In 2022, a mid-size sponsor-backed company facing a wall of maturing debt executed a Liability Management Exercise (LME). It bought eighteen months. In 2024, facing the same wall again at higher cost, it executed another one. The math got worse each time. The exit never arrived.
That sequence is not unusual. It is, in our view, the defining credit story of this cycle.
LMEs take several forms: uptiers, drop-downs, double-dips, maturity extensions. The structure varies. The commercial logic does not. The financial sponsor raises new super-priority debt to address near-term liquidity pressure, pushes out a maturity that would otherwise force a reckoning, and avoids the headline cost and operational disruption of a formal bankruptcy. For a company on a genuine recovery path, that runway can be the difference between a restructuring and a refinancing. For many companies we study, the fundamental problem (too much debt relative to the cash the business generates) does not get resolved by an LME. It gets deferred, typically at higher cost.
LME volume reached a record high in 2024, and the structural conditions driving that activity remain firmly in place. (Source: JP Morgan) Understanding what happens after one closes has become essential analytical context for anyone with exposure to middle market credit.
The term “liability management” implies a degree of remediation that these transactions rarely deliver. It is worth being precise about the mechanics.
In a typical uptier, the sponsor works with a subset of existing lenders to create a new super-priority tranche, structurally senior to the existing debt. Proceeds fund near-term liquidity needs and extend the maturity runway. The lenders who did not participate find their position subordinated, with reduced collateral coverage and weaker enforcement rights than they held the day before.
Drop-down structures work similarly in effect. Assets are transferred to an unrestricted subsidiary, which then issues new debt against them. The original lenders retain their claim on the now-stripped parent. The new lenders hold security against the assets that actually generate cash flow.
In many cases, the post-LME capital structure carries more total debt than before the transaction, at a higher blended cost. The new super-priority tranche typically prices at a meaningful premium to the incumbent debt it displaced in the waterfall. For a company already struggling to service its existing obligations, that is not relief. It is additional pressure.
The 2024 LME cycle is instructive. Companies that executed transactions in 2022 and 2023 to address their original 2021 vintage overleveraging are now executing second transactions to address the stress created by the first. The problem was deferred. It was not resolved. The road did not get shorter.
The post-LME dynamic produces a specific and fairly predictable seller: the incumbent CLO holder. Understanding why requires understanding what happens to their position the moment the transaction closes.
Before the LME, the CLO manager holds a loan that is stressed but has not yet technically defaulted. After it closes, several things happen at once. The incumbent loan is typically downgraded, often into CCC territory, triggering the mark-to-market mechanics we described in a prior piece in this series. The new super-priority debt has structurally subordinated the incumbent position. And the post-transaction capital structure, with multiple tranches carrying different maturities, covenants, and enforcement rights, is precisely the kind of complexity that CLO managers are not staffed or incentivized to underwrite.
The result is often forced selling. Not because the CLO manager has formed a negative view on the business. Because the structural tests governing their vehicle require them to reduce CCC exposure and restore overcollateralization compliance as quickly as possible. They become weak hands at exactly the moment the security is hardest to price.
The distinction matters enormously for buyers attempting to assess what the clearing price actually reflects.
One feature of the post-LME environment that receives less attention than it deserves: the transaction typically makes the credit more transparent, not less.
Prior to an LME, the company may be operating under legacy documentation written during the 2019 to 2022 origination environment, when lender protections were at historically weak levels. Information rights are limited. NDA processes to access borrower materials are cumbersome. Covenant compliance is opaque.
The LME changes that. The new super-priority tranche is negotiated in the current environment, with current market terms. Reporting requirements are tighter. Covenants are more substantive. The legal process of executing the transaction generates disclosure the secondary market did not previously have access to.
For an investor entering post-LME as a new buyer rather than an incumbent holder, the analytical starting point is considerably better than it was before. The business has been forced into transparency. The capital structure, however complex, is now fully documented and publicly negotiated. The go-forward risk is more legible than it was in the legacy structure.
Approximately 60% of recent LME activity has involved companies with sub-$1 billion in total debt outstanding. (Source: Octus) That is the segment where we focus. The concentration is not coincidental. Smaller companies tend to have fewer refinancing options, more concentrated revenue, and simpler business models, making them more amenable to the kind of hands-on operational involvement that can actually address the underlying problem, and more prone to the LME-driven stress that creates entry points in the first place.
Post-LME securities in this segment have generally traded at discounts that do not fully reflect the restructured risk profile of the business. The new super-priority tranche has recently priced approximately 115 basis points wide of average single-B spreads. (Source: Moelis) For senior secured paper in a freshly documented capital structure, with improved information rights and forced sellers clearing the incumbent holders, that spread premium may represent compensation for complexity and transaction overhead rather than for fundamental credit risk.
That distinction is where we spend most of our analytical time.
Not every post-LME situation becomes an attractive investment. The fundamental issue is usually too much debt, and some of these companies will require a formal restructuring before the equity value that justifies the debt stack can be realized. The question for each situation is whether the entry price, the terms of the new debt, and the operational path available to the business produce a risk-adjusted return that justifies the complexity.
The companies that executed LMEs at the peak of the 2024 cycle are approaching that decision point now. The maturity wall through 2028 ensures there will be more behind them.
For a full discussion of how Axar approaches the LME-driven opportunity set, including how CLO mechanics and competitive dynamics interact with post-transaction pricing, download Credit Unbound at axarcapital.com.
This content is provided for informational and educational purposes only and does not constitute investment advice or a solicitation to invest. All investments involve risk, including potential loss of principal. The views expressed reflect the current opinions of Axar Capital Management LP, which may change without notice. Past performance is not indicative of future results. Axar Capital Management LP | 402 W 13th Street, 5th Floor | New York, NY 10014
What is a Liability Management Exercise and how does it differ from a formal bankruptcy?
An LME is an out-of-court restructuring mechanism through which a financial sponsor addresses balance sheet stress by issuing new debt, typically at super-priority rank, to fund liquidity needs and extend maturities. Unlike a formal bankruptcy, an LME does not require court supervision, moves faster, and avoids the reputational and operational disruption of a Chapter 11 filing. The tradeoff is that the fundamental balance sheet problem is rarely resolved. Total debt typically increases, interest burden rises, and the original causes of stress remain in place, deferred rather than addressed.
What are the most common LME structures?
The most prevalent structures are uptiers, in which a subset of existing lenders participate in a new super-priority tranche that primes the remaining incumbent debt; drop-downs, in which assets are transferred to an unrestricted subsidiary and used to secure new financing; double-dips, which combine elements of both; and maturity extensions, which are typically simpler in structure but provide less liquidity relief. Coercive exchanges, in which holdout lenders face pressure to participate on unfavorable terms, have also become more common as documentation has evolved.
Why do CLO holders tend to sell post-LME?
CLO managers face structural incentives to reduce CCC exposure following an LME, as the transaction typically triggers credit downgrades across the incumbent capital structure. The mark-to-market treatment of CCC-rated loans under standard CLO indentures creates direct overcollateralization cushion pressure. Combined with the increased analytical complexity of the post-transaction structure and the deterioration in recovery prospects for the subordinated incumbent tranche, CLO holders are generally forced sellers at prices that reflect structural constraint as much as fundamental value.
Does an LME improve or worsen a company’s credit quality?
Neither unconditionally. An LME that provides genuine liquidity runway to a business with a viable operational recovery path can improve the probability of eventual debt repayment. An LME executed on a business with structural operating problems and no credible path to deleveraging typically makes the eventual credit event worse: more total debt, higher interest cost, and a more complex capital structure for the next round of creditors to navigate. In our analysis, the latter describes many LMEs in the current cycle.
What makes a post-LME situation potentially attractive for new buyers?
Several factors can make post-LME securities interesting for investors entering as new buyers rather than incumbent holders: improved documentation relative to the legacy structure, forced selling from CLO holders clearing their positions, a capital structure that has been stress-tested and disclosed through the transaction process, and entry pricing that may reflect complexity and transaction overhead rather than fundamental credit deterioration. Whether these factors translate into attractive investments depends on the business quality, the terms of the new debt, and the investor’s ability to underwrite and manage through the resolution.
Axar Capital Management LP is a $3.3 billion opportunistic investment manager focused on U.S. middle market companies with $200 million to $800 million in debt outstanding. Founded in 2015 and 100% employee-owned, Axar specializes in complex situations where traditional institutional capital operates inefficiently. The firm is headquartered at 402 W 13th Street, New York, NY.
Disclaimer: Axar Capital Management LP ("Axar") has prepared this content for informational purposes only. This content is not intended to constitute legal, tax, financial, or investment advice. While all information contained herein is believed to be accurate, no guarantee, representation or warranty is made as to its accuracy, completeness or fairness. Certain information reflects the current opinions of Axar which may prove to be incorrect and are subject to change. Past performance is not indicative of future results. Investing involves a material risk of loss. Certain statements herein reflect forward-looking views, which are inherently uncertain and subject to change. Actual results may differ materially.