Outlook 2024: Distressed volume steady; retail, health care pressured; index returns improve

By Cristal Cody

Tupelo, Miss., Dec. 29 – The distressed space grew over 2023 as interest rates climbed and inflation exploded, war expanded and other geopolitical events hampered issuers.

Retail and health care were among the corporate sectors under the most distress during the year, sources reported.

Familiar names either disappeared or reincarnated into other formats, such as Bed Bath & Beyond Inc. after it filed for Chapter 11 bankruptcy in April and sold its intellectual property to stalking horse bidder Overstock.com, Inc.

Pharmaceutical manufacturer Mallinckrodt plc filed its second Chapter 11 bankruptcy in August after just emerging from bankruptcy a year earlier.

The move had been expected since the company skipped paying interest payments on two of its bonds in June.

DISH Network Corp. found itself the first ever recipient of a fine from the government in the first space debris enforcement action ever taken. By the end of the year, DISH’s paper was streaking higher as the company neared closing a merger with EchoStar Corp. after clearing regulatory hurdles in early December.

Volatility-inducing was the theme for 2023, according to a report from Christine Short of Wall Street Horizon.

“Despite markets roaring back in Q4, many corporate event indicators showed companies taking a more cautious approach to finish out 2023,” Short said.

Fewer companies raised dividend amounts in the third and fourth quarters. Some actually began to announce dividend decreases. Buyback announcements were the lowest since data collecting began in 2018, and reverse stock splits gained in popularity, Short noted.

“In another sign of distress for corporations in 2023, the number of reverse stock splits increased from their averages,” she said. “In total, 262 companies announced reverse stock splits throughout the year [versus] the 5-year average of 169. Typically, companies pursue reverse splits when they are trying to raise the value of otherwise fallen share prices.”

AMC Entertainment Holdings, Inc. brought numerous offerings across securities in 2023, including conducting a reverse stock split in August.

Meanwhile, sports broadcaster Diamond Sports Group, LLC filed for bankruptcy, while its paper “got some looking” at by traders late in December on a potential deal with Amazon.com Inc. after languishing in deep distressed territory following the Chapter 11 bankruptcy filing in March, a source said.

Distressed bank paper from banks that collapsed back in the spring also started making a run higher in December as traders smelled money left in the names.

First Republic Bank and Signature Bank New York both rallied as the year wound down.

Signature Bank’s notes climbed over 20 points in December.

First Republic and Signature Bank were among three regional banks that were seized by regulators in 2023.

“Bondholders of Signature Bank are moving prices up because the FDIC took over the bank in March, and traders and investors discovered the FDIC balance sheet showed Signature Bank had a positive net worth of $46 million, so there could be some value in this thing,” a trader said. “Similar speculation in First Republic. It’s not as dramatic, but it was trading at less than $1, now it’s more in the $5, $6 area. But Signature Bank was the catalyst.”

Signature Bank’s 4% subordinated notes due 2030 were quoted prior to the news coming out on Dec. 1 at 5½ bid, 6½ offered.

By the week before Christmas, the bonds had rallied to a 28 handle.

Distressed volume steady

The distressed bond market remained hefty going into 2024 with defaults predicted to rise.

Downgrades in the junk space have exceeded upgrades by $72 billion versus a $38 billion margin over the past three months, BofA Securities Inc. analysts said in December.

Several bankruptcies in the U.S. and global spaces have disrupted sectors, including WeWork Inc.’s Nov. 6 Chapter 11 bankruptcy filing that is weighing on the CMBS space and commercial real estate investment market, sources note.

Fitch Ratings reports weaker outlooks for some industries, including weaker demand for North American building products and materials companies and retail volume.

Oleg Melentyev, head of U.S. high-yield credit strategy at BofA Securities, said in a press conference in December there should be no “confusion on a lack of impact from substantially higher interest. We firmly believe the impact’s coming. We estimate we’re looking at $300 billion of debt trading at distressed levels.”

The bank also is focusing on the corporate space where $200 billion of bonds and loans are trading at deeply distressed levels.

“We're looking at bonds and loans with dollar prices below 60 cents on the dollar,” Melentyev said. “Historically, issuers that experience these deep levels of distress end up restructuring their debt in one form or another.”

BofA said it also tracks about $500 billion in “pre-distress” bonds and loans that are trading north of 600 basis points and where a new coupon could be 10% or higher if it were reset at current levels.

In addition, Melentyev said the bank is tracking $235 billion of debt in “look-alike issuers” that are dominated by single-B rated names with a heavy sector concentration in its top-five focus sectors – technology, health, services, financials and retail and remain vulnerable to repricing wider.

The total amount of deeply distressed debt did not change materially in 2023 and has stayed in a range of $150 billion to $200 billion, BofA said.

“What happened behind the scenes is that the distressed paper was marked in the 40s a year ago when the consensus firmly believed in imminent and inevitable recession,” according to a report. “Today, it trades closer to 60 pts, as the consensus now firmly believes in the soft-landing.”

S&P Global Ratings said it expects the U.S. trailing-12-month speculative-grade corporate default rate to reach 5% by September 2024, above the 4.1% long-term average, with consumer-reliant sectors the most impacted.

“Credit stresses are growing, and borrowers will need to adjust to a new playing field in which financing conditions could become even tighter; near-term relief seems unlikely, as all-in borrowing costs look set to stay elevated, investors become more cautious, and U.S. GDP growth looks set to slow,” S&P said.

“Issuers have taken steps to address near-term maturities, trimming speculative-grade corporate debt due in 2024 by 34% over the past year, but speculative-grade debt coming due rises through 2028, and escalating maturities will add pressure to issuers' financing needs in coming years,” S&P noted. “Lower-rated borrowers may feel more severe liquidity strains if approaching debt maturities coincide with a period of challenging financing conditions.”

Distressed returns

S&P U.S. High Yield Corporate Distressed Bond index month-to-date total returns for December were over 6% just ahead of the holidays.

Year-to-date distressed total returns rose to more than 22% by late December.

Monthly returns were strong at the start of 2023 but soon came under pressure over several months before seeing gains closing out the year.

The strongest month in 2023 was at the start of the year with January’s distressed index returns of 7.99%, while the weakest was in October with returns at minus 6.27%.

Index returns totaled 1.03% in February, minus 4.2% in March, 2.68% in April, minus 0.63% in May, 4.67% in June, 2.96% in July, 1.9% in August, 0.55% in September and 4.1% in November.

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