Hello, and welcome to The Credit Edge, a weekly markets podcast. My name is James Crumby. I'm a senior editor at Bloomberg. This week, we're very pleased to welcome back to the show Emilia Pollard, who reports on distressed debt for Bloomberg News in New York. How are you, Amelia, I'm great, Thanks so much, James. We're also delighted to have Mike Campalone, who covers retail for Bloomberg Intelligence, also in New York.
We'll be coming back to Mike shortly. Lots of fascinating stuff going on in the retail and consumer sect right now, so do stay with us. But first, Amelia Pollard with Bloomberg News Distressed Debt. You had a great story this week on struggling companies who are finding a lifeline new money to keep them alive a bit longer, but they're going bust anyway. Investors are essentially giving more cash to doomed companies and they're not making anything better. In fact,
they seem to be making it worse. Deck Chairs on the Titanic, Amelia, what's going on? What's the situation?
Yeah, that's the perfect way to describe it. James, and many people I spoke to while are broughting the story said that these deals, which are known as liability management transactions and the most jargon me buzzword out there right now, are essentially basically just rearranging Dectairs and the Titanic.
And the reason why lenders have an incentive.
To give new money is that these are existing lenders that are already in the capital structure, so they already have skin in the game, so to speak, and have a big incentive to try to keep the company afloat. And these deals known as liability management exercises or transactions, they're referred to both synonymously basically our last ditch efforts
to buy the company time. So what we've seen in recent weeks, though, is that a lot of the deals that happened in twenty twenty and twenty twenty one, and even as recently as last year are starting to unravel. As you know, the pain of high interest rates and waning consumer spending is really not is not helping the situation for these companies, and they're not able to turn things around in the way they had hoped to.
So let's just stop for a minute and look at it. Sort of in more broad terms liability management. First, that sort of sets off a load of jargon and lums in my mind. What does it mean just taking some debt and refinancing it with new debt maybe longer maturity, maybe cheaper or what is it? What is it? In basic terms?
Yeah, basically it is, you know, getting new The company gets receives new money in exchange for either pushing out maturities or you know, kind of making some kind of
arrangement that gives the lenders a benefit. And typically what we've seen in recent years is these these deals have been around forever, but the most recent breed of these deals are pretty contentious, and you often see a group of lenders left behind and often they're so pissed off that they will sue the company or the other lenders and becomes a very big, dramatic mess very quickly.
But there are.
Two specific types that have become exceptionally popular, and forgive the moment of jargon jargon, but I will.
Explain about them.
One is an up tearing transaction, and that's something that we saw the mattress Maker sort of Simons do in twenty twenty. And essentially all that means is that a group of lenders agrees to give new money in exchange for being bumped up in their repayment line. So given the worst case scenario, the company files for bankruptcy, they will be the first ones to get paid back. And in testimony from executives for these funds who had given new money or weren't able to.
Give new money, some of them said that.
Their base case scenario was that sort of would eventually file for bankruptcy, just did not.
The writing was on the wall.
They had too much debt, you know, the industry itself was hurting, and so they wanted to ensure that they were in the best position when that did happen. We've seen a number of deals since in twenty twenty kind of replicating the structure of that deal. And then the other one that has become very popular has been something
known as the drop down. And this is something that Ja Crue pioneered a few years ago, and it essentially strips collateral from a group of lenders and facts and new group of lenders, and it's often the most valuable collateral, you know, so whether it's a subsidiary. In some cases, we saw something like that with Envisioned healthcare, where subsidiary was kind of used as new collateral that was seen
as highly valuable by lenders. And so those two types are the ones that those two types of deals are the ones we're seeing unraveling. And in some cases it's because so much litigation has emerged, as in the case of Serda, where the companies really are love with no option but to put the company.
In chapter eleven, you mentioned though it's got worse over the last couple of years. I'm wondering why that's his. I mean, is it that company's getting more desperate because of the macro environment. Is it the advisor and laws are getting creative in you know, finding solutions. Is it the fact that none of these deals had any covenants in the easy times? What's the reason for coming to a head now?
Yeah, well, I think you just listed the big three, but you know, those are all reasons why this coming to a head now. And I think we start to see we started to see some of these really crop up in twenty twenty and early twenty twenty one, the era of easy money. You know, it was easier to
get new money in that at that time. But now we're still seeing it's big still popular, and it was still popular last year as the economy started to tighten a bit, and you know, credit markets were not as readily available with new money, and so companies were increasingly tapping existing lenders to get new financing. And that's what
we've seen here. And then you know, I wrote this story just on the heels of two big filings that had liability to management deals under their belts in Kora, which is an aerospace supplier, and also dee Bold Nicksdorf, which is like one of the biggest ATM makers in the world. And so I think that we're starting to see these deals are essentially a bet that the companies were able to turn things around with interest rates as high as they are.
They haven't been able.
To do that, but it's essentially good money off to bed. I mean, that's just throwing money down the pan because they're already involved in the situation. They're hoping to get some kind of benefit in the longer terms. The what's the play.
Yeah, the play is basically just bettering their position. So you know, one thing we saw with Serta for instance, the mattress company, is that the two different groups of lenders were basically giving the company competing contentious offers of how to reconfigure the debt, and once one group caught win that the other group was, you know, pitching a very contentious plan as well. They were like, okay, well, we need to you know, put together our own proposals
so that we can get ahead. And so it's a little bit of a race to the box them as well, in which lenders are kind of you know, pushing each other to get you know, the best in the best position in case of a default. And I think that that's what we're seeing where lenders, if blenders have a base case of a default in place, I think they're trying to ensure that they're in the best possible position when the repayments start for creditors.
Do we expect more of this?
I think so.
I mean, there there were a lot of liability management deals in the last couple of years, and it seems like, you know, professionals are only cooking up more breeds. I think that upteering and drop downs are you know, the only only two of the types of you know, kind of contentious deals that are merging from this era.
But I'm sure there will be more.
It seems like, you know, there's every time that you know, a new clause or you know, sentence or two is added to these credit agreements to block you know, an upteering deal or drop down deal. You know, there's always some legal gap that lawyers will find. Is there a pattern too? It Is it related to a particular sector or kind of deal?
I mean, is it all retail. We're going to talk to Mike Campblown a bit about retail, But is it is it mainly in one sector?
You know, it's not. It's that's something that's interesting about these kind of deals. It's so.
It's so diverse and the types of companies and that do these sorts of transactions. And I think that's really evident. And you know, just the two that we saw last week or two weeks ago now within Quora and people next Door if that, you know, any company that has a lot of debt is going to try to do one of these transactions.
Is it mostly private equity backed companies? You think?
Yeah?
You know, I mean I think that there is a sponsor component to this. I'm not sure how much those sponsors are driving these sorts of deals, but in sort of for instance, you know, there there was some testimony from their p sponsor during the bankruptcy hearings and their role in kind of facilitating and helping to field interests from lenders that were proposing these sorts of deals. So they definitely play a role. Whether or not they're soliciting these kinds of transactions, I'm not sure.
And when they end up in bankruptcy what you're saying in your stories that they're actually making them much more complex and much more messy. They're also all ending up in Texas, so I'm interested in why that's is as well.
Yeah, they are. They love Texas.
I think maybe all of the filings have been in Texas so far this year, of the ones that have libel management deals, or at least the vast majority. I think it started actually again with Surda, not to bring up Surda for the fifth time in this.
Call, but.
Sort of filed in Texas in January, and the bankruptcy judge there, David Jones has been kind of a pioneer in blessing many pieces of this highly controversial transaction, and the most recent one came only this week in which he said that the deal was made in good faith and that was one of the arguments that the spurned lenders was making was that the deal reached this implied covenant of good faith and fair dealing, which basically means
that the intent of the original credit agreement, you know, was not to have this this sort of subverted transaction down the line. And so the fact that Judge Jones has been so willing to kind of step in and you know, make sweeping decisions and basically established case precedent in the process has attracted a lot of other companies to the venue.
So he's being easier on these companies only from the investor standpoint, well.
Some would say, some would say he's being easier in the company.
I mean, I think that you know, any bankruptcy court and judge's main prerogative is for the company to survive, you know, And so I think that that's that's really the goal here, and I think that they he presumably saw the litigation as a you know, a barrier to the company survival, and he cited the fact that the other group of lenders had proposed an equally contentious type of deal, so you know, they were they were very ready to do their own type of transaction and only
because they were left and behind.
Were they so pissed off? Okay, but this doesn't always end badly. You mentioned J Crew earlier. They're still in business. How can this come to a happy ending here? There are some success stories. One that we saw was with board Writers, which is a surfwhere retailer. They did a contentious deal in recent months and they were ultimately bought by Authentic Brands, which is I think they agreed to buy them in March. So that you know that a sale out of court is would be seen as a
success by many. And I think that whenever these deals are proposed or lenders are interested in doing this sort of transaction, they'll point to success stories like this. So you know, I think that we cited a study from Fitch that's out of thirty types of these kinds of deals, twenty four amounted to a default or a bankruptcy down the line. So but you know there are there are six that didn't, and lenders and companies will keep on pointing to those is as reasons why it might be
worth it in the end. But mostly bad, so far, so far, mostly bad. That's you're a lawyer.
Yeah, I mean, I'm for sure unless you're a lawyer or any professional retained for these kinds of deals.
So before we talked to Mike Campbell and Bloomberg Intelligence, what's the next big story to watch on your beat, Amelia.
I think the next big one is the fact that a lot of the companies that we've seen in file for bankruptcy this year have been ones that have been you know, highly very telegraphed in. They've been names that have been on our radar for months, if not years, and you know, I have had a huge amount of
debt for a long time. I think something that will be interesting in the broader market and economy as if we start to see pretty healthy companies pivot quickly into a distress situation, and I think that will be evidence that interest rates are you know, really starting to bite in a way that is causing severe repercussions. And the other thing that we're looking at is just how commercial real estate is being impacted right now by interest rates.
That's one of the biggest you know, industries or sectors to have distress debt right now, and I think that will be a story that'll play out for the rest of the year.
Great stuff familiar pull out from Bloomberg News. Thanks so much for joining us. Read all of Amelia's scoops on the Bloomberg terminal and of course at Bloomberg dot com.
Thanks so much having me James, So.
As I mentioned earlier, we're glad to have with us Mike Campalone, who looks at retail companies for Bloomberg Intelligence.
How's it going, Mike, Hey, James, thanks for having me on.
So in retail, what's the outlook? How strained are consumers right now given such high inflation, rising rates and a recession coming?
Yeah? Absolutely so. You know, we've been looking at recent credit card transaction data and it showing consumers continue to pull back on retail spending, and while their preference for or experience related categories continued, that pace has actually started to slow. So furniture supporting goods and clothing accessory stores all within retail experience the greatest demand driven contraction that we've seen in that data.
You know.
More generally, retailers across sub sectors have warned up an increasingly more pressured consumer, but we certainly see more red flags from auto part home improvement, and select apparel retailers as well, especially those catering to a lower income earning consumer. Retailers have given us a fairly consistent outlook for twenty twenty three, which includes pressure both on the top and bottom line in the first half of the year, with
some of that pressure easing in the second half. You know, easing freight costs seem to be the largest contributor to retailers improved tone in the backup of the year, and we expect to see that as well.
So you said consumers are kind of pulling back across the board. Is it away from discretion? Are you away from sort of nice to have and more to what people need to have right now?
Yeah, that's absolutely true. And you know, after one Q earnings, some of those themes that retailers have expressed to us at the beginning of the year have really held consistent with our expectations. You know. Some of those themes include inventories realigning, so as supply chains and product costs decline. In twenty twenty two, we saw inventories were extremely bloated, as you may remember, and as demand and timing we're significantly out of sync. So we're seeing that rebalancing start
to happen. The second theme, freight costs are easing. Like I said earlier, that's going to benefit retailers who import from Asia the most. So we've seen spot rates pushed lower, which has enabled some retailers to renegotiate annual shipping container contracts that they typically hold in the spring, and that's why we're going to see that benefit, that freight benefit in the second half of the year for most names.
And then lastly, the weakest sub sectors last year within retail are going to see the greatest improvement this year. So department stores, apparel and footwear, and value sectors will benefit from this more conservative inventory planning after substantial markdowns last year to clear that access inventory.
It's interesting that bricks and mortar scenes becoming back people as you want to go out to shop now.
So yeah, so you know, I think how retailers are differentiating themselves, and you know, what they've learned from the pandemic is the physical store remains extremely important, and that's both from an in store shopping experience and also leveraging physical footprints that retailers have to bolster their logistics and distribution network. So stores are still important, and it's more about store footprint optimization than getting rid of stores completely.
And as part of that, I mean, you're going out to shops because you couldn't for so long. Is it sort of revenge spending as we've been calling it.
Yeah, you know, there was definitely that theme of revenge spending and people wanting to just spend money that was built up during the pandemic, whether through uh, you know, stimulus fueled money that people were receiving, or just a desire to do things and shop again. So we've seen that revenge spending on goods definitely pulled back, and it's still lingering around in the travel and experience sector. But like I said earlier, we're starting to see those trends fade.
So it has to come to an end. I mean, obviously it's some that the pandemic has been you know, there's it's supposed to be over now, although everyone's wearing masks skin because of the air quality. But the the idea that you know, there was this boom eventually fades. Is it Is it gonna just go to zero? I mean, are we going to just see a big, big drop off in consumption? You think?
You know, I think it's unique to the sub sectors within retail. You know, one one space, uh, you know, particularly where there's been a lot of shift in spending and also in credit profiles is the the department stores. So you know, it's the department stores are an absolutely interesting space within retail for us from a credit perspective, and we've seen drastic changes in some of these companies' profiles for the names we cover, so Macy's, Coal's, and
Nordstrom just over the past three years. So Macy's has done an exceptional job delevering its balance sheet. It's reduced funded debt by over two billion dollars over the past three years. It's pushed out near term debt maturities with no significant bomb maturities over the next five years, and it has a capital structure that's mainly unsecured. The company's Polaris initiative has also started to benefit the company's margins that have historically lacked peers a pre pandemic, and we
expect that trend to persist for Macy's this year. You know, Nordstrom continues to face operating challenges, especially with its rack business. We think that these issues will continue to extend pressure on its credit profile over the near term, and the company has two hundred and fifty million of bombs charities in twenty twenty four that also need to be addressed,
you know. And then lastly, moving on to Coles, I think that name has seen the most drastic negative shift in its credit profile over the past three years, at a time where probably execution risk is likely at its highest with new management in place. So Cole's had a financial policy last year that prioritized shareholder returns via buybacks, which a person was seven hundred million dollars for the year, and that's despite the company generating negative free cash flow
during that time period. So you know, definitely a shift in spending across different subsectors of retail, department stores being a very unique space within there as well, both from a consumer spending shift and from you know, indiosyncratic credit risk that exists within some of these names. So a lot going on there.
So regardless of the quality of the product and the experience and all that stuff, and you know, whether you love the store or not, it really does seem to be more about how how the companies have managed their balance shees right, in terms of like you know, with suddenly in this much much higher rate, and.
Absolutely absolutely, we could not agree more with that. We are prefer names that have prioritized cleaning up the balance sheet last year, and that's just putting them in a better position this year from a capital allocation standpoint and being able to deploy capital, even if it's more limited, deploy capital in the right places, like investing in stores and cafecs.
And so how they differentiating themselves in the context of credit quality.
Yeah, so you know that definitely names are differentiating selves by you know, investing in the physical store like we were staying like we were saying earlier, and leveraging that store for their distribution network. And then you know, second from the type of business that the that this retailer operates in, Like we were saying, there's so many different subsectors within retail. So how how are retailer is differentiating itself via its product offering and it's its store experience
is really making a difference. So something like an off price retailer like TJX is really benefited benefiting from last year's inventory blood and they're able to secure a larger surplus of branded products at a lower cost, so both improving the company's margin profile, offering consumers a lower price point option at a time where wallets are already being strapped.
So both a combination of a capital allocation historically prioritizing the balance sheet and continuing to invest into the company's business and store footprint, and then also this differentiating the product and service that the retailer offers.
Let's talk about the risk of I mean, since we've credit guys, Emilia Apollo from Bloomberg News was talking about the stress generally, and we've seen a lot of bankruptcy, a lot of defaults, and a lot of them have been in retail. A lot of them been happening over the last few years. Is there more of that to come? Yeah?
So I was actually reading a recent SMP report that was similar to Amelia's story, and it was pointing out that consumer discretionary actually has topped the list of sexor sectors with the most bankruptcies this year in the US. So yeah, we've definitely seen some notable retail bankruptcies this year, including Party City and bed Bath and Beyond, who both
followed for Chapter eleven earlier this year. And that was a combination of weakening consumer demand, higher costs, and then really unsustainable debtloads.
Has it been cleared out now or is there more of that to come? You think?
Yeah, we think that there's still risks for obviously highly levered, sponsored owned retailers and who operate in segments of retail that are super content concentrated in UH product offerings that are fading away. So whether it's you know, home improvement,
auto parts, and even some apparel retailers. So that kind of combination of very specific business segment that the retailer operates in and sells products out of, and just high debt loads that are unsustainable, you know, could could continue that trend of retail bankruptcies.
So again you mentioned household names like Party City. I mean those those would seem to be good businesses. Everyone wants a party, but just purely because they didn't manage that debt properly, they're blowing up.
Yeah, yeah, yeah, blowing up. And I don't know if you met a pun intended there. The helium shortage actually was a big driver of the bankruptcy UH for Party City as well. So yeah, a combination of just business risks and unsustainable debt loads.
So what do you see the value right now? Mike, I mean in terms of, you know, what would you say is a good credit pick or what's a pan?
Yeah? Absolutely, yeah, And a little shameless plug for our BI Credit Picks and Pans reports that we put out on multiple times throughout the year, So absolutely check is out to all our listeners if you haven't. But from a relative value perspective, at the beginning of the year, within our vi I Credit Picks and Pans report UH, and specifically for retail, in our picks, we included Macy's,
t j X, and Target At. Some of the names that could outperform in Some of the names that were on our pans list were VF Corp UH and under Armor, and we kind of stand by those, uh, those views that we outlined at the beginning of the year.
What's PF.
VF Corp. Is the owner of brands like Timberlane, Dickey's. It's a really a conglomerate of our portfolio of brands that has had a historical emphasis on buying and selling brands and managing its portfolio consistently. So we you know, we've kind of pointed to some of the risk associated with that name just in how it does business in
that sense, but then also a growing debtload. It has to fund an unfavorable tax decision related to its twenty eleven acquisition of Timberland that it had a fund with all debt. So just higher debt loads and already aggressive business just is increasing risk for.
That name and on you and under Ahma, that's an interesting one. I just see people wearing that everywhere I go, So why is that not doing so well?
Yeah? So under Armour has had challenges that it's faced even pre pandemic, and it's really struggled with just turning around that business since then. You know, the prior CEO abruptly left I want to say last year, so we have new management in place, and that's just even pushing event risk higher for the name. So challenges there that were pre pandemic are now even under more of a microscope with new management management in place. So absolutely a show me story.
Now, Thanks very much Mike campellone of Bloomberg Intelligence. You can read all of his great analysis on the Bloomberg terminal. Do check it out, and we hope to see you back on the show soon. Mike.
Thank you so much, Jeeves, and.
Thank us again to Emlia Pollard from Bloomberg News. Read all of her great distress debt scoops on the Terminal and at Bloomberg dot Com. I'm James Crombie. It's been a pleasure having you join us again. Next week on the Credit Edge