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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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iHeart Skips $106M Interest Payment, Enters 30-Day Grace Period

iHeartCommunications has failed to make a $106 million February 1 interest payment to holders of its 14% senior unsecured notes due 2021, entering instead into a customary 30-day grace period with its lenders.

For nearly 11 months, iHeartMedia has been negotiating the terms of a sweeping debt exchange targeting roughly $14.6 billion of its $20 billion debt load at its iHeartCommunications subsidiary, including $6.3 billion of its term loan debt. Despite sweetening the offer a month later, the out-of-court restructuring failed to gain traction with noteholder participation reported at just 0.4% at the Jan. 18 update.

After being extended multiple times, the current debt exchange deadline is 5 p.m. EST on Feb. 16.

In a press release the company said that active discussions are continuing among its lenders, noteholders, and financial sponsors on the terms of a debt restructuring.

Citi analyst David Phipps said in a note to investors this morning that he does not expect a successful debt exchange owing to varying interest among creditors. In the event of a bankruptcy, Phipps expects iHeart term loans and priority guarantee notes to trade down at least 10 points since no interest would be paid during bankruptcy.

Restructuring proposals filed with the SEC late last year disclosed iHeart’s sponsors, Bain Capital and Thomas Lee Partners, had offered creditors 87.5% of the reorganized equity, as well as 87.5% of the company’s stake in Clear Channel Outdoor, its partially owned billboard subsidiary.The filing also showed that senior lenders had yet to bridge their differences on key terms, which as reported, include the value of the Clear Channel Outdoor business, the assets of which became a source of a contention following iHeart’s disputed 2015 transfer of Clear Channel Outdoor shares to its Broader Media unit.

Bain Capital and Thomas Lee Partners–owned iHeartMedia operates as a media and entertainment company through three segments: iHeartMedia, Americas Outdoor Advertising, and International Outdoor Advertising. The company formerly known as Clear Channel changed its name to iHeartMedia, Inc. in September 2014.

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Toys R Us Plans to Close Up to 182 Underperforming Stores

Toys R Us is seeking bankruptcy court authority to close up to 182 “underperforming brick-and-mortar store locations” in the United States, according to a court filing.

The company has roughly 900 stores in the U.S.

According to a Jan. 23 court filing, the company has not yet made the final decision to close all of the locations, saying that some final decisions will depend upon whether the company is able to negotiate more favorable lease terms for those stores.

The company did not specifically state when those final decisions would be reached, but said lease negotiations are “continuing.” The company said, however, that it expects most of the closings to be completed by April 16.

The company said the store-closing plan follows a performance evaluation that included “an extensive store-by-store performance analysis of all existing stores evaluating, among other factors, historical and recent store profitability, historical and recent sales trends, occupancy costs, the geographic market in which each store is located, the potential to downsize certain stores, the potential to consolidate certain Toys “R” Us and Babies “R” Us locations within a reasonable proximity of one another, the potential to negotiate rent reductions with applicable landlords, and specific operational circumstances related to each store’s performance.”

With respect to the stores pegged for closure, the company said that “overwhelming majority … have negative sales trends and have failed to meet the performance standards set by the debtors.”

The company added that it may ultimately need to close additional stores, noting that it had recently filed (and following a hearing yesterday, the Richmond, Va., bankruptcy court had granted, according to the court docket) a motion to extend the deadline for deciding on the assumption of store leases through the date that a reorganization plan is confirmed (the current deadline to decide upon leases was April 16).

As reported, the company is targeting the summer of 2018 for confirming a reorganization plan, with the goal of emergence from Chapter 11 ahead of the 2018 holiday season.

Meanwhile, in connection with the current round of story closings, the company is seeking to retain two groups, joint ventures Hilco Merchant Resources/Gordon Brothers and Tiger Capital Group/Great American, to manage the process and related sales of merchandise and furniture, fixtures, and equipment.

A hearing on the motion is set for Feb. 6. — Alan Zimmerman

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Distressed Debt Outlook: Lack of Leveraged Loan Covenants May Lengthen the Default Process

With more than $2.5 trillion outstanding in the U.S. high-yield bond and leveraged loan markets—twice that of pre-crisis volumes—and leverage at lofty levels, the opportunity set for investors specializing in buying up the debt of troubled companies could be significant. In time.

In this long bull market, default rates have remained stubbornly low, with the pool of debt trading in distress at nearly 80% less than the February 2016 peak. Right now, there just aren’t as many companies in distress as there used to be.

“Pickings for distressed investors are very slim right now, but that can change on a dime,” says Jeff Hammer, co-head of Houlihan Lokey’s illiquid financial assets practice, adding that this market has always proven to be one where you need to move quickly, and in size, in order to make the kind of returns that can carry you through to the next cycle.

Covenant erosion

Covenant erosion has been an ever-present concern for investors on both sides of the Atlantic over the last few years, and while a lack of investor protections is deemed unlikely to increase the overall default volume, it may lengthen the default process if there is no covenant-related event to force struggling borrowers to the bargaining table with their lenders. Such a delayed default could potentially worsen recoveries.

Among defaulted credits within the loan market, 81% of issuers in the S&P/LSTA Index in 2017 were covenant-lite. This compares to 55% in 2016 and to just 14.3% during the 2009 default peak. — Rachelle Kakouris

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Leveraged Loan Portfolio Managers Foresee Steady Increase in Default Rate, to 2.24% in 2018

Rather than a sudden spike, portfolio managers of U.S. leveraged loans foresee a slow inflection higher in the headline default rate, marked by pockets of distress in certain sectors. With energy having already experienced its own default cycle, retail, broadcasting, and healthcare are seen as the next potential trouble spots.

At the macro level, participants in LCD’s quarterly survey reined in their default forecasts somewhat, but still see a steady increase, with expectations that the loan default rate will end 2018 at 2.24%, from the current 1.91%.

The sentiment is more benign than that expressed in the third-quarter survey, when respondents had forecast a 2018 rate of 2.42%.

Almost all responses regarding where the expected one-year forward default rate will fall, at year-end 2018, were in a range of 2–2.70%.

Default Rate Projection 2018

Further out, loan investors, on average, expect the default rate to finish 2019 at 2.65%. The views here, polled for the first time this quarter, for the most part (80%) ranged from 2.25–3.30%.

Looking back

The end of year is an opportune time to review the accuracy of past predictions.

Defaults within the S&P/LSTA Leveraged Loan Index jumped to 1.95% in November. While still well short of the 2.44% year-end 2017 rate predicted by loan managers this time last year, a potentially substantial default lurks in the shadows. With few expecting iHeartMedia to even hold another earnings call with its current balance sheet intact, a default on the company’s Clear Channel term loans D and E would, hypothetically speaking, push the default rate to a 33-month high of 2.63%.

LCD also asked participants when they expect the default rate to breach 3.1%—the historical average. More than half (67%) now expect this to be a 2020 event (on an intra-year basis), with only 33% expecting the historical average to be breached in 2019. This is down from 93% forecasting 2019 at the third-quarter reading.

— Rachelle Kakouris

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Toys ‘R’ Us High Yield Bonds Sink in Trading Mart Amid Bankruptcy Mention

Near-term debt of Toys ‘R’ Us went into a tailspin today after news reports that the company has hired Kirkland & Ellis to assist in a restructuring also made mention of a possible bankruptcy filing.

The company’s $208 million of 7.375% senior unsecured holdco notes due 2018 hit a 19-month low of 75, versus quotes of 95 on Tuesday, according to sources.

Such a massive deterioration could, of course, facilitate a take-out of the bonds at much more favorable price, a debt exchange being one strategy that Fitch Ratings said in a note this morning the company could employ.

“Fitch expects the $208 million of 7.375% senior unsecured holdco notes to be paid down through future exchanges into other debt or by transferring cash from various operating entities through restricted payment and investments baskets,” analyst Monica Aggarwal said in today’s report.

The company’s $450 million of debt maturities coming due in 2018 consists of a €48 million French PropCo facility due February 2018, the $208 million of holdco notes due October 2018, and $186 million of B-2/B-3 term loans due May 2018.

Toys ‘R’ Us issued the following statement to LCD, but did not immediately respond with a comment on reports that it has hired Kirkland & Ellis or to reports that it is weighing bankruptcy as an option.

“As we previously discussed on our first-quarter earnings call, Toys ‘R’ Us is evaluating a range of alternatives to address our 2018 debt maturities, which may include the possibility of obtaining additional financing. We expect to provide an update about these activities, as well as the many initiatives underway to provide an outstanding customer experience in our global retail locations and webstore during the holiday season, during our second-quarter earnings call on September 26th,” Toys ‘R’ Us communications officer Amy Von Walter said in the emailed statement.

The issuer’s covenant-lite B-4 term loan due April 2020 was quoted at a 74.75 bid today, down nearly two points from the last session, sources said.

The company last year successfully completed a series of transactions to address its looming debt maturities after the toy retailer hired advisors, including Lazard, to assist in the refinancing of its capital structure.

Wayne, N.J.–based Toys ‘R’ Us is controlled by Bain Capital, KKR, and Vornado Realty Trust. Ratings are B–/B3 CCC. — Rachelle Kakouris/Kelsey Butler

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