The LME I am referring to is not the London Metal Exchange, although there is a nice bull market taking place in a number of commodities. Rather, LME is referencing liability management exercises, in which public and private companies decide their overleveraged capital structures will be unsuccessful, and the best way to reduce debt in lieu of bankruptcy is to engage in coercive exchanges with creditors. Liability management sounds benign, but it’s often a prelude to bond haircuts and/or removing covenants or collateral. The exercises include drop downs, priming and non-pro rata uptiering transactions. It is interesting as it seems quite prevalent now, occurring in a strong credit market with spreads near all-time tights. In these markets, we typically see more straightforward actions such as dividend deals and leveraged recaps — good old-fashioned shareholder-friendly activity that may cause some anxiety for bondholders and the occasional ratings downgrade but don’t pose an immediate existential threat.
Despite low and projected default rates, distressed exchanges in the first quarter 0f 2024 were the fourth-largest quarterly total on record, according to J.P.Morgan.1 The current market features a number of high-profile and large index issuers, such as DISH Network Corporation, Ardagh Group, CommScope, Altice USA, Level 3 Communications and Bausch Health, that may engage or have engaged in LME. The Bloomberg article titled, “Credit-Market Clashes are Getting Uglier, Dirtier and More Common,” identified the trend of adverse creditor-on-creditor and creditor versus sponsor/company situations.2 The article specifically referenced aggressive actions in the J. Crew, Envision Healthcare and Serata Capital Partners structures. Two years later, the aforementioned has been proven to be accurate, and the higher-for-longer interest rate scenario will likely result in more of these situations.
Key Takeaway
Participating in credits where LME is about to occur or has occurred requires a great deal of patience, a tolerance of volatility, a willingness to invest new money and a long-term time horizon. There may be a tradeoff when deciding to engage — similar to a football coach on the cusp of a playoff spot, advising the owner on free agents and focusing on the current year or stockpiling future draft picks in the hopes of a Super Bowl win down the road. Both are viable strategies. The issue with the latter is that if current performance is bad, the coach might not be employed to enjoy the payoff.
Sources:
1J.P.Morgan
2Bloomberg – Credit-Market Clashes are Getting Uglier, Dirtier and More Common; 5/10/22
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