Outlook 2023: Distressed market on watch for prospects as defaults climb; retail in focus

By Cristal Cody

Tupelo, Miss., Dec. 30 – Distressed debt volume ran thin at the start of 2022 but saw steady contributors by the year’s close with inflation soaring amid rising interest rates, heightened volatility from the Russia/Ukraine war and other geopolitical issues and supply chain woes.

“Definitely expect market volatility,” a source said of 2023.

A wide range of companies saw their fortunes change, both for the better and the worse in 2022.

Chapter 11 bankruptcy filings came over the year from issuers including Talen Energy Supply LLC, TPC Group Inc., Revlon Consumer Products Corp. and Endo International plc.

The year marked a heavy round of distressed debt exchanges from companies including Diamond Sports Group LLC, Wolverine Escrow LLC, Envision Healthcare Corp., Bausch Health Cos. Inc., Rite Aid Corp., Diebold Nixdorf Inc. and Bed Bath & Beyond Inc.

By the end of 2022, there were plenty of distressed bonds to peruse.

“A list of potential defaulters shows that the market is well aware of where the problems are and marks them accordingly,” according to a note from BofA Securities, which estimates a default peak of 5% in 2023. “As a result, there are enough bonds trading in the 40s, 50s, and 60s to make up for projected defaults. The current cohort of distressed names is trading at 78 pts in BBs, 70 pts in Bs, and 62 pts in CCCs.”

BofA analysts said that 85% of defaults come from the distressed segment, with the rest from non-distressed, and estimates the “current dollar price of potential defaulters as 62 pts.”

A higher default rate is expected in 2023, ranging from about 3% to as high as 6%, sources report.

“That should spawn some opportunities,” a trader reported. “I would be watching retail – it could be tough.”

Distressed retail

Kohl’s Corp. was dropped to junk by Moody’s Investors Service in December.

Other retailers stayed under pressure in 2022 with several undertaking distressed debt exchanges.

Bed Bath & Beyond extended its offers to exchange its senior notes from Dec. 5 to Dec. 19 and then again to Jan. 4.

The company is offering to exchange its outstanding notes for new second- and third-lien debt.

Bed Bath & Beyond’s 3.749% senior notes due 2024 (C/D) traded in the low 30s by the year’s end, a source said. The retailer’s other paper was trading in the teens.

The distressed retail space was peppered over the year with names including Rite Aid and Staples, Inc.

Rite Aid’s bonds traded with handles in the 50s to low 70s after its second debt exchange transaction of 2022.

The 8% senior secured notes due 2026 (B3/CCC-/CCC) were quoted in early December at 59 bid, 60 offered.

“Rite Aid remains highly leveraged, notwithstanding its recent debt paydown, and we think growth prospects are deteriorating and market share is declining,” according to a S&P report. “We anticipate revenue declines in fiscal 2023 marked by less traction than we anticipated at its pharmacy benefits manager.”

Rite Aid reported that $200 million-plus of debt was paid down in fiscal year 2022, and the company has no debt due until 2025.

Revlon’s notes sunk by the year’s end following the bankruptcy filing and remained weak in December as the issuer prepared to file its plan and disclosure statement by Dec. 22.

Revlon’s 6¼% senior notes due 2024 traded around 5 bid in December, a source said.

Party City Holdings Inc.’s paper moved lower in 2022 as the issuer faced ratings downgrades and its addition to watch lists.

“Party City, Rite Aid, Artera Services LLC and Team Health Holdings Inc. represent new additions to Fitch’s Top Market Concern list, driving the total to $42.7 billion from $38.8 billion in October,” Fitch said in November.

Party City’s 8¾% senior secured notes due 2026 (Caa1/CCC+) were trading at 30½ bid by December, a source said.

Companies on edge

A growing list of companies saw distressed secondary interest in 2022 that is expected to continue into 2023.

Online car retailer Carvana Co.’s junk paper, fresh off pricing at par in April, moved well into the distressed space by December.

Carvana’s 10¼% senior notes due 2030 (Caa2/CCC) traded at 42 bid, 43 offered, a source said.

Carvana sold the issue at par on April 27 in a $3.28 billion offering.

AMC Entertainment Holdings, Inc. was a fairly constant name in the distressed space in 2022 as the company made some changes that raised eyebrows. The movie theater owner reported on March 15 that it purchased a 22% stake of gold and silver mine operator Hycroft Mining Holding Corp. for $27.9 million in cash.

Pharmaceutical names such as Endo and health care issuers also saw heavy pressure during the year with settlement after settlement against pharmaceutical companies and retailers related to the opioid crisis were announced in 2022.

In 2023, most “underperformance” is expected to come from commodity-exposed areas such as metals, packaging and energy; industrials, including capital goods and autos; utilities and cable which “is being dragged lower by one of the highest projected downgrade rates,” BofA analysts said.

China also is likely to continue to impact the markets as defaults and downgrades weigh on the property developer space from companies including Greenland Holding Group Co. Ltd. and 2022 fallen angel Country Garden Holdings Co. Ltd., according to market sources.

Distressed financials

Meanwhile, the financial space also has seen some distress in 2022.

U.S. banks’ operating performance is anticipated to deteriorate in 2023 due mainly to rising loan loss provisions, according to Fitch.

Credit Suisse Group AG came by the high-grade primary market in November with a $2 billion offering of 10-year notes (Baa2/BBB) that priced with a 9.016% coupon.

Credit Suisse’s junk perpetual securities remained weak in December, while the firm’s credit default swap spreads also widened as the company restructures its investment banking business.

The company’s 9¾% perpetual securities (/B) traded at 85¾ bid and yielded over 14%, a source reported.

Goldman Sachs Group Inc.’s 3.8% perpetual securities (Ba1/BB+) were trading late in the year with a handle in the high 70s, a market source said.

U.S. banks’ operating environment, asset quality, funding and liquidity were the credit drivers expected to experience the most softness relative to 2022, Fitch said.

Key items to watch in 2023 include the trajectory of inflation and pace of monetary tightening, U.S. unemployment conditions and the effect on credit losses and loan underwriting standards, Fitch said.

Weak junk bond issuance of about $180 billion is predicted for 2023, a 40% drop from the last two-year average supply but still about 60% above 2022 levels, according to BofA analysts.

A recession is all but a given for 2023, sources report.

The year ahead is being pegged as a “mild recession in line with the 1969/1970 recession,” according to S&P U.S. chief economist Beth Ann Bovino.

Gross domestic product growth is expected to weaken 0.1% in 2023, S&P said.

The S&P U.S. High Yield Corporate Distressed Bond index headed into late December with a year-to-date total return hovering near the minus 25% area.

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