The US appears likely to enter a default cycle in the near future, according to senior fund managers and economists. A recent bout of M&A transactions involving chapter 11 cases point in the same direction. Taking deals involving bankruptcy cases as a proxy for distressed M&A, 16 such transactions were announced in the US in Q1, up 14.3 percent year on year, according to Dealogic. The aggregate value of those deals reached US$1.8 billion, a gain of 76 percent from the same period in 2023.
Zooming out, that value total is 33 percent lower than the Q1 average over the past three years, owing mostly to a spate of larger deals in early 2021, when ten bankruptcy-related M&A transactions worth a combined US$6.3 billion were announced. Meanwhile, the volume of these types of deals in Q1 2024 was up 71 percent from the Q1 average of the past three years. This means the recent trend has been toward smaller deals involving bankruptcies, but mid-market and larger companies have been affected as well.
Chapter 11 deals
In the largest of these recent deals, announced in January, regional sports network operator Diamond Sports Group entered into a restructuring plan to emerge from chapter 11 proceedings. The company was faced with a combination of declining linear subscriber numbers and a debt load exceeding US$8 billion. These challenges were exacerbated by the broader shift in consumer preferences toward streaming platforms, which affected traditional cable TV revenues. Under the arrangement, Amazon agreed to invest US$115 million in exchange for a minority stake in Diamond. The restructuring agreement also includes a US$450 million loan to finance the proceedings and pay down debt.
In the same month, cryptocurrency exchange platform Celsius Network successfully restructured under a chapter 11 bankruptcy plan in which creditors will receive more than US$3 billion in cryptocurrency. The plan also included the spinoff of Celsius’s bitcoin mining business to creditors. Now known as Ionic Digital, it is one of the largest pure-play bitcoin mining companies in the market and is in the process of listing itself on a national securities exchange.
Meanwhile, global IT company ConvergeOne, now known as C1, received court approval late this month for a prepackaged chapter 11 plan that will reduce approximately 80 percent of its debt and provide for US$245 million in new equity commitments. The terms will allow C1 to continue operating, while the financing will support the restructuring process and future business activities.
Commercial property
Sector exposure has a considerable impact on financial distress. Investment research company MSCI noted earlier this year that the value of distressed US commercial real estate swelled to US$85.8 billion by the end of 2023, driven by troubled office properties as declining prices, higher borrowing costs and ballooning insurance premiums weighed on the market.
The balance of distress, which includes financially struggling assets and properties taken back by lenders, rose throughout last year. However, the pace of new trouble slowed in Q4, when fresh distress exceeded resolutions by US$4.2 billion, down from US$9 billion in Q3.
Potential distress, which may signal future financial trouble, reached US$234.6 billion at the end of last year. Multifamily properties made up the largest pool of potentially distressed assets, with a value of US$67.3 billion, followed by office properties, at US$54.7 billion.
In addition to the higher cost of capital, which presents major headwinds for all commercial real estate sectors, multifamily properties are contending with lower rent growth and rising property taxes. In Texas, for example, owners of these properties have seen double-digit increases in property tax assessments, meaning non-controllable expenses are outpacing income growth. Meanwhile, office-space owners continue to grapple with the aftermath of the pandemic and the shift toward remote working.
Banking stress
Stress in the property sector is having pronounced downstream effects. In March, S&P Global downgraded its outlooks for five US regional banks due to their exposure to commercial real estate loans, raising concerns about a repeat of last year’s banking crisis led by Silicon Valley Bank and Signature Bank.
First Commonwealth Financial, M&T Bank, Synovus Financial, Trustmark and Valley National Bancorp all had their outlooks revised from “stable” to “negative,” citing the possibility that stress in commercial real estate markets could affect the banks’ asset quality and performance. This brought the total number of banks under S&P’s watch with a negative outlook to nine, equivalent to 18 percent of all the US banks it tracks—a result the ratings agency says is partly due to sizable commercial real estate exposures.
This coincides with a consortium of investors, including former Treasury Secretary Steven Mnuchin’s Liberty Capital, agreeing in March to invest more than US$1 billion to rescue New York Community Bancorp, which had been set back by its commercial real estate exposure and by challenges stemming from its own rescue of Signature last year.
If a default cycle is indeed on the horizon, commercial real estate will most likely be the epicenter of distressed M&A activity in the US. The International Monetary Fund reported earlier this year that US prices in the sector had fallen 11 percent since the Fed began raising rates in March 2022, while the Mortgage Bankers Association estimates that 20 percent of the US$4.7 trillion of outstanding US commercial mortgages held by lenders and investors will mature by the end of this year. This could mean further pain for America’s smaller banks.
