In a year marked by a surge in corporate failures, debt investors are grappling with diminishing hopes of recovering substantial amounts from distressed companies. The ongoing battles are taking a toll on creditors as early signs indicate a sharp decline in recovery rates. The recent bankruptcy filing of GenesisCare, a prominent cancer treatment specialist with backing from private equity titan KKR & Co. and China Resources Pharmaceutical Group Ltd., serves as a stark reminder of the value erosion witnessed during today’s business collapses.
Historically, during default cycles, providers of leveraged loans could anticipate reclaiming 70% to 80% of their investments from companies facing financial ruin. However, those days seem to be firmly in the past. Insiders with knowledge of the matter but not authorized to speak publicly reveal that some GenesisCare investors are steeling themselves for a mere mid-teen percentage recovery, signaling a concerning shift in a lending landscape already heading for historically low recoveries.
This unsettling trend underscores the financial vulnerabilities exposed as the era of easy money recedes, leading heavily indebted enterprises to the brink. As some investment banks remain cautiously optimistic about the prospect of a gentler economic descent, the precipitous drop in recoveries from leveraged loans casts a shadow over lenders.
Much like the Envision Healthcare crisis, which was linked to KKR and unfolded last year, the GenesisCare debacle underscores how companies are capitalizing on looser loan safeguards that lenders reluctantly embraced in their quest for higher yields amidst a low-interest-rate environment. Allegedly, GenesisCare secured a “debtor in possession” financing arrangement, including a substantial $200 million commitment to sustain its operations. Regrettably, this maneuver disadvantaged existing loan holders, as per insiders familiar with the situation.
KKR declined to comment on the matter, and GenesisCare remained unresponsive to requests for comment.
“Companies are resorting to financial maneuvers due to lenient documents granting them flexibility,” states Fraser Lundie, head of fixed income at Federated Hermes in London. “Even if defaults remain below historical peaks, the prospect of deteriorating recoveries could bring us to the same outcome.”
GenesisCare’s plight joins an expanding roster of restructuring calamities that have left their mark on US lenders. An August report from Bank of America strategists suggests that Envision’s first-lien loan might nearly collapse to zero in terms of recovery. Recovery rates for entities like media firm Diamond Sports and air-miles specialist Loyalty Ventures hover at around 10%, while tech firm Avaya Inc. and energy company Heritage Power face about 30% recovery rates.
Bank of America strategists estimate the average recovery rate from bankrupt companies this year to be 25%, based on loan prices observed 30 days post-default. However, they predict that in the long run, the rate could climb to 50%.
The repercussions of GenesisCare’s fate, given its multi-currency borrowing, suggest that the trend of paltry recoveries could extend beyond US borders, impacting Europe as well. Notable investors like Blackstone Inc., Bain Capital, and HPS Investment Partners managed to divest from US GenesisCare loans, although some at a significant cost. Conversely, many firms found themselves constrained by Europe’s “whitelist” restrictions on selling a 500-million euro loan to a select pool of buyers.
According to insiders, the European loan is presently valued at a mere 12 euro cents bid price, while the dollar loan stands at 13 cents.
Tristram Leach, head of European credit at Apollo Global Management, points out that transfer restrictions create liquidity challenges and “air pockets.” Tight whitelist constraints hinder lenders from exiting loans they are becoming less enthusiastic about.
While debt investors experience greater flexibility in the US, corporate companies, borrowers, and buyout firms have displayed heightened ruthlessness during restructurings. These corporate firms leverage looser loan terms to extract valuable assets from current creditors or acquire fresh debt, effectively pushing debt investors down the repayment ladder. This tactic is commonly referred to as “uptiering” or “priming.”
The Envision case stands as a stark example, where the company executed an out-of-court restructuring that removed its most promising division from existing lenders, pledging it as collateral for a fresh loan, before eventually declaring bankruptcy.
Derek Gluckman, an analyst at Moody’s Investors Service, remarks, “Private equity firms, when cornered, will resort to any available means to safeguard their returns, often at the expense of other existing lenders.”
The outlook for lender rights remains bleak, compounded by the Texas judge’s June ruling upholding Serta Simmons Bedding’s emergency refinancing. The move granted the mattress manufacturer $200 million in new funds but pushed certain lenders, including Apollo, further back in line for repayment.
The prevailing economic optimism and the recognition that market prices don’t precisely mirror eventual recovery provide a glimmer of hope. However, even the most optimistic estimates still project recovery rates significantly lower than those of previous cycles. Balancing the probability of borrower default and the recovery amount upon default is a critical aspect of leveraged loans. Despite better-than-expected default rates, the bleak picture of recovery rates could spell trouble for lenders.
Roberta Goss, head of bank loans and CLOs at Pretium Partners, projects recoveries to hover in the low 40s, offering a sobering perspective on the road ahead.