Renegotiation or Bankruptcy? The Effects of Out-of-Court Costs on Distress Resolution

A recent change to the U.S. tax code (IRS Regulation TD9599) lowered the costs certain creditors incur when restructuring debt out of court. We use this setting to show how CDS spreads gauge the cost wedge between in- versus out-of-court distress resolution. CDS spreads declined by record figures on the regulation's announcement, with declines concentrated among distressed firms with higher ratios of syndicated loans -- the credit category treated by TD9599. Critically, distressed firm's loan renegotiation rates more than doubled, reducing their exposure to financial distress costs, which we estimate are up to 36% of firm value. Those firms' access to syndicated loans increased while associated interest markups declined.