The Rise of Post-Restructuring Distressed Debt: A New Frontier for Credit Investors

The corporate debt landscape has entered a new era, marked by the rise of post-restructuring credits as a compelling alternative to traditional distressed debt. As credit investors navigate a world of elevated interest rates, weak loan documentation, and aggressive liability management exercises (LMEs), post-restructuring debt is emerging as a defensible niche with superior covenants, higher yields, and cleaner risk profiles. For institutional investors and limited partners (LPs), this shift represents a strategic inflection point—one that demands immediate capital reallocation into this underappreciated asset class.

The LME Wave: A Catalyst for Structural Change

Since 2020, LMEs have become a dominant tool for borrowers and private equity sponsors to avoid formal bankruptcy. These out-of-court restructurings often involve complex capital stack reordering, such as uptiering (issuing new senior debt to subordinate existing claims), drop-downs (removing collateral from existing lenders), and double-dip financings (combining new debt and equity). While LMEs delay insolvency, they also create asymmetric outcomes for creditors. For example, in the Selecta case, a Dutch court-approved restructuring transferred ownership to a creditor-led ad hoc group (AHG), resulting in a four-tier capital stack with looser covenants for the new senior secured 1O notes. This allowed the AHG to dominate future restructurings but left non-AHG creditors with subordination risks.

Such scenarios highlight a critical insight: post-LME credits often feature cleaner capital structures and tighter covenants compared to their pre-restructuring counterparts. Unlike traditional distressed debt, where covenant-lite loans leave lenders with minimal oversight, post-restructuring credits typically include enforceable financial covenants, liquidity triggers, and documentation blockers to prevent further non-pro-rata restructurings. These enhancements reduce the risk of creditor-on-creditor violence and provide a clearer path to recovery.

Strategic Entry Points: Yield, Covenants, and Recovery Potential

Post-restructuring credits offer three distinct advantages that make them attractive entry points for credit investors:

1. Higher Yields with Lower Volatility:
   Post-LME credits often trade at wider spreads than traditional high-yield debt due to their distressed status, but their improved covenants and reduced liquidity risk can generate superior risk-adjusted returns. For instance, the Victoria case illustrates how a post-restructuring super senior facility from Arini secured extended maturities and lower default risk for participating creditors, even as non-AHG holders faced subordination.

2. Enhanced Covenants and Recovery Visibility:
   Unlike covenant-lite loans, post-restructuring credits frequently include incurrence covenets (e.g., restrictions on asset sales, dividend payments) and financial maintenance covenants (e.g., leverage ratios). These terms provide early warning signals of distress and limit borrower flexibility to extract value. For example, the WBD anti-boycott covenant—a novel restriction on creditor coordination—signals a broader trend toward enforceable protections in post-LME deals.

3. Cleaner Risk Profiles:
   Post-LME credits often avoid the "pencil yield" pitfalls of traditional distressed debt. By mid-2024, 10% of interest income from business development companies (BDCs) came from Payment-in-Kind (PIK) interest, which defers cash payments and inflates non-cash yields. Post-restructuring credits, by contrast, prioritize cash-based recoveries and transparent capital structures, reducing the risk of deferred losses.

Risk Mitigation: Why Post-LME Credits Outperform Traditional Distressed Debt

The data underscores the advantages of post-LME credits over traditional distressed debt:
- Lower Default Rates: As of 2025, post-LME credits have averaged a 5.7% default rate, compared to 8.2% for traditional high-yield debt (Fitch, 2025).
- Higher Recovery Rates: Post-LME recoveries are 15–20% higher than traditional distressed debt, per Bank of America Global Research. This is due to the inclusion of new money, asset repositioning, and tighter covenants that preserve collateral value.
- Reduced Creditor-on-Creditor Violence: LMEs often create divergent outcomes, but post-restructuring credits mitigate this by codifying terms in court-approved agreements. For example, the Country Garden restructuring in China secured 70% noteholder support through a two-class scheme, ensuring a more equitable capital stack.

The Case for Immediate Reallocation

For credit investors, the case for allocating capital to post-restructuring credits is compelling. Here's how to act:
1. Prioritize Post-LME Credits with Documentation Blockers: Look for deals with "omni-blockers" or anti-cooperation covenants that prevent future non-pro-rata restructurings. These terms typically command a 60–80 bps premium per year.
2. Target Sectors with Aggressive LME Activity: Real estate, energy, and leveraged buyouts (LBOs) are hotspots for LMEs. The Country Garden case in real estate and Selecta in industrials exemplify how sector-specific distress drives innovative restructuring.
3. Engage in Ad Hoc Group Negotiations: Investors with scale and industry relationships can influence LME terms, securing favorable lien positions or new-money commitments. This is particularly relevant in cases like Victoria, where third-party facilities (e.g., Arini) reshaped recovery dynamics.

Conclusion: A Defensible Shift in Distressed Debt Strategies

The rise of post-restructuring distressed debt is not a passing trend but a structural shift in credit markets. As LMEs become more prevalent, investors must adapt their strategies to capitalize on the improved covenants, higher yields, and cleaner risk profiles of post-LME credits. For those who act now, this niche offers a unique opportunity to reallocate capital into a high-conviction asset class with asymmetric upside and downside protection.

The time to act is now. Post-restructuring credits are redefining what it means to "buy the dip"—and for credit investors with the foresight to recognize this shift, the rewards could be substantial.