EM defaults, especially in the past four years, include several re-defaulters.   The prolonged period of high interest rates undermined companies' capital structures, setting the stage for a wave of credit distresses. The number of re-defaulters, as well as their share of as a percentage of defaulting entities in EMs, rose in the past three years. About 33% of defaulters in 2023 were companies that had previously defaulted, rising to 60% in the first half of 2024 (chart 1).

Chart 1

Since 2021, we count 10 re-defaulters in emerging and frontier markets (EFM; see the Notes section; excluding confidentially-rated issuers; table 1)

Table 1

Table 2

The majority of re-defaulters are located in Latin America.  Reasons for that aren't necessarily because of country risks but perhaps more due to fewer financing options for distressed companies, prompting them to launch debt exchanges to avoid grueling bankruptcy processes. The latter take too long and generally leave companies with even less financing options afterward. There's no evident re-defaulter concentration across sectors. Telecom and transport are tied at six since 2008, with the former sector displaying three defaults in 2019 (for miscellaneous reasons), and the latter sector with three defaults between 2023 and 2024 following the severe strains brought by Covid restrictions.

Chart 2

Typical conditions for default are bonds trading at discount, low value creation, and liquidity problems. The sample of re-defaulters in table 1 displayed a combination of bond prices significantly below par, negative economic value added (EVA; namely the differential between the return on capital and the weighted average cost of capital [pre-tax version for simplicity]), and weak liquidity.

Bonds trade significantly below par as markets' perception of the issuer's credit risk increase. However, that creates an incentive to buy debt back at discount and re-balance the capital structure, maximizing returns when conditions improve. We typically assess those situations as default (distressed exchange).

A negative EVA implies returns available to shareholders aren't enough. In such a case, companies may seek to reduce debt burden to improve shareholders' returns. Companies that struggle to generate value also exhibit low EBITDA interest coverage ratios (below 1.5x). The chart below shows the normalized distributions of these indicators among re-defaulters.

Chart 3

Poor Business Performance Is Common Among Re-Defaulters

Problems start with business underperformance.   Re-defaulters usually perform debt exchanges to gain time to overhaul their operations, but conditions never improve as much or as fast as needed. In fact, only three defaults (Maxcom Telecomunicaciones S.A.B. de C.V., Gol Linhas Aéreas Inteligentes S.A., and Enjoy S.A.) saw EBITDA margins improve after their defaults (chart 4). However, the recoveries were insufficient to turn things around as capital structures of these companies were, at that point, unsustainable.

The following issuers didn't get much relief from defaults.

In February 2022, India-based Future Retail Ltd. implemented a restructuring plan, which we viewed as tantamount to default following a steep drop in revenue during the pandemic. Less than a year after the first default, the second wave of Covid-19 aggravated the situation, and the company missed the principal payment on its domestic debt. This occurred despite the review period allowed by the Reserve Bank of India, as the company failed to monetize its format stores and its cash flow was insufficient to meet financial obligation. Consequently, the company missed the coupon payment on its senior secured notes due on July 2022, triggering a downgrade to 'D' from 'SD'. Soon afterward, we withdrew all ratings as requested by the issuer.

The Brazilian telecom Oi S.A. has been struggling with competition and the declining demand for traditional services since its first default in 2016. In October 2020, it launched a debt restructuring aimed at reducing debt and free up capital to expand its fiber assets. In 2022, its credit fundamentals remained weak (high debt leverage, low EBITDA interest coverage ratio, and weak liquidity), despite the completion of its asset sales plan. It re-defaulted in the first quarter of 2023, given its request of an injunction relief, as negotiations with creditors took longer than expected. We raised our issuer credit rating to 'CCC-' from 'D' in May 2024, as the telecom operator received the approval of its judicial reorganization plan. The CreditWatch positive listing indicates the potential of a further upgrade, after we reassess the company's capital structure and liquidity following the conclusion of its debt exchange (likely in July 2024).

Gol, the second-largest Brazilian airline, went through a distressed exchange in Q3 2016. As competition got fiercer and market conditions weakened, the company's liquidity and capital structure eroded. Gol's performance and liquidity improved gradually, although its leverage remained a key credit concern. The pandemic hit the airline industry hard, and Gol wasn't the exception. While it managed to withstand refinancing risks in 2020 and 2021 through a capitalization plan, it took a hit from tight financing conditions amid an increase in fuel prices in the second half of 2022. The margin compression amid high capital spending and lease expenses eventually pushed the company to a debt exchange in March 2023, which we considered tantamount to default.

The Brazilian infrastructure operator Invepar restructured its debt in Q4 2021 as the pandemic severely disrupted operations of its main asset, the Guarulhos airport. But its problems intensified when the reauctioning of a concession for the operation of its subsidiary (the BR-040 toll road) extended well beyond expectations, and the legal dispute with the city of Rio de Janeiro over the concession of the subsidiary Lamsa impaired Invepar's dividend stream. In October 2023, Invepar restructured its two domestic bonds, which we deemed as distressed. This eased short-term liquidity risks, while the company continues to depend on external conditions to repay the debt: the pending resolution of Lamsa's legal dispute and the ability of the Guarulhos airport to upstream cash dividends by 2027, once the airport amortizes its loan from the Brazilian Development Bank.

MHP SE, Ukraine's leading poultry producer, experienced severe business and financial disruption stemming from the conflict with Russia, undermining the company's liquidity position and ability to meet its financial obligations. That led to a missed coupon payment in March 2022. The company was largely unable to generate cash from exports out of Ukraine (53% of total revenue) as ports and export facilities were blocked. We subsequently upgraded MHP to 'CC' on its greater ability to honor its short-term financial obligations, given extended waivers on principal payments on its bank borrowings. That enabled the company to preserve liquidity to finance working capital needs for the 2023 sowing season. However, MHP's operating results were depending on external factors: war developments, export ability, and the support from the Ukrainian government or state-owned bank. In November 2023, the company completed a distressed exchange on a portion of its debt that we considered to be in default. Its performance continues to suffer from the war, as key infrastructure and main assets are damaged and labor and logistics costs are markedly higher. Access to new funding for working capital and capex remained problematic. Given logistical challenges and staff shortages, cash flow deteriorated in 2024, with $1.6 billion of gross debt outstanding and no access to equity/capital markets.

On Aug. 13, 2021, the Argentine conglomerate CLISA - Compañía Latinoamericana de Infraestructura & Servicios S.A. (CLISA) defaulted on a distressed debt exchange, aimed at reducing the interest burden and improve liquidity. We subsequently upgraded the company to 'CCC' while the macroeconomic environment remained challenging: Argentina's high fiscal deficit reduced spending on public works and delayed payments, while CLISA's client portfolio mainly consists of public entities. CLISA's operations continued to erode from continued working capital outflows, delays in rate negotiations, and cost overruns amid high inflation. In January 2024, we downgraded the company to 'CC' on consent solicitation that implied paying a coupon fully 'in kind' as opposed to a mix of cash (73%) and in kind (27%), as the original terms stated. Once the consent was approved in February 2024, we considered it to be a default. CLISA's operations continue to suffer from the drastic cut in public-works spending.

Chart 4

Margins of the following issuers improved after defaults, but their capital structures were too weak to allow for credit recovery.

Maxcom Telecomunicaciones had struggled with high leverage for many years. It defaulted four times prior to its last default in 2021. Its offering of connectivity services was small and less competitive than those of peers, so it experienced constant drops in market share and limited growth. In addition, the pandemic triggered a liquidity shortfall, as the spending on non-essential telecom services among government entities (Maxcom's main clients) and enterprises fell. Revenue and EBITDA dropped 35% and 20%, respectively, in Q1 2020 (the EBITDA margin growth ratio is misleading in this sense, RoC was negative for the entire period analyzed). Looming maturities, recession, and certain setbacks (disputes with the tax-collection agency) had depleted the company's liquidity, which forced it to miss the interest payment in Q2 2021.

In March 14, 2023, we downgraded Gol to 'SD' on a distressed debt restructuring. We assessed Gol's capital structure as unsustainable and liquidity as weak. The refinancing alleviated liquidity pressures. However, leverage remained very high and operating cash flow negative. The company defaulted on Jan. 26, 2024, by filing for Chapter 11 bankruptcy, after announcing in December 2023 it had hired financial advisors to help strengthen its capital structure (triggering the downgrade at that time to 'CCC-' from 'CCC+'). Despite improved operating performance during 2023, the company faced a heavy debt burden, high lease payments, capital expenditure, sequential delays in delivery of new MAX aircraft, and working capital outflows, exposing Gol to persistent refinancing needs in the following years.

The Chilean casino operator Enjoy had defaulted in April 2020 as pandemic-induced lockdowns were devastating its gaming operations. Profitability returned to pre-pandemic levels in 2022, although its capital structure remained overleveraged. In 2023, despite the recovery in gaming revenue due to the resumption of operations and higher traffic in the casinos, higher operating fees under the renewed municipal licenses, which together with high inflation in Chile and greater expenses associated with the reactivation of the business, kept margins at about 8%, below the pre-pandemic levels of 14%. That forced the company to restrict investments and projects in order to address its debt burden and working capital outflows. We downgraded Enjoy to 'D' on Jan. 31, 2024, on a judicial reorganization filing.

But not all defaulters are created equal.

The following EM issuers are what we consider as 'virtuous cases', namely issuers that have defaulted once and returned to a certain level of profitability in order to withstand adverse credit shocks (chart 5):

• We downgraded the Brazilian airline Azul S.A. to 'SD' in July 2023 on a distressed debt exchange. The company had withstood most of the pandemic-induced shock and its domestic operations were resilient, but its capital structure remained heavily leveraged. Tight financial conditions at that time forced Azul to perform a debt exchange that we deemed tantamount to default. We subsequently raised our ratings to 'B-', given the abating refinancing risk and lower lease payments. Liquidity prospects were strengthened materially but the cost of debt increased and the company remained highly leveraged. Coupons on the exchanged notes rose to 11.5% and 10.875% from 5.875% and 7.25%, respectively, previously. We forecast capex will remain elevated and operating performance to keep improving.

• The Argentine oil and gas company YPF S.A. was among the few domestic entities that had skirted major damage from the sovereign defaults. But severe transfer and convertibility (T&C) restrictions imposed by the sovereign in 2021 forced the domestic entities, including YPF, to undergo debt exchanges that we deemed as default in February 2021. We had subsequently upgraded the company to 'CCC+' from 'SD', while its substantial investment in the following months kept leverage relatively high. In June 2022, we revised upward the company's stand-alone credit profile to 'b' from 'b-' on strong financials as production grew and prices increased. However, the sovereign's downgrade in March 2023 to 'CCC-' on increased T&C risk prompted the company's downgrade to 'CCC-'. On March 15, 2024, we raised the rating on YPF to 'CCC' on lower T&C risks (following the sovereign's upgrade that month) although YPF's operations remain sound and the company keeps investing heavily to expand its asset base and production.

Chart 5

Overall Trends Among EM Re-Defaulters

• Re-defaulters generally display weak bond pricing, negative EVA, low interest-rate coverages, soft liquidity, and low profitability for a protracted period of time.

• In the majority of cases, profitability of re-defaulters does not pick up after the first default, as these issuers have faced shocks that undermine their performance, such as the pandemic lockdowns' adverse impact on airports, the Russia-Ukraine conflict for MHP, the government policy uncertainty for CLISA, and reliance on external developments for Invepar.

• Companies that usually don't re-default have resilient operations and relatively adequate capitalization levels. A re-default can be prevented by the improving operating performance, and ambitious--yet sustainable--capital expenditure plan, and an operating structure resilient to multiple shocks in the medium run, with a strategic awareness of the pros and cons of the political landscape in which the issuer operates (see CLISA and YPF case studies).

When looking at the overall corporate default numbers across regions, EMs appear to be at a sweet spot, with only a 2% default rate among the speculative-graded issuers, in line with the long-term historical average, and lower than among their European and the U.S. peers. However, as specified above, most of defaults in 2023 (84%) occurred in Latin America, compared with the 10-year average of 45%. Year to date, All EM defaults in 2024 happened in the same region. Moreover, the region has the highest concentration of weakest links (four out of six), together with the highest negative bias (22% as of June 24).

Notes

EFM: Emerging and Frontier Markets

EMs in this study consist of the following subregions and respective countries:

• Asia-Pacific: Bangladesh, Bhutan, British Indian Ocean Territory, China, Fiji, Hong Kong, India, Indonesia, Macao Special Administrative Region of China, Malaysia, Mongolia, Pakistan, Papua New Guinea, the Philippines, Sri Lanka, Taiwan, Thailand, and Vietnam.
• EMEA: Angola, Armenia, Azerbaijan, Bahrain, Belarus, Bosnia and Herzegovina, Bulgaria, Benin, Cote d'Ivoire, Croatia, Cyprus, Egypt, Estonia, Gabon, Georgia, Ghana, Hungary, Jordan, Kazakhstan, Kenya, Kuwait, Latvia, Lebanon, Lithuania, Mauritius, Montenegro, Morocco, Namibia, Nigeria, Oman, Poland, Qatar, the Republic of Moldova, Russia, Saudi Arabia, Slovakia, South Africa, Tunisia, Turkey, Ukraine, the United Arab Emirates, and Uzbekistan.
• Latin America and the Caribbean: Argentina, Barbados, Belize, Bolivia, Brazil, Chile, Colombia, Costa Rica, the Dominican Republic, El Salvador, Grenada, Guatemala, Honduras, Jamaica, Mexico, Panama, Paraguay, Peru, Trinidad and Tobago, and Uruguay.

Frontier markets in this study consist of the following subregions and respective countries:

• Asia-Pacific: Cambodia and Marshall Islands.
• EMEA: Liberia, the Syrian Arab Republic, and Togo.
• Latin America and the Caribbean: Aruba, Bahamas, Curacao, Netherlands Antilles*, Turks and Caicos Islands, and Venezuela.

Related Research

• Credit Conditions Emerging Markets Q3 2024: Policy Uncertainty May Hinder Resilience, June 25, 2024
• An Increase in Distressed Exchanges Drives Defaults in Europe, June 12, 2024

Credit FAQ: The Rise of Repeat Defaulters, April 11, 2024