Debt Restructuring: Recent trends, insights and market dynamics

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Amaury Guzman: Hello and welcome to What's The Deal?, our investment banking series on J.P. Morgan's Making Sense. I'm your host today, Amaury Guzman from J.P. Morgan's Leveraged Finance desk. With me today, I have Dan Pombo, a managing director and head of the Restructuring and Debt Advisory practice, in our Debt Capital Markets team. Today we're going to be reviewing an area of the market that we don't often talk about, and that is credit restructuring activity. Dan, glad to have you here with us today.

Dan Pombo: Pleasure to be here.

Amaury Guzman: Dan, before we get started, and for the benefit of our listeners, can you tell us a little bit about yourself and your career at J.P. Morgan?

Dan Pombo: Sure. So I started at J.P. Morgan 26 years ago, originally in Leveraged Finance Origination, and then I moved to the Leveraged Loan Capital Markets' desk for a few years. And then during the great recession, we were not very busy and restructuring was getting really busy, and the head of Restructuring asked me if I wanted to make a change, and join the restructuring team? And I thought that was a great idea. And I've been there ever since.

Amaury Guzman: Oh, wow. Some may say that it worked out.

Dan Pombo: It worked. (Laughs).

Amaury Guzman: (Laughs). No pun intended.

Dan Pombo: Pu dum bum.

Amaury Guzman: (Laughs). Thank you for that. Why don't we dive right in. For the better part of last year, we've had guest speakers come into the podcast and speak of how strong the market has been by various measures, fundamentals, technicals, primary market activity has been at record levels, particularly on the leverage loan side and specifically to the refinancing of debt coming due. However, there is an area of the market that hasn't been able to refinance near-term maturities as easily. Can you give us an overview of the restructuring activity we've seen in the market over the last 12 to 18 months?

Dan Pombo: Sure. Yeah, so just to level set some quick stats. There's $2.8B outstandings, across the leverage loan in high-yield bond markets, and that excludes direct loans. And in 2024, there were $84B of defaults in that universe, resulting in a 3.1% default rate. And for context, that's roughly in line with 2023, but it's high relative to historic norms, which in non-recessionary years typically is below 2%, so we're in an elevated default context here. A few drivers of that elevated default activity, despite the wide open capital markets that you mentioned over the last couple of years, not every company has been able to refinance. The most speculative credits have struggled to refinance over levered capital structures. Now that interest rates have reset higher, these companies can no longer afford their capital structures if their cost of capital was completely reset to current interest rates. And so as they approach maturities, they find the regular way capital markets very challenging to access and often these companies are facing changes and challenges in their industries that has impacted their profitability as well. For example, industry dynamics are changing rapidly in healthcare, media, telecom, and technology.

Amaury Guzman: Thank you for that. That's really comprehensive at a broad level, but if you were to try to dive a little deeper here, any specific trends that you could pick apart, within restructuring specifically?

Dan Pombo: Yeah, sure. A couple jump out. First, we're seeing much more activity in the loan market relative to the bond market, as it relates to defaults. It used to be the, the loan market experienced a lower default rate than the high-yield market, because it's typically secured, higher in the capital structure, et cetera. But in the last couple of years that's flipped, and in 2024, over three quarters of the defaults happened in the loan market. The second trend that I'd point out, and this one's really interesting, we include in our default stats, both in-court restructurings, which are chapter 11 filings and out-of-court restructurings. The latter are liability management transactions for distressed companies. We can it as a default if loan and bondholders are exchanging below par or taking a haircut. And before COVID, the volume of these haircut transactions was negligible, but since 2021, their share of total default volume has been growing. And in 2024 for the first time, the volume of out-of-court restructurings was greater than in-court, and it wasn't even close, 70% of all restructurings last year were done out-of-court.

Amaury Guzman: Oh, wow. That flip in outcomes is really interesting. Primarily as you pointed out, that loans are, for the most part, secured, so them having a higher portion of vote rates versus bonds in this case is surprising, as well as the higher amount of processes that are getting resolved out-of-court. In your view, what explains this flip or this trend?

Dan Pombo: Well, two things. First, the cost of filing for chapter 11 has become prohibitive. Professional fees have risen dramatically in recent years, to the point that they're now materially reducing creditors recovery in court, as professional expenses are paid before creditors. And second, covenants in today's documents are very permissive. Companies have a lot of flexibility to move assets away from their creditors and use them to raise new money and extend their maturity runways, which effectively primes the existing creditors. This has given rise to the so-called creditor-on-creditor violence theme that has been written about extensively in the last few years.

Amaury Guzman: Got it. And how has this changing landscape impacted your business?

Dan Pombo: Yeah, sure. So if we were to go back, say 10 years when restructurings were done primarily through a Chapter 11, J.P. Morgan's role was limited to raising capital to fund their restructurings, through dip financings typically, and to recapitalize the capital structures upon emergence from bankruptcy through exit financings. And we still do that activity, but now that the majority of restructuring processes are getting resolved out of court, the conflict regime of chapter 11 that precludes us from advising clients that pursue an in-court Chapter 11 filing, no longer applies as often. So historically, directors and officers have viewed traditional banks as conflicted in distressed situations due to their credit exposure, and for restructurings in Chapter 11 that precluded banks from advising companies in restructurings. This led to the rise of boutique firms in the restructuring space to handle those advisory assignments. But that's not really the right way to look at out of court restructurings or liability management exercises. In our view, it's generally not beneficial for a client to impair their revolver bank exposure. Companies spend decades building those banking relationships and in addition to low cost working capital, banks offer numerous other services that are tremendously valuable. It's almost never the objective to impair those lending relationships. Consequently, if the objective is to renegotiate with their institutional lenders and investors that hold their term loans and bonds, there's no conflict to be managed using a bank such as J.P. Morgan.

Amaury Guzman: I see. Well, I think that's very clear. So as a segway, if a company is looking for a bank or an advisor to accompany them in one of these restructuring processes, what value can they extract from our broad platform in this space?

Dan Pombo: Sure. Well, the skill set that's needed to negotiate with creditors aligns with the expertise that J.P. Morgan exhibits every day, in serving as an arranger for syndicated financings, we are the perennial market leader in originating, leveraged finance and allocates more high yield bonds and leverage loans than anyone else. In our view, no one has the relationships with high yield bond investors and institutional lenders that we have, it's a differentiated relationship. When an outreach comes from a boutique advisor without the sales platform that we command, that message is received differently. And what I find really interesting is that boutiques also represent creditors. J.P. Morgan never represents creditors or investors. We are always hired by the company, so we are never in a position where we are representing company A in negotiations with creditor X, while at the same time pitching creditor X to represent that creditor in their negotiations with company B, for example. Also, our sales and trading operation gives us unparalleled market color. We know exactly what's happening in the market, and the ability to talk to a company's investors and lenders simultaneously through our sales desk. We don't have to rely on bilateral negotiations with an advisor. Such a dynamic could result in a lowest common denominator approach, as opposed to a market clearing result. Because of our market making activity, we have a better idea of where a deal could or should clear, rather than relying on bilateral negotiations with an advisor to a group of creditors that can suffer from group think, and are often driven by the least constructive creditor in that group. Also, keep in mind that hiring J.P. Morgan is not by itself a signal to the market that the company is contemplating a restructuring because of the breadth of what J.P. Morgan can provide. The market's rightly associate the hiring of a boutique with a restructuring, whereas the hiring of J.P. Morgan is a much more benign signal to the market. J.P. Morgan can be associated with capital raising, M&A, strategic advice, etc. And when it comes to the nuts and bolts of liability management, no one is better. J.P. Morgan has led the liability management league tables for years.

Amaury Guzman: That's very compelling, particularly the argument around finding market clearing results as opposed to a lowest common denominator for our clients. If we were to try to exemplify or illustrate a case study or a recent example where they've delivered that, anyone you would point to?

Dan Pombo: Yeah, we just actually priced a deal a couple of weeks ago that was emblematic of this new regime. I'll keep the name of the company out of it to protect the innocent, but we just recently worked with a company that had a near-term maturity, sizable, billion-billion and a half, and had ample flexibility in their credit documents. As creditors organized into an ad hoc group and then signed a cooperation agreement with each other, they then presented the company with a self-serving transaction, that would've driven their cost of capital materially higher and eliminated much of the company's flexibility. Companies facing that situation typically would hire a boutique firm to negotiate with the advisors to the ad hoc group, but in this case, we came up with a market-based approach that was materially more attractive, and J.P. Morgan was brought into the fold to lead the negotiations for the company. And so leveraging our insight into the markets and our relationship with the investor base, we were able to come up with a differentiated transaction structure that was much better than what the group proposed, and we found an investor outside the group that was willing to support our alternative structure. So we leveraged that proposal to re-engage the existing creditor group on much more competitive terms. That structure allowed us to refinance their near-term maturity in a market at a yield that was roughly 400 basis points tighter than what the ad hoc group originally proposed. So it was a win-win for the company who got a very competitive refinancing done at market terms, as well as for the creditors who avoided a transaction where assets were moved out of their reach.

Amaury Guzman: Dan, thank you so much for that. I think that's an example, as I'm sure that's one of many, that clearly speaks to the value that we deliver for our clients, particularly in this segment of the market. Before we finish, I'd be remiss not to bring up our upcoming Leveraged Finance and High Yield conference in Miami in the next couple of weeks. This year is our 30th anniversary, for a J.P. Morgan debt veteran like yourself, what are you looking for the most this year, other than the warm Florida weather?

Dan Pombo: Yeah, it's always a great event. The High Yield Conference has become a big event in the restructuring community as well. I'm chairing a panel discussion on current trends in the liability management space, which should be really interesting given how quickly the space is evolving. It's always an opportunity to reconnect with colleagues past and present, and I always pick up a few insights and ideas just from talking to the attendees and participating in all the discussions. It's always a highly rewarding couple of days.

Amaury Guzman: That's great. I'll plan on attending that panel, and I personally look forward to meeting with all of our clients in Miami in a couple of weeks. I think we're towards the end of our allotted time here, so thank you so much to Dan Pombo for his time today, and thank you to our listeners for tuning in to another episode of What's the Deal. We hope you enjoyed this conversation, I am Amaury Guzman. Until next time.

Voiceover: Thanks for listening to What's The Deal? If you've enjoyed this conversation, we hope you'll review, rate and subscribe to J.P. Morgan's Making Sense, to stay on top of the latest industry news and trends, available on Apple Podcasts, Spotify, and YouTube. To stay ahead of the curve, sign up for J.P. Morgan's In-Context newsletter, packed full of market views and expert insights delivered straight to you. To subscribe, just visit jpmorgan.com/in-context. This material was prepared by the investment banking group of J.P. Morgan Securities LLC and not the firm's research department. It is for informational purposes only and is not intended as an offer or solicitation for the purchase sale or tender of any financial instrument.

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