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Accordion’s Quarterly Turnaround & Restructuring Market Update

The Accordion view

Issuance: Leveraged loan and high-yield bond markets were open for business in Q12024, with robust new issuances at levels not seen since 2021. As syndicated spreads tightened to multi-year lows, issuers took advantage and refinanced obligations, including a number of large legacy private credit facilities that were refinanced via leveraged loans during the quarter. Strong issuances additionally allowed issuers to push out maturities — with the 2025/2026 maturity wall now looking significantly more manageable than even just a quarter ago.

Fundamentals: Fundamentals across credit markets still trend positively, with leveraged loan issuers and business development company (BDC) portfolio companies reporting healthy revenue and earnings growth. Interest coverage looks to have troughed in recent quarters, with a continuation of earnings growth and/or rate cuts in 2024 to potentially provide a tailwind to forward fundamentals.

Distress: Credit distress measures across markets generally continue to increase. Leveraged loan downgrades continue to outpace upgrades (as they have since June of 2022), though the ratio has moderated versus prior year levels. Default rates for leveraged loans and private credit are higher than pre-pandemic levels, though below peaks seen in 2020 and 2021, with the leveraged loan distress ratio (measuring the percent of loans trading below 80% of par) above historical medians. Bankruptcy fillings remain on an upward trend — commercial Chapter 11 filings in Q12024 were up 40% versus the same quarter a year ago, and Chapter 7 filings increased 20%.

We continue to expect growth in turnaround and restructuring activity. Increases in distress are likely to be issuer and industry idiosyncratic and not macro-driven —with future rate cuts acting to mitigate distress levels.

Quarterly Topical: Has Interest Coverage Finally Troughed?

In a higher-for-longer rate environment, interest coverage is a critical distress measure. Concurrent with the rapid and sharp rate hike cycle beginning in the first half of 2022, interest coverage levels for BDC portfolio companies and leveraged loan issuers have consistently declined. Recent quarters, however, have shown stabilization — with interest coverage ratios broadly stable from Q32023 to Q12024 across BDCs and leveraged loans.

Across three BDCs that publicly disclose portfolio interest coverage (Ares Capital Corporation, Goldman Sachs BDC Inc, and MidCap Financial Investment Corporation), interest coverage has stayed flat over the last three quarters following approximately six quarters of consecutive declines as rates increased. With respect to leveraged loans, weighted average interest coverage on a sample of outstanding issuers stands at 3.9x, flat quarter-over-quarter and up modestly from the trough of 3.8x in Q32023. The percentage of leveraged loans with cash flow coverage (inclusive of CapEx) below 1.5x has improved to 23% of issuers in the sample, down from 26% in Q32023 and versus a peak of 29% in Q22020. Note, for both BDCs and leveraged loans, interest coverage remains below pre-2020 levels.

BDC portfolio companies and leveraged loans continue to report healthy earnings growth. This, combined with a forward U.S. rate curve projecting cuts in 2024 (per Pensford Financial), and rate cut activity in recent days from major foreign central banks (notably The European Central Bank and The Bank of Canada), indicates that the current period likely represents trough interest coverage levels for this rate hike cycle, with upside for forward fundamentals.

Figure 1 and 2. Source: Company presentations and PitchBook LCD.

CREDIT MARKET UPDATE

Leveraged Loans
Figure 3. Source: Pitchbook LCD. Includes distressed exchanges.

Leveraged loans (measured by the Morningstar LSTA Leveraged Loan Index) returned 2.5% in Q12024, following a 2.9% return the prior quarter. Lower-rated credits drove the bulk of performance, with the CCC Index posting a 5.2% return (2.2% the prior quarter) versus 2% for the BB Index. Issuers took advantage of tightening spreads with $143B in institutional new issuances — almost triple that of the prior quarter ($56B) and the strongest quarter of issuances since Q32021 ($157B). Issuers additionally took advantage of favorable market conditions to extend maturities, with a record approximately $33B in amend-and-extend transactions during the quarter.

Against robust new issuances, however, default activity continues to increase. The LTM leveraged loan default rate (including distressed exchanges) was 4.2%, up from 3.9% the prior quarter and approximately double one a year ago (2.2% for LTM Q12023). Credit rating downgrades continue to outpace upgrades. On a trailing 3-month basis, downgrades outpaced upgrades by 1.6x, though the pace has moderated versus a year ago (2.5x). Q12024 did bring a measure of relief within other distress indicators – the leveraged loan distress ratio (measuring the number of loans trading below 80% of par) ended the quarter at 5.0%, down from 6.4% a quarter ago and 8.8% a year ago, though it remains above the 10-year median value of 3.7%.

High-Yield Bonds
Figure 4. Source: Pitchbook LCD.

High-yield bonds returned 1.5% in the quarter (measured by the Morningstar US High Yield Bond Index), following a 7.1% return in Q42023. High-yield spreads (measured by the ICE BofA US High Yield Index) tightened to 315 basis points, down from 339 basis points the prior quarter and well below Q12023 levels (458 basis points).

Issuers took advantage of favorable spreads with $85B in issuances in Q12024, a 10-quarter high and more than double the prior quarter ($41B). Approximately 75% of issuances in the quarter were related to refinancing of existing obligations after a lackluster issuance market in 2022 and 2023. As with leveraged loans, Q12024 brought a measure of relief with regard to outstanding distress – the S&P US High Yield Corporate Bond distress ratio ended the quarter at 5.4%, down from 5.8% a quarter ago, with the pace of speculative-grade defaults (per S&P Global Ratings) additionally moderating versus Q12023.

Private Credit (BDCs)
Figure 5. Source: Company filings. Average of seven large-cap BDCs.

BDC portfolio companies continue to show resilience with respect to fundamentals. Ares Capital Corporation (ARCC), for example, noted in Q12024 that their underlying portfolio reported LTM weighted average EBITDA growth of 10% — while Blackstone Secured Lending Fund (BXSL) reported 6% LTM EBITDA growth Similarly, the Golub Capital Altman Index (GCAI – measuring median revenue and earnings growth of 110 – 150 companies in the Golub Capital loan portfolio) reported year-over-year revenue and earnings growth of 5% and 11%, respectively in Q12024.

Q12024 additionally brought stability with respect to credit quality – net asset values (NAV) grew modestly quarter-over-quarter, with stability in portfolios’ ratio of fair value to cost. Across a sample of seven large-cap BDCs, non-accruals (defaults) represented (on average) 2.5% of the portfolio at cost – approximately flat versus the prior quarter. Note, this level of non-accrual rates remains below the 2020 peak (3.0% in Q22020) but above pre-pandemic levels. Earnings call commentary additionally notes amendment activity has remained modest and consistent each quarter, driven by strong underlying portfolio company performance.

Bankruptcy & Restructuring

Bankruptcy activity continued to climb in Q12024 with 1,368 commercial Chapter 11 filings — down from Q42023 (1,545) but up approximately 40% versus Q12023 (999 filings). Subchapter V filings showed similar dynamics. Conversely, Chapter 7 commercial filings totaled 3,717, up from both the prior quarter (3,457) and a year ago (3,032).

Restructuring activity at boutique investments banks continues to accelerate. Houlihan Lokey (HLI) reported 35 fee events in Q12024, up from 30 the prior quarter. HLI earnings call commentary noted an expectation “that these elevated [restructuring] levels will continue through fiscal 2025,” matching optimism from peers regarding increased activity.

Figure 6 and 7. Source: Epiq Bankruptcy Analytics and company filings.

Debtwire reported 425 restructuring mandates in Q12024 – approximately in-line with the prior quarter (441 mandates). Though this mandate count is materially lower versus Q12023 (636 mandates), it continues to represent a significant uptick over the muted levels seen in late 2021 / 2022, where reported mandates averaged approximately 350 per quarter. Mandates in Q12024 were spread across 94 companies — with activity most concentrated in Healthcare (20 companies), Industrial Products (13), and Retail (8).

Conclusion

Q12024 distress trends remain consistent with prior quarters; defaults and bankruptcies continue to increase off the abnormally low levels experienced in 2021 and 2022, and downgrades outpace upgrades. Liquidity conditions, however, have improved versus the prior quarter as open debt markets allowed issuers to refinance higher-cost obligations and push out maturities. Assuming borrowers continue to post revenue and EBITDA growth at levels seen in recent quarters, rate cuts later in 2024 should provide an additional boost to company liquidity and drive interest coverage off current trough levels. In the interim, we expect to see above-average restructuring activity levels in the healthcare, restaurant, and consumer sectors.


Additional Sources
  1. Pitchbook LCD
  2.  S&P Capital IQ Pro
  3. Company earnings call transcripts and presentations
  4. Debtwire
  5. Epiq Bankruptcy

About the Authors

Accordion's Turnaround & Restructuring Team
Accordion's Turnaround & Restructuring Team
Insights written by: Pat O’Malley, Jake Pechukas, and Will Bryce

Accordion's Turnaround & Restructuring team is comprised of seasoned restructuring, reorganization, and turnaround professionals who identify the factors contributing to cash flow and liquidity issues, rescue companies in crisis, and set them on a path from value stabilization to value creation. The team works directly with the company’s ecosystem of stakeholders to present the best options to resolve the business-threatening event. Once the immediate crisis is averted, the team engages in either a consultative or management role to implement the strategic changes needed to improve EBITDA, turnaround overall business performance, and deliver on the value thesis.   Read more

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