When the Music Stops, Read the Fine Print

Something is shifting in the markets.

Inflation expectations hit 5.2% last week in the US, the highest since March 2023. Three weeks ago the bond market was pricing in rate cuts. Now the probability of a Fed rate hike by year end (24.6%) is more than three times the probability of a cut (7.5%). Fed fund futures have pushed the next expected cut all the way out to October 2027.

That shift is showing up in US credit. Only 26% of leveraged loans sit above par, down from roughly 65% earlier this year. Software names make up just 1% of that number.

And Morningstar put out a statistic last week that deserves more attention: over the past 12 months, 16 of 17 US private credit rating downgrades to default or selective default were distressed exchanges. Not formal filings. Not orderly processes. Negotiated outcomes where the documentation determined who got paid and who didn’t.

That’s the picture in America, but if you think Europe is insulated, think again. As I wrote in the Financial Times last week, the European market has seen a sharp rise in liability management exercises over the past two years: Altice France, Altice International, Ardagh, Victoria, Selecta, Hunkemöller. 

Borrowers are now going further than just using covenant flexibility. Altice USA filed a lawsuit against a group of major creditors including Apollo, Ares, and BlackRock, arguing that their cooperation agreement amounts to an illegal cartel. If that argument succeeds in a US court, expect European issuers to bring the same playbook across the Atlantic. If that doesn't work, there's always the coop blocker to fall back on - it's not cleared in Europe yet, but if history is anything to go by, borrowers and sponsors won't stop trying.

This is the pattern on both sides of the pond. Borrowers restructure through liability management exercises, exchange offers, and consent solicitations. If something doesn't work, the finance team will draft around it in the next deal. Every one of those transactions turns on what the credit agreement actually says: subordination mechanics, basket capacity, intercreditor provisions.

Meanwhile, AI continues to threaten disription. According to the restructuring newsletter Petition, a tweet went viral last week claiming AI can now draft legal contracts better than $800/hour lawyers. The restructuring community’s reply went for the jugular: “ok now do the Kirkland & Ellis Superpriority Credit Agreement and Exit Consent to Existing First Lien Credit Agreement.” 

Like all jokes there is a kernel of truth there - a template NDA and a live covenant negotiation in a distressed deal are different universes. And right now, credit professionals on both sides of the Atlantic are embroiled in the latter. AI cannot read these risks for you.

Some liability management exercises are more marathon than sprint. Take The LYCRA Company - it filed Chapter 11 last week after seven years of serial restructuring transactions stacked on top of each other: acquisition debt, mezzanine enforcement, an IP drop-down, a failed sale, a change of control trust, and a plan with tiered penny warrants and distribution waterfalls. EBITDA down 67% in two years. Talk about kicking the can.

The people who can read these documents are making the calls. Everyone else is relying on someone else’s summary. On either side of the Atlantic, that’s no longer a shortcut you can afford.

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