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Reshaping Defaults: How Liability Management Exercises Redefined Restructuring in 2024
Out-of-Court Deals Eclipse Traditional Bankruptcies in a High-Rate Restructuring Revolution
The Buyside Journal
January 13, 2025 • Estimated Reading Time: 6 minutes
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“The essence of strategy is choosing what not to do.”
In 2024, the leveraged loan market witnessed a pivotal shift, driven largely by the increasing prevalence of out-of-court liability management exercises (LMEs).¹ These transactions surpassed traditional payment defaults and Chapter 11 bankruptcies, reflecting a broader trend among companies seeking to avoid costly bankruptcy proceedings and manage liquidity under sustained high interest rates.¹
Default Metrics Show a New Reality
As of December 31, the Morningstar LSTA US Leveraged Loan Index presented a transformed default landscape:
Payment default rate (by amount): 0.91%¹
Payment default rate (by issuer count): 1.45%¹
LME default rate (by issuer count): 3.25%¹
Dual-track default rate (including LMEs): 4.70%¹
This dual-track rate, which combines traditional payment defaults with LMEs, reached its highest level since tracking began in 2016.¹ Payment defaults alone fell to their lowest levels in years, with the rate by amount down from 1.53% at the end of 2023 to 0.91% in December 2024.¹ Similarly, the rate by issuer count declined from 2.05% to 1.45%.¹
LMEs now account for 69% of restructuring activities by count, highlighting their dominance in the default ecosystem.¹ These transactions have reshaped the market's approach to distress management, with healthcare and software sectors contributing significantly—making up 18% and 21% of LME activity, respectively.¹
Drivers of LME Dominance
Two critical factors underpin the rise of LMEs:
Monetary Tightening:
The Federal Reserve’s 5% rate hike between March 2022 and July 2023 put immense pressure on companies with floating-rate debt.¹ Though rates stabilized in the 5.25%-5.50% range before a modest 50 basis-point cut in September 2024, companies rushed to create breathing room outside the bankruptcy courts, anticipating future rate relief.¹Preserving Equity Stakes:
Sponsored companies—those backed by private equity—drove 77% of LMEs in 2024.¹ Sponsors favored LMEs as a mechanism to protect equity stakes, sidestepping the erosion associated with Chapter 11 filings.¹ In contrast, non-sponsored companies exhibited a higher rate of conventional payment defaults.¹
Key Transactions and Sector Impacts
Among notable LME transactions in December:¹
iHeartMedia: The radio broadcaster restructured 92% of its debt out-of-court, extending maturities and issuing new secured debt. This move prompted a downgrade to Selective Default (SD) by S&P, as creditors received less than originally promised.¹
Empire Today: The flooring company conducted a distressed exchange, subordinating existing debt and relocating intellectual property assets to a new entity, leading to an SD rating.¹
Veritas Holdings Ltd.: Following a debt exchange tied to its asset sale to Cohesity, Veritas underwent a complex restructuring involving new term loans, equity issuance, and a partial cash paydown, resulting in an SD designation.¹
Historical Trends and Future Risks
History suggests LMEs do not always stave off traditional defaults:
In 2023, 14% of companies engaging in LMEs returned with payment defaults or bankruptcy filings within a year.¹
During the pandemic-induced wave of 2020, this figure rose to 27%, while 2022 saw 33% of LME participants default again.¹
Such trends underscore the need for cautious optimism. While LMEs offer a temporary lifeline, they often signal deeper structural weaknesses that can resurface.
Forward Indicators: Mixed Signals for 2025
While market sentiment for 2025 suggests easing credit conditions and tighter spreads, challenges remain:
Distress Ratio Decline: The distress ratio—a leading indicator of default activity—eased to 3.02% by par amount and 4.44% by issuer count in December, marking its lowest level since mid-2022.¹
Maturity Wall Reduction: Borrowers reduced the looming 2025 and 2026 maturity walls by 84% and 75%, respectively.¹ Outstanding 2025 maturities now total just $13.5 billion, compared to $44 billion for 2026.¹
However, rating agencies signal caution. Downgrades exceeded upgrades by a 3:1 ratio on a rolling three-month basis in December, the highest level since February 2023.¹ This suggests that while immediate distress may have eased, vulnerabilities remain in the broader market.
Implications for Investors
Investors should monitor these developments closely, as they offer insights into the evolving leveraged loan market:
Opportunities in Distressed Debt: Companies unable to manage prolonged interest rate pressures may present attractive targets for distressed investors.
Sector-Specific Risks: Healthcare and software sectors dominate the LME landscape, necessitating sector-specific due diligence.
Long-Term Default Risk: Historical data highlights the likelihood of post-LME defaults, making the evaluation of underlying fundamentals critical.
The rising prominence of LMEs in 2024 reflects the adaptability of companies and sponsors in navigating challenging financial conditions. While these exercises offer temporary relief, their effectiveness as a long-term solution remains uncertain, leaving the door open for traditional defaults to reassert themselves as credit markets evolve.