Robertshaw, a troubled appliance partmaker, cut two controversial financing deals last year to try to keep itself afloat. Then, this year, it filed for bankruptcy anyway.

That’s becoming a pattern, according to one analysis by Bank of America: when companies get contentious financings that give special treatment to a handful of their creditors, they still default again about 40% of the time.

The financings not only pit lenders against each other and cut into recoveries, they sometimes trigger litigation. In an economic landscape that could worsen, many investors are saying these so-called liability management exercises are a bad deal in contrast to filing for bankruptcy and undergoing a more comprehensive restructuring.

“When you have a problem with an enterprise, wasting time is value-destroying,” said Dan Zwirn, chief executive officer at Arena Investors. “Recoveries go down. It might be accretive to marks in the short term - whether that’s the loans, bonds or equity - but it’s ultimately value destructive.”

For investors left out of these deals, investments can turn sour quickly. In one July analysis of the deals, senior debt in capital structures often underperformed more junior debt in the aftermath of liability management, Barclays Plc strategists found.

The trouble with these financings is only growing. This year there’s been at least US$24 billion of debt that’s been exchanged by distressed companies looking to fix themselves, one of the most active years for this activity since 2008, according to a report from JPMorgan Chase & Co.

“Many LMEs have not meaningfully delevered issuers in anticipation of lower interest rates,” said Surbhi Gupta, a managing director in Houlihan Lokey’s financial restructuring group, referring to liability management exercises. Given the current elevated rate environment, some of these issuers may need to approach lenders again to reduce leverage further, she said.

For Tony Yoseloff, managing partner and chief investment officer at Davidson Kempner Capital Management, while there are some merits of restructuring debt out of a bankruptcy court, it can also be akin to “rearranging seats on the Titanic.”

Liability management deals have become more common over the past decade, as investors conceded protections in credit agreements and the cost of bankruptcy skyrocketed. Borrowers are now looking to such deals as a way to survive until the Federal Reserve starts cutting interest rates.

More than half of restructuring experts surveyed by AlixPartners in a study released in July said liability management efforts in the past 12 months were temporary fixes that don’t resolve the fundamental issues of a business. If a company’s problems persist, it makes the next restructuring harder because there’s no more room to manoeuvre, the report said.

Bank of America in its May report pointed to Rite Aid, Diebold Nixdorf, WeWork and Curo as examples of companies that had undergone liability management exercises since 2022 and ended up defaulting again. According to Oleg Melentyev, head of US high-yield strategy at the bank and author of the report, liability management exercises can be successful if the terms of the deal are “substantial enough,” and the new capital structure is very different from the old, unsustainable one.

“It remains to be seen which transactions will be successful and which won’t work,” said Ed Testerman, partner on the US research team at King Street Capital Management. “In most instances, if the earnings profile doesn’t improve, these companies are over-levered and the reality is many of them will have to restructure.”

Still, for some lenders, it’s lucrative to become part of the group that provides new funding. That’s one way to participate in a market that’s otherwise starved for new issuance, and it’s a preferable alternative to being caught on the losing end in a new capital structure.

“Some of the best risk-adjusted deals we are seeing in the market right now are in rescue financing,” said David Rosenberg, Oaktree Capital Management’s head of liquid performing credit. “Being able to put new money to work as a lender is a powerful thing, especially if you have the expertise to structure it accordingly.”

Barclays expects a wave of debt restructuring exercises to continue and become more contentious. Flimsy creditor agreements are likely to prevail even in new issue loans because a dearth of fresh supply has made investors desperate to deploy capital, according to the bank’s report from last month.

Some investors, like Ivo Turkedjiev, managing director at New Mountain Capital, argue that might mean a large collection of companies limping along in worse condition.

“You’re kicking the can down the road,” he said. “Would everyone be better off if the company filed and totally restructured its debt versus have a zombie out there that keeps walking but is really tough to recover?”

  - Bloomberg