In the past few years, LMEs or Liability Management Exercises have become a preferred route for investors and lenders to resolve financial stress at their portfolio companies. They are a cost-effective method to restructure outstanding liabilities while bypassing most of the regulatory complications and lengthy timelines associated with bankruptcy. However, many of these LMEs have been failing recently with some statistics stating almost 30% of these total restructurings opting for a subsequent LME or an eventual bankruptcy filing. Experts also believe that this number might increase as a growing number of firms face strained balance sheets and depleting liquidity as demand slowdown in several industries and macro-economic uncertainty increases.
LMEs, for the unversed, can be described as out-of-court transactions that involve a creative use of companies’ credit documents for non-regular way refinancings— such as dropdowns, uptiering, double dips, and non pro-rata exchanges— that would not result in a change of control, unless there is non pro-rata distribution of equity among pari-passu lenders. A general LME usually also involves a debt haircut and a restructuring of interest payments to allow stressed companies to turnaround their operations and revive their businesses. On the face of it, these exercises look like a good solution for financially troubled companies, so what exactly causes these LMEs to fail?
In this article, Swapnil Sawant from 9fin explains why LMEs fail and why they may be losing their sheen.
Meet Swapnil Sawant, senior distressed credit expert
Swapnil Sawant has extensive experience in distressed and special situations investments. As a senior distressed research analyst, he has an in-depth knowledge of the intricacies involved in investing in under-performing, highly leveraged or financially strained companies. He holds an MBA from Columbia Business School and has worked with financial heavyweights like Bain Capital Credit, Lombard Odier and Cerberus Capital Management over the years. His deep understanding of evaluating distressed investment opportunities and chalking out possible liability management exercises provides a crucial insight into the deal making activities in such situations.
Reasons for failure #1: A solution that never solved anything
One of the reasons why LMEs fail, according to Swapnil, is that they never really solve the problem in the first place. Most of the recent LMEs involved taking a haircut on the debt and then adding new tranches of debt for a myriad of reasons, which keeps the leverage at the same level as pre-LME. While the older debt gets a haircut and provides some relief to the issuer, new debt infused in the company usually comes at a much higher price and the net effect from the transaction is negligible. Interest outflows remain almost the same while the debt burden also continues to pressure the operations. One of the best examples of this would be SI Group, a pharmaceuticals company that produces performance additives, which only last September had restructured its debt by capturing a discount on its outstanding debt and adding new tranches of debt for general corporate purposes. The net debt obligations remained almost the same as pre-LME while the interest cost increased post the transaction as new debt came at a significantly high cost and several restrictions. Just six months post the restructuring, SI Group is again considering a subsequent LME. Some other investors also complained that such transactions are often too aggressive and rely on heavy discounts from lenders while keeping several options for equity owners to gain from a possible turnaround. This often leads to distrust among lenders and a subsequent LME becomes a big hurdle for sponsors and issuers.
Reason #2: No actual turnaround
LMEs are often viewed as a temporary relief for troubled companies to allow them time to turnaround their operations. In some cases, these turnarounds are hard to come by. According to Swapnil, most of the recent failed LMEs dealt with companies that operated in industries going through a cyclical downturn. The demand revival was less in the hands of the sponsors, in which case the temporary relief provided proves insufficient and LMEs fail. Industries such as commercial and residential real estate, home redecorating, chemicals and other industrial manufacturers are prime examples of these. Trinseo, a chemical company, launched an LME in December 2024 to get some breathing room to manage its debt servicing as demand in its end-user continues to remain weak. To get the deal done, it designated two subsidiaries as unrestricted subsidiaries under its existing credit agreements and indentures and had these subsidiaries guarantee the incremental term loans and new second lien notes. Even after the restructuring, some of the company’s notes continue to trade much lower than par.
Reasons for failure #3: Valuation mismatch
The discount on debt to be taken by lenders to allow companies some time to recover plays a critical role in the success of an LME. The usual process of determining this discount involves calculating the value of the business by discounting future cash flows, which are assumed to be higher post LME due to the lowered debt servicing commitments. In some cases, this valuation exercise becomes a big point of contention, says Swapnil as he continues to analyze what is the correct LTV, or Loan to Value, that lenders must consider. In some failed LMEs, lenders considered this valuation to be much higher than what it should actually be and the discount taken on the debt proved to be insufficient to revive the business. Going back to the earlier point, most LMEs in some way depend on a possible turnaround, and the valuation usually reflects that assumption. So, when the turnaround does not take place the way lenders imagined, they usually go back to a subsequent LME or ultimately file for bankruptcy.
Reason #4: Too late to succeed
Some of the LMEs, Swapnil says, have been unsuccessful because they waited too long to get the process started. In such cases, the company in question may be relying on an operational turnaround, and when the earnings continue to underperform, it runs out of liquidity and resorts to raising last-minute funding at extremely high pricing, which drives it deeper into financial stress. The general trend seen nowadays is for companies to start thinking about restructuring for debts coming due in 2027. With macro uncertainty at its peak, it is becoming difficult for the issuers to finalize the transaction in due course. Xerox recently became a prime example of this. While the company was already facing troubles with decreasing profits and increasing leverage, it focused on acquisitions to strengthen its product portfolio rather than restructuring its debt and when it ultimately did announce a repayment of its nearing maturities after reporting somewhat lower than expected earnings, it had to raise a new second lien term loan at a much higher cost, which ultimately led to the stock and bonds trading down.
For Swapnil, LMEs will continue to retain their popularity, however, they might have to adapt to the changing times. As the market develops in maturity, private equity firms and lenders are also becoming more comfortable with taking aggressive debt maneuvers. M&As and IPO activities have been sluggish recently, which have only added to the allure of LMEs as a way to alleviate financial troubles. Some companies facing near term maturities are also feeling pain from the new government’s policies, for eg: Hellman & Friedman-backed At Home, famous for creating the first intentional double dip structure in 2023, has reengaged PJT Partners to scour additional capital amid tariffs pressure. For such companies, LMEs can be a good option to abide time while coming to terms with changing macroeconomic conditions.
