Credit rating agencies are bracing for a huge wave of what’s known as "hidden defaults" as the worst recession since the Great Depression devastates the Canadian economy.
Rating firms are predicting that more companies will pursue distressed debt exchanges, in which they try to overcome liquidity problems by swapping debt or buying it back at a discount. Such moves are less stark than missed payments and can fly under the radar for the general investing public, but often result in losses for creditors and are usually counted as defaults by rating companies.
Moody’s Investors Service forecasts an increase in the overall number of Canadian distressed exchanges during the economic downturn stemming from the coronavirus pandemic and low oil prices. Fitch Ratings said the "price dislocation" in high-yield bond markets could lead to a surge in the practice. There have already been a handful of them this year, including Indonesian coal firm Geo Energy Resources Ltd. and Chinese business park developer Yida China Holdings.
There was an increase in such practices during the global financial crisis, and cases have remained high in recent years as borrowers struggled under debt they had piled on in a decade of cheap money. Distressed exchanges as a share of total defaults rose from around 10% in the years before 2008 to roughly 40% subsequently, according to Moody’s.
In the practice, borrowers offer creditors new or restructured debt securities in exchange for the ones they hold. Companies can also offer cash to buy back notes at a substantial discount. The packages amount to less than what the firms originally owed.
Investors may agree to distressed exchanges for a variety of reasons: they might believe the borrower needs time to turn things around, or they may feel they would lose more if the company were forced into liquidation.
However, distressed exchanges can be acrimonious, as was the case for Chinese firm Asia Aluminum Holdings, where bondholders formed a group to oppose a buyback proposal in 2009, as they felt it was too low. The company eventually canceled the bond buyback and liquidators were appointed.
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