowers are partially hedged or can absorb several quarters of higher interest payments before the additional cash cost catches up with them,” he told IFR. Another factor is that borrowers don’t face strenuous tests from lenders.
“Compared to previous downturns, more borrowers either have no covenants or just a leverage test with significant headroom and they can absorb the additional debt service cost until they either need to refinance or the cashflow pressure becomes unsustainable,” Savvides said.
Companies that have so far decided to embark on full-scale restructurings have tended to be smaller and medium sized, with less resources and fewer options than larger corporates.
“Distress is much more marked across small and medium-sized corporates. Their default rates are much higher. Larger corporates are able to hedge and organise themselves much more easily and are just less volatile,” said Andrew Wilkinson, a partner and co-head of restructuring at law firm Weil.
That said, Weil has published a survey showing there are increasing signs of distress looming across Europe. The survey said the UK and Germany were geographies to watch and real estate and consumer sectors to focus on. “It is inevitable the default rate will rise,” said Wilkinson.
"Amend and extend"
France has seen some large restructuring cases emerge, such as of care home operator Orpea and supermarket chain Casino. Wilkinson said more might follow now the “extraordinary” government support during last year’s energy crisis looked likely to fade away.
Debt advisers said it was only when loans needed to be refinanced that problems might emerge. So far, many facing such hurdles have chosen to take pre-emptive action to confront them well ahead of when they need to make such a move. Private companies have led in this regard.
“We are now helping many of our clients revisit their capital structure, reset covenants or amend and extend credit facilities,” said Savvides. “Many companies took on significant leverage in a low rate environment and now find themselves over-levered at current rates.
“Some have more time than others and it has led to a wave of strategic options analysis – some turn to shareholders for equity to pay down debt, others are bringing in new capital or converting some of their existing debt into PIK notes, preference shares or equity.”
Savvides said some were also considering asset disposals in order to delever, and some cases were proving trickier than others, saying: “A particular challenge has been working around CLOs that cannot extend as they are outside their investment period.”
While in many cases a syndicate of bank lenders might be happy to extend maturities on a facility in return for higher margin, a CLO fund might be reaching maturity itself, meaning this was not an attractive option for them.
In some instances, such reluctant lenders might be dragged into an amend and extend deal by using “you snooze, you lose” provisions in loan documents that allow a minority lending syndicate member who does not object to a proposal from being forced into the new deal.
Fitch said similar liability management transactions were likely to increase for larger leveraged issuers too, with the primary market remaining quiet, and that could potentially affect minority holders.
“Liability-management transactions can materially affect creditor recoveries, particularly for minority lenders that may not have the ability to participate in the transaction or roll over existing debt into the new structurally or contractually senior tranches,” said Joshua Clark, a director at Fitch.