How to make the most of resilient capital markets
and an extended runway
Overall, the U.S. economy has performed stronger than many
expected in 2023, and the Fed may be close to pulling off its
elusive “soft landing,” bringing inflation under control
while avoiding a recession.
The strong economy and capital markets have been a boon to both
consumers and corporates. Credit markets, even for lower-rated
companies, have been resilient over the past few months and
sponsors continue to get deals done. Refinancing activity,
distressed exchanges, and liability management exercises have
pushed out many of the normal liquidity and debt wall triggers that
lower-rated credits would otherwise face. Double-dips, drop-downs,
and other creative financing tools are being used with increasing
frequency, buying both time and optionality.
As borrowers look to access these markets while the window is
still open, they must understand the consequences of increased
capital costs and take advantage of the newfound runway to
implement operational changes.
Markets are resilient…but at a cost
Although Chairman Powell’s recent comments signaled a freeze
to additional rate hikes in the near term, he demonstrated the
Fed’s determination to keep rates higher for longer. The strong
Q3 GDP print adds further uncertainty to future rate moves and
markets will continue to watch closely for signs indicating that
the Fed may truly pause or instead continue increases. As the
markets continue to digest the higher for longer mantra, interest
rates continue to set decade-long highs with the 10-year yield
crossing the 5% threshold for the first time in 16 years and lower
rated credit yields reaching peaks not seen since the 2008
Given this environment, perhaps it’s no surprise that
bankruptcies are also on the rise. Through October, U.S.
bankruptcies are at their highest levels since the pandemic (Figure
2) and may end the year at levels not seen since 2010.
However, much of the increase is a result of smaller companies
and those in the real estate sector, in particular, feeling the
Larger corporates, with access to creative financing options,
have tapped the markets more readily, buying themselves time and
optionality outside of court.
Lower rated companies who are evaluating refinancing options
need to be aware of the potential cost. Currently, speculative
grade credits who have sizable maturities in 2024 and 2025 have an
average coupon rate of 5.6%, however, the average yield for those
same borrowers now averages 8.7% as markets factor in individual
credit concerns and account for the recent shift in the wider
interest rate environment1. Additionally, the average
coupon on refinanced loans for similarly situated, speculative
grade credits, has averaged 8.4% over the past 6
Borrowers must be acutely aware of the fact that their actual
cash interest payment may increase by 3%, or more, when considering
their options, especially crucial for companies facing business and
Evaluating your options; liability management will no doubt be
For companies evaluating their options to tackle near term
maturities, many will have discussions about various liability
management transactions available based on the specific structure
of their credit documents and overall creditor makeup. These
transactions often provide solutions to near-term maturity walls
and increase optionality given an extended liquidity runway.
To best evaluate and execute on these options, it’s
important to map out the path to operationalize the transaction and
understand the long-term implications to the operations and cash
flows of the business. For example, double-dips and drop-downs
require an understanding of the cash flows between parents and
subsidiaries and any effect on operations or shared services
between them. Uptiers require a collateral analysis and a review of
the borrowers ability to service new debt. Chewy releases and asset
sales call for effective execution of spin-offs and carveouts, as
well as an analysis of the impact on go-forward operations and the
ability to service new debt.
Utilizing the options made available in borrower friendly credit
documents and an open window in the credit markets to tap these
transactions can buy a company time and runway. Effectively
executing the transaction and planning for the post-transaction
operational improvements will be key to taking advantage of this
So, you’ve bought some time
Taking additional liquidity and buying additional time are all
overall positives in the short term.
Taking full advantage of this opportunity requires concentrating
on two critical realities:
- Financial maneuvers cannot fix operational
challenges. Recent examples abound of companies falling
back into distress or even filing for bankruptcy after undertaking
a refinancing (particularly expensive ones) or liability management
exercises over the past few years.
- Interest coverage is the name of the game.The
face of leverage has changed in this new high-rate world. Previous
leverage metrics are not nearly as telling as a review of interest
coverage. The current cost of credit, and a company’s ability
to truly service their ongoing debt costs will need to be accounted
for when undertaking new financial moves.
What should you do next?
As we outlined inour 18th annual Turnaround and
Transformation Survey, the number one challenge restructuring
experts see in the year ahead is the cost and availability of
capital. That reality is not going away anytime soon.
First, map out a business plan with both the financial and
operational overlays, with a true liquidity and working capital
forecast. One place where many fall short is being realistic about
operational realities. Lay out different scenarios and understand
how revenues and cash flows will be impacted.
Doing so will give you a better sense of the future and avoid
unexpected surprises. Staying informed and being adaptable and open
to new opportunities can help you pivot when necessary.
Second, understand how bottom lines will be affected by
increased capital costs.Game plan for operational maneuvers to minimize
these impacts. A decade of cheap credit may have lulled many
management teams to ignore the significant cost of covering their
debt and resulting decrease of cash to invest elsewhere.
Remember that building a financial buffer takes time and
discipline. Even if your growth expectations don’t meet your
initial targets, having a financial buffer in place will provide
you with a safety net and financial security. More tactically,
identify non-productive assets to shed, analyze and determine your
highest (and lowest) ROI investment opportunities, and prepare a
zero-based budget to pinpoint the key areas requiring management
and employee focus. Identifying these areas, sticking to your
investment strategy, executing the company’s strategy, and
effective communication with employees and investors will help
companies prepare themselves for life in a higher rate world.
Gaining additional time is just the first step in fixing a
company that is struggling. Take advantage of this
opportunity: Mapping out a realistic go-forward business
plan and applying operational effectiveness to financial maneuvers
is the only way to ensure long-term success.
1 Source – Bloomberg – US speculative grade credits
rated CC- to BB+ with loans greater than $250mm maturing in 2024
2 Source – Bloomberg – US speculative grade credits
rated CC- to BB+ with loans greater than $250mm who have refinanced
since April 2023
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guide to the subject matter. Specialist advice should be sought
about your specific circumstances.