A newly published analysis of distressed exchanges, or DEs, by Moody's Investors Service finds corporates' use of DEs increasing since the global financial crisis, with companies such as Chesapeake Energy and Claire's Stores contributing to the rising tide of companies turning to DEs in an effort to stave off reorganization. Looking ahead, Moody's analysts expect distressed exchanges to continue to be a prominent type of default for North American non-financial companies as the drivers of DEs remain in effect.

According to Moody’s a distressed exchange occurs when a distressed company offers “creditors new or restructured debt, or a new package of securities, cash or assets, that amounts to a diminished financial obligation relative to the original obligation.”

Among the key factors driving the increased use of DEs are the presence of private equity sponsors as owners of high yield companies, the growth of the distressed debt asset class, weakening of corporate debt covenants and the incentives of senior lenders who are often better off after distressed exchanges.

"Of the rated non-financial companies analyzed, distressed exchanges accounted for about one-quarter of the default events in 2008, and one-third in 2009, compared with 10% before the Great Recession," noted Sharon Ou, a Moody's Vice President. "Between 2010-2016, distressed exchanges as a share of defaults remained high, at nearly 40% on average, but surged to 52% in 2015, largely as a result of the high numbers of DEs executed by Exploration & Production companies following the plummet of energy prices."

In the report, Moody's reviewed the 322 distressed exchanges recorded for North American non-financial corporates between 1990-2016, analyzing the effect of a distressed exchange on debt reduction, recovery rates and likelihood of averting a subsequent default within three years after the initial exchange.

Of the 322 analyzed, a full 87% of the DEs led to debt reduction, and 40% resulted in maturity extensions for near-term debts, deferral of principal or interest payments, or amendments to payment terms that either converted interest payments from cash to payment-in-kind, reduced coupon rates or both.

The distressed exchanges also tended to produce high recoveries for investors on initial default, as measured by ultimate recoveries, Ou said. Average bond recovery rates for all lien positions were higher for distressed exchanges than for other types of default. Ou cautions, however, that while recoveries were higher for DEs in the initial exchanges, bond recovery rates were lower in subsequent bankruptcies.

With respect to avoiding subsequent defaults, an analysis of 218 distressed exchanges from 1990-2013 found that companies that executed distressed exchanges were more likely than not to avoid subsequent default during the following three years, demonstrating the effectiveness of DEs in helping companies avoid bankruptcy or payment default. A full 67%, or 146, of the issuers did not experience a subsequent default within three years of the initial distressed exchange.