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Leveraged Loan ‘Weakest Links” Ranks Grow as Credit Quality Remains in Spotlight

LCD’s Weakest Links analysis for the U.S. leveraged loan market continues to highlight a strong undercurrent of risk.

During the third quarter of 2018, the share of loan Weakest Links was unchanged from the second quarter, at 7.2%. But the absolute number of issuers making up the Weakest Links rose from 87 to 93 during the third quarter. LCD’s loan Weakest Links are issuers in the institutional loan market with a corporate credit rating of B– or lower and a negative outlook.

The third-quarter count is the highest since LCD began tracking the number in 2013. Since that time the count has more than tripled, from 28 to the current 93.

An increase in Weakest Links can be an indicator of financial distress down the road, as the default rate on these issues remains sharply higher than credits not in the Weakest Links grouping. In the first three quarters of 2018, 11% of the credits from the 2017 year-end loan Weakest Links cohort have restructured, including the defaults of retailers Nine West and Sears, as well as Oil & Gas issuers Fieldwood EnergyPhiladelphia Energy, and Harvey Gulf. Looking back further to the Weakest Links from 2013, 32% have defaulted or restructured through the third quarter of 2018.

In contrast, 0% of the credits rated B or higher at the end of 2017 have defaulted or restructured, and just 6% in total of that pool at year end 2013 had done so in through today. – Ruth Yang

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JC Penney High Yield Debt Plunges into Distressed Territory

J.C. Penney 8.625% second-lien secured bonds due March 2025—which priced at par just five months ago—slid some 10 points in trading Thursday, marking their inaugural descent into distressed territory at 73.5, trade data show.

The move follows the release of a substantially narrower-than-expected bottom line for the struggling department-store operator, as second quarter adjusted EBITDA of $105 million clocked in 45.5% below Street forecasts, based on consensus data compiled by S&P Global Market Intelligence.

Meanwhile, J.C. Penney’s 5.875% secured notes due July 2023 were off as much as 4.75 points in Thursday trading, declining to all-time lows of 89.75, before settling in midafternoon trading to 90.75 The secured tranche was placed in June 2016 at par, as part of a $500 million print backing the pay-down of real-estate term debt.

The issuer’s B term loan due 2023 (L+ 425, 1% LIBOR floor) was quoted in a 92.375/94.125 context in morning trading, down from 95/95.875 yesterday, according to market sources.

Management also slashed the company’s full-year EPS guidance to a loss per share of $0.80 to $1, from a prior forecast of a $0.07 loss to a $0.13 gain previously—sending shares to new sub-$2 lows. Sources highlighted that the company seems to be pursuing “buying and chasing” as it looks to take substantial markdowns to balance its inventory.

J.C. Penney’s secured bonds had previously declined in May, following mixed first-quarter results and the resignation of its then-CEO Marvin Ellison, who announced plans to pursue opportunities with Lowe’s Companies.

J.C. Penney is a Plano, Tex.–based operator of more than 1,000 department stores across the U.S. — James Passeri/Tyler Udland

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PetroQuest Energy skips Interest Payments, Warns Ch. 11 Possible

PetroQuest Energy has deferred $14.2 million in interest payments due Aug. 15 to holders of its 2021 notes.

According to a Form 8-K filing with the SEC, lenders under the company’s loan agreement have agreed to forbear from calling default until 11:59 p.m. EDT on Sept. 14, 2018 following the non-payment.

Holders of the company’s $275 million of 10% second-lien senior secured PIK notes due 2021 and $9.4 million of 10% second-lien notes due 2021 have entered into a customary 30-day grace period.

The independent energy company recently retained Seaport Global Securities as its financial advisor and Porter Hedges as legal advisor to assist in analyzing and evaluating alternatives with respect to its capital structure.

The advisor hire and missed interest payment comes as the issuer’s option to make PIK interest payments on the $274.6 million of 2021 notes at 1% cash/9% in-kind expired.

The company said is it seeking alternatives, which could include private debt exchanges and filing for protection under Chapter 11 of the U.S. Bankruptcy Code.

The PIK bonds were placed in 2016 as part of a distressed exchange after the company missed an interest payment on its then-outstanding unsecured bonds, which it later made good on as a consequence of the exchange.

CCC+ PetroQuest Energy is an independent energy company engaged in the exploration, development, acquisition, and production of oil and natural-gas reserves in Texas and Louisiana. The company’s common stock trades on the OTCQX market under the symbol PQUE. — Rachelle Kakouris

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Defaults Remain Scarce but Leveraged Loan ‘Weakest Links’ Spike to New High

loan weakest links

The number of leveraged loan “Weakest Links,” or at-risk debt issuers that can be viewed as potential default candidates, spiked to 87 in 2018’s second quarter, the most since LCD started tracking this indicator in 2013. The recent figure is up from 78 in the first quarter and from 81 at the start of the year.

The second-quarter activity brings the Weakest Links share of the outstanding U.S. leveraged loan issuer universe to 7.2%, the second-highest level on record.

LCD’s Weakest Links analysis tracks the queue of at-risk credits—defined as U.S. loan issuers with a corporate credit rating of B– or lower (excluding defaults) by S&P Global Ratings, with a negative outlook or implication. The analysis is based on credits in the S&P/LSTA Leveraged Loan Index, but if a credit exits the Index it remains in the Weakest Links universe until its rating is withdrawn or until it defaults.

Of note, several high-profile consumer-related industries continue to contribute heavily to the Weakest Links, including retail and oil & gas.

As far as Weakest Links go, there is good news. Of the 78 issuers that were Weakest Links at the end of 2017, 10% (eight issuers) have been upgraded out of the Weakest Links category. Additionally, two issuers have had ratings withdrawn due to positive actions: Aricent was acquired by Altran and Caribbean Restaurants withdrew its rating after paying down debt.

The bad news: 14% (11 issuers) of those 2017 year-end Weakest Links defaulted or completed distressed exchanges in the first half of 2018. The defaulters include iHeart Communications, of course (iHeart entails $6.3 billion in Clear Channel bank debt), retailer Nine West, and two Oil & Gas producers—Fieldwood Energy and Philadelphia Energy SolutionsDel MonteProserv, and Sears each underwent distressed exchanges.

While the number of leveraged loan Weakest Links climbs, defaults in the market remain stubbornly rare. The current U.S. loan default rate is roughly 2%, according to LCD, compared to an historical average of about 3%. While a low default rate generally points to a healthy asset class, loan market detractors note the booming share of covenant-lite leveraged loans now in place, saying those credits could be especially hard hit when the credit cycle turns, and defaults surge. – Ruth Yang

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Diebold Debt Dives Deeper into Distressed on S&P Downgrade

diebold logoBonds backing Diebold Nixdorf tumbled another 12.5 points today, falling deeper into distressed territory at 57.5, trade data show, after the issuer was tagged with a two-notch S&P Global Ratings downgrade after the closing bell yesterday. The notes have now slid 34.5 points so far this month, from closing July levels around 92, and are down about 21.25 points week-over-week, according to MarketAxess.

Meanwhile, the issuer’s dollar B term loan due November 2023 (L+275, 0% LIBOR floor) was quoted at 84.625/86.25 on Thursday, indicating a week-over-week decline of roughly 10 points, sources said. The issuer’s euro-denominated B term loan (E+300, 0% LIBOR floor) was quoted at 83.625/85.75, from a Monday context of about 96.5. Both term loans were placed in April 2017, totaling $475 million and  €415 million respectively, with proceeds backing Diebold’s acquisition of Wincor Nixdorf.

After flagging covenant concerns on the issuer’s quarterly earnings release last week, creditors were again jolted by Monday’s filing of Diebold’s 10-Q with the SEC, which revealed that Diebold Nixdorf shareholders earlier this month requested redemption of roughly 2.4 million shares with a value of about $160 million. The company expects to use balance-sheet cash and borrowings under its revolving facility to fund the obligations, according to the filing. Diebold reported total cash of roughly $299 million at the end of the quarter. The filing also cautioned that the borrower is at risk of violating certain maintenance covenants governing its credit agreement as soon as this quarter.

S&P Global on Wednesday lowered the issuer’s corporate rating to B, from BB–, with a negative outlook, from stable previously, citing leverage concerns and the company’s ongoing efforts to amend is credit facility to avoid a maximum net leverage covenant violation. The ratings agency also cut Diebold’s secured and unsecured debt ratings to B and B–, respectively, from BB– and B+.

“Further weakening its near-term performance is the company’s newly announced DN Now multi-year business improvement and savings plan (which requires high costs in 2018), which comes after previous unsuccessful tries and at a time when the company is operating at its lowest liquidity level since the transformative acquisition of Wincor Nixdorf AG in 2016,” according to the Wednesday report.

Moody’s on Tuesday downgraded the issuer’s corporate rating by two notches, to B3, from B1, and revised its outlook to negative, from stable. The agency also cut its ratings on the company’s first-lien credit facilities to B3, from B1, as well as those on Diebold’s senior unsecured notes to Caa2, from B3.

Moody’s said the moves were driven by Diebold’s recent weaker-than-expected operating performance, meaningfully diminished liquidity, and the agency’s expectation that the company will face continued operating challenges in the coming year.

Diebold Nixdorf (NYSE: DBD) provides commerce services, software, and technology. — James Passeri/Mairin Burns

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PetSmart Downgraded to CCC due to Likelihood of Debt Exchange

S&P Global Ratings has downgraded PetSmart to CCC, from CCC+, citing an increased likelihood of the company pursuing a debt exchange over the next 12 months that would be viewed as distressed.

“Although the company does not have any meaningful near-term maturities and liquidity is likely to remain adequate, we think PetSmart’s capital structure is unsustainable given the continued weak results at its brick-and-mortar retail stores and operating losses at Chewy,” analyst Andy Sookram said in the report.

S&P revised its recovery rating on the company’s $4.3 billion first-lien term loan and its $1.35 billion of senior secured notes to 4, from 3, to reflect the release of Chewy.com as a guarantor under the term loan and the senior secured notes.

This allows the unsecured noteholders to share any residual value of Chewy.com on a pari passu basis with any deficiency claims of secured term lenders and noteholders. S&P also revised the recovery rating on the company’s

 

$1.9 billion of senior unsecured notes due 2023 and its $650 million of senior unsecured notes due 2025 to 5, from 6, reflecting its view of improved access to value that unsecured creditors have at Chewy.com pursuant to the release of the guaranty. (See “PetSmart unsecured bonds rally on Chewy spin-off news,” LCD News, June 4, 2018. $)

Chewy.com still guarantees and provides collateral to the ABL lenders.

Phoenix-based PetSmart faces significant headwinds in its strategy to turn around operations, which have been hurt by heightened competition from other online retailers, regional pet supply stores, and mass channel operators.

S&P sees a greater probability of a debt exchange or restructuring following the recent dividend to parent Argos Holdings that represents 20% of Chewy.com’s outstanding common stock. As a result, PetSmart’s ownership of Chewy.com has been reduced to 80%. This transaction could facilitate a potential separation of Chewy.com from PetSmart’s consolidated operations, which could occur either through additional dividends to the parent company, a potential sale, or a combination of these alternatives.

Following an EBITDA drop of about 30% for the last twelve months ended April 29, S&P views PetSmart’s capital structure as unsustainable given its forecast for continued EBITDA declines. The company’s $750 million asset-based revolver remained undrawn, with cash on hand at $331 million against debt of $8 billion. — Rachelle Kakouris

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With Defaults Low and Oil Prices Rising, Distressed Debt Continues to Disappear

Thanks to a decade-long stretch of low interest rates, which has made it easier for troubled companies to kick the debt can further down the road, the already-scant opportunity for funds looking to buy up paper at distressed levels continues to shrink.

A seventh consecutive decline in the U.S. distress ratio has pushed the share of bonds trading in excess of 1,000 bps over the risk-free Treasury rate—the common measure of distress—to its lowest level in 3.5 years. At just 5.2%, it is significantly below the post-crisis high of 33.9% from February 2016, according to S&P Global Fixed Income Research.

In dollar terms, that equates to just $48 billion, merely a hair’s breadth from the near-four year low of $46 billion reached last month, and just 15% of the February 2016 high of $328 billion.

The dearth of opportunities is even more stark in leveraged loans, where the share of performing loans in the S&P/LSTA Leveraged Loan Index trading below 70 cents on the dollar (a level normally associated with deep distress and significantly high default risk) fell to just 0.56% as of May 30, the lowest it has been since December 2014. –

us loan distress ratio

One area where this is distress, of course, is retail, where the rate recently hit 24%, and in cosmetics/toiletries (32%, though that’s entirely driven by one loan issuer: Revlon). Both of these numbers are post-crisis highs, according to LCD.

While those numbers are eye-catching, the retail segment does not constitute a significant segment of outstanding leveraged loans, so the amount of paper involved is not large. – Rachelle Kakouris

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Pacific Drilling, Lenders Spar Over Chapter 11 Progress, Exclusivity

pacific drillingSenior lenders of Pacific Drilling are keeping up their pressure on the company to reorganize sooner rather than later, objecting to the company’s requested 120-day extension of its exclusive periods to file and solicit acceptance to a reorganization plan, despite the company’s offer to agree to mediation in the Chapter 11 case in exchange for the extension.

The battle over exclusivity evidences the continuing breakdown of trust between the parties in the case, at least insofar as the senior lenders are concerned. Lenders have maintained since the case was filed that the company was merely seeking to delay the case and was not acting in good faith to develop a reorganization plan.

The company’s secured lenders late last month sought to force the company into mediation, but the company argued that mediation would be premature at this relatively early stage of the case, and the bankruptcy court overseeing the case denied the secured noteholders’ motion.

In connection with its requested exclusivity extension filed late last month the company said it would now be willing to engage in mediation with secured lenders, provided, among other things, that the senior creditors agreed to the exclusivity extension.

But senior noteholders would not bite, suggesting that the company’s offer to engage in mediation was insincere.

In a March 14 objection to the proposed exclusivity extension, an ad hoc group of secured noteholders noted that while the company “promised serious plan negotiations beginning in January,” it was not until the filing of its exclusivity motion last week that the company agreed to a mediation process.

“If past is prologue,” the ad hoc group asserted, “the debtors have not—and thus will not—show diligence, and extending exclusivity will not advance the cases.”

Beyond rejecting the company’s mediation offer, the ad hoc group charged that the company had “squandered” its first four months in Chapter 11 and “cannot point to any progress [it has] made to show cause to extend exclusivity.”

The ad hoc noteholder group further said, “What makes this failure even more egregious is the comparative simplicity of the task at hand: a balance sheet restructuring to be negotiated among well-organized creditor groups with experienced counsel.”

The company argued in its exclusivity extension motion last week that “after a contentious start to the Chapter 11,” it has “been working hard to jump-start meaningful restructuring negotiations.” The company also asserted that “a lot has been going on in these cases, mostly out of court,” citing numerous telephone conversations and face-to-face meetings with creditors, its development of a business plan, and its efforts to resolve various contingencies, including an arbitration case in London that could add $350 million to the company’s unrestricted cash and eliminate a $336 million unsecured claim against the company.

But the ad hoc noteholder group was not buying that, either.

“It was not until months after the cases were filed, and as their 120-day exclusivity period drew to a close,” the group said in its objection, “that the debtors even retained experts and began to put together a business plan.”

Wilmington Trust, the agent bank under the company’s senior secured credit facility, made a similar argument, reiterating its concern that the company and its equity sponsor, Quantum Pacific, were simply seeking to delay the case in the hope that changing market conditions would ultimately create value for an equity recovery in the case.

Meanwhile, lenders under the company’s prepetition revolver and Citibank, the agent under the company’s RCF, did not formally object to the extension, since doing so would, under the cash collateral orders entered in the case, endanger adequate protection payments to RCF lenders.

Still, Citibank said in its response to the motion, “The [bankruptcy] court … should be under no illusion that the agent supports the debtors’ request to extend their exclusive periods within which to file, and solicit acceptances on, a plan of reorganization.”

Similarly, an ad hoc panel of RCF lenders said in a court filing, “The absence of an objection to the motion should not be construed as affirmative support for an extension of exclusivity and that the RCF group has concerns regarding the progress of these cases.”

A hearing on the exclusivity extension is set for March 21. — Alan Zimmerman

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iHeart Again Extends Forbearance as Bankruptcy Looms

iHeartMedia lenders have again agreed to forbear from calling default on the company’s missed interest payment, as the radio broadcaster continues to work on a consensual pre-arranged bankruptcy filing.

In a Form 8-K filed with the SEC, iHeartMedia said lenders have agreed to forbear on the missed interest payment until 11:59 p.m. Central Time on March 12, from the previously extended deadline of March 7.

As reported, iHeart failed to make a $106 million Feb. 1 interest payment to holders of its 14% senior unsecured notes due 2021 issued via subsidiary iHeartCommunications, entering instead into a customary 30-day grace period with lenders.

The company earlier this week filed a draft restructuring support agreement and term sheet showing senior lenders—including holders of the company’s term loans and priority guarantee notes—stand to receive 93.25% of the recapitalized equity, bridging the gap on a key sticking point of contentious year-long negotiations between the company’s sponsors and its debtholders.

iHeart is also is also operating under a customary 30-day grace period after it missed interest payments due on two series of priority-guarantee notes, ramping up the pressure among its more senior lenders to achieve a comprehensive restructuring of the company’s $20 billion debt load. — Rachelle Kakouris

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S&P: As Oil & Gas Rebounds, US Distress Ratio Sinks to Lowest Level Since 2014

The U.S. distress ratio has dropped to its lowest level since September 2014, tightening to 6.5% in January, from 7.4%, amid strengthening commodity prices, according to S&P Global Fixed Income Research.

distress ratio“The oil and gas sector continued to improve throughout 2017 as hydrocarbon prices recovered and stabilized,” noted Diane Vazza, head of the S&P Global Fixed Income Research group, in a Feb. 1 report titled “Distressed Debt Monitor: Strengthening Commodities Sectors Compress The Distress Ratio To Its Lowest Level Since 2014.”

“Accordingly, since their highs in February 2016, the distress ratios for the oil and gas and metals, mining and steel sectors have steadily decreased,” Vazza said.

Moreover, the oil and gas sector accounted for the highest month-over-month decrease in the number of distressed credits, moving to 15, from 23. As such, the oil and gas sector’s distress ratio decreased to 7.9% as of Jan. 15, from 88.5% as of Feb. 16, 2016.

The outlook for the oil and gas sector in 2018 is generally stable, reflecting a continued flattening of oil and natural gas pricing, but performance will depend heavily on potential OPEC production cuts and price volatility, S&P Global says.

The distress ratio for the metals, mining and steel sector decreased to 5.6%, from 82.3% over the same roughly two-year period referenced above.

Distressed credits are speculative-grade (rated BB+ and lower) issues with option-adjusted composite spreads of more than 1,000 basis points relative to U.S. Treasuries. The distress ratio (defined as the number of distressed credits divided by the total number of speculative-grade issues) indicates the level of risk the market has priced into bonds.

As of Jan. 15, the retail and restaurants sector had the highest distress ratio at 17%, followed by the telecommunications sector at 15.9%. — Rachelle Kakouris

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