By Thomas Osmun, Managing Director, AlixPartners and Joseph Mazzotti, Director, AlixPartners
From the second half of 2008 through the majority of 2009, restructuring industry participants — lenders, attorneys, investment bankers, financial advisors, crisis managers, distressed debt investors, et al. — saw something of a boom in the insolvency business. Driven by the global financial crisis and Great Recession, marquee names such as Lehman Brothers, General Motors, Chrysler and General Growth Properties, among others, filed for bankruptcy protection and made front-page headlines on an almost daily basis. And, while these big-name companies gained much of the media attention, many in the restructuring industry were also keeping busy with in-court restructuring activity for small- and mid-cap companies, which also grew considerably.
Even as the recession officially ended, continued slow economic growth, high levels of corporate debt and widely publicized sovereign and municipal debt concerns created an expectation within the industry that formal restructuring activity would continue apace. Ironically, though, at least as measured by U.S. bankruptcy activity, the trend seems to have reversed. In spite of continued high levels of corporate debt, bankruptcies through year-end 2011, as well as the run-rate for the first two quarters of 2012, are down dramatically from 2009 across the spectrum of company sizes (see Figure 1). Moreover, with a few exceptions, like Eastman Kodak Co. and Ally Financial’s mortgage subsidiary Residential Capital LLP (or ResCap), bankruptcy activity over the past two-plus years has tended to affect primarily the small- and mid-cap sectors of the market. Large-cap bankruptcy filings declined from 57 in 2009 to ten in 2011, representing an 82% reduction in activity during that time.
In addition to the reduction in bankruptcy filings, the duration of time companies spend in Chapter 11 has declined significantly. The average stay in bankruptcy is now about half of what it was just five years ago, declining from approximately 430 days (or about 14 months) then to 217 days (just over seven months) today. Based on AlixPartners’ analysis of public bankruptcy data for the past year, a key driver of these shorter durations is the fact that approximately 43% of the companies in Chapter 11 with $100 million or more in assets or liabilities were “pre-packaged” bankruptcies (i.e., the terms and conditions of treatment for creditors and debtor release provisions are agreed upon, by virtually all creditors, in advance of the Chapter 11 filing) or “pre-arranged “bankruptcies (i.e., though the exact terms and conditions couldn’t be agreed upon prior to filing a consensus has been achieved among institutional creditors owed large amounts of money by the debtor company that a Chapter 11 case should be filed). The upshot: Companies and their advisors are now doing a lot of the work that was previously done in Chapter 11 prior to the actual bankruptcy filing.
Where, then, have all the bankruptcies gone? And what is driving down the length of time that companies are spending in Chapter 11? A variety of factors have contributed to these trends, including:
- The shrinking of the “debt-maturity wall”
- Continued low interest rates
- An “amend-and-extend” preference among many lenders
- The aversion to “going to court”
The Debt-Maturity Wall
As Figure 2 shows, companies have been very successful in pushing out their debt maturities over the last few years, as lenders have agreed to amend covenants and extend favorable terms rather than forcing previous agreed-to repayments. Contributing to this “pushing” of the maturity wall has been the increase in the amount of cash investors poured into funds that invest in high-risk debt (making more money available for companies looking to refinance debt) and the increase in out-of-court restructuring activity, with many lenders demonstrating an aversion to trading in their loans for equity, thereby making an extension of existing debt about their best option (unless they’re able to negotiate a sale or merger).
Standard and Poor’s data from the end of 2008 showed a total of $394 billion in leveraged-loan debt maturing in 2013 and 2014. As of August 31 of this year, similar data showed a total of just $84 billion maturing next year and the year after. In other words, the maturity wall that a few years ago was going to keep restructuring professionals busy with Chapter 11 work for the foreseeable future has been pushed out several years. Whether future conditions in the debt market allow companies to push it out yet again three or four years hence remains an open question.
Low Interest Rates
LIBOR rates, of course, fell dramatically during the recession — from approximately 3.81% in October 2008 to 0.23% in December 2009 — and have remained comparatively low since. Lower interest rates, largely driven by the Federal Reserve’s monetary policy, have had a two-pronged effect on Corporate America as it relates to its need (or lack thereof) for restructuring: Lower interest rates have allowed companies to refinance and push out debt maturities, while also allowing companies to reduce the cash flow needed for interest payments.
This combination of less-imminent maturity schedules and the reduced cash-flow impact of interest payments, in turn, helped reduce default and insolvency rates from what they otherwise might have been. Again, whether this is a good thing or a bad thing for companies — long term — remains to be seen. James Bullard, CEO and president of the Federal Reserve Bank of St. Louis, gave a speech earlier this year in which he decried continued near-zero interest rates for robbing Baby Boomers of their investment income — which in turn is leading to the vicious cycle of lower consumption by that huge cohort and therefore even less business activity in America. Again, time will tell, but the phenomenon has certainly changed the face of the restructuring business of late.
Amend and Extend
Meanwhile, the phrase “amend and extend” (as in loan covenants and terms) has indeed become a common refrain both in both the restructuring business and in halls of Corporate America over the last few years. Basically, it’s a synonym for “kicking the can down the road,” only in more sedate, euphemistic terms.
There has been a sharp increase in not only out-of-court restructurings, but also a large increase in loan amendments including an extension of the maturity. Often these “amend-and-extend” restructurings do not fix either the underlying capital structure or operating issues in a substantial or permanent way. A well-executed restructuring can do both of those things (despite bankruptcy’s often scary reputation). Why is this happening? We believe the answer lies in a combination of less willingness of senior lenders to write down or write off loans, a dearth of attractive investment alternatives for corporate lenders, lenders continue to show little interest in biting the bullet and writing down or writing off loans. Again, good or bad long term (for bankers as well as companies)? As they say in advertising, “Watch this space.”
Court is Adjourned
Since Chapter 11 as most of us knows it today was promulgated by the Bankruptcy Reform Act of 1978, in-court insolvencies in the U.S. have been widely viewed as being “debtor-friendly” (i.e., more “rehabilitative” toward companies than insolvency protocols for many, if not most, countries outside the U.S.). However, the 2005 changes to the U.S. Bankruptcy Code are generally considered less debtor-friendly than before, creating stricter timelines for debtors, and strengthening the ability of creditors to drive the outcome. Additionally, U.S. trustees — Justice Department-appointed “watchdogs” over the bankruptcy process — have also become more assertive, recently fighting debtors on issues of venue (Houghton Mifflin) and executive compensation (Kodak, ResCap).
Additionally, increasing business complexity today, including thorny cross-border insolvency issues, can make a corporate filing a jurisdictional nightmare. By comparison, an out-of-court restructuring often involves just a relatively limited set of constituents (primarily major lenders and only the largest suppliers), which, other things being equal, can make a deal easier to reach. Debtors thus have less incentive today to pursue an in-court (Chapter 11) resolution. We have seen recent cases where an insolvency proceeding appeared to be inevitable (and would have been the likely outcome in the past), only to have diverse groups representing lenders, equity and other major constituents work together to negotiate an outcome preferable to a filing, even a pre-arranged one.
Will the trend toward out-of-court restructuring activity continue? Of course, that depends on what happens with the underlying drivers. Changes in governmental monetary policy after the election or changing market conditions could, of course, drive an increase in interest rates. On the one hand, another recession in the U.S. could reduce market liquidity, while on the other a stronger increase in economic growth could create more attractive investment options for lenders. Any of these changes could lead to an increase in bankruptcies if companies are less able to refinance or to restructure out-of-court.
Further complicating the picture is concern today over global governmental debt issues, both for sovereign debt and, inside the U.S., at the municipal and state levels.
The concerns over the sovereign debt of Greece, Spain and Italy have been much in the news; and of course in January, France and eight other euro-zone countries had their debt downgraded by Standard & Poor’s. From the end of 2008 through the end of 2011, the compound annual growth rates for sovereign debt outpaced GDP growth rates for most of the major world economies, raising the specter of further bailouts and sovereign-debt restructurings if the trend continues.
In the U.S., some two dozen municipalities have filed for Chapter 9 (roughly the municipal equivalent of Chapter 11) protection in the past 18 months, notably Jefferson County, AL in late 2011, and the cities of Stockton and San Bernardino, CA during 2012.
So, what does this all mean for the restructuring industry? The answer really depends upon on which side of the table you currently occupy. If you’re a buyer of restructuring services (lenders, company managements, boards of directors, et al.), the slowdown in the restructuring industry over the past few years has, among other things, provided you with the option of considering a wider range of available restructuring professionals, given the slowness in the overall market. Professionals that were previously fully committed on huge projects such as General Motors or Lehman Brothers now have capacity to work with smaller companies, including out out-of-court situations. Today’s unprecedented climate provides lenders, companies and boards the opportunity to find exactly the right advisor with exactly the right background and experience — and often a more experienced one than would have been available in the past.
From a restructuring professional’s perspective — be that person a lawyer, a banker or a business consultant — the changes in the environment have required firms to become much more flexible in their overall approach. Although out-of-court restructurings provide work for professionals, such engagements tend to be of shorter duration than bankruptcies and require fewer sets of professionals — because there are usually fewer constituents. Thus, professionals in the industry generally need to be able to successfully manage a larger number of shorter and/or smaller assignments than in the past, and broaden their business development avenues. Restructuring professionals need to be more creative by expanding services to new areas and by developing expertise that differentiates them from other competitors.
The rise in stress on government debt also creates interesting challenges for restructuring professionals. On the sovereign-debt side of the equation, the role restructuring professionals will play in this arena remains somewhat unclear, given the involvement of governments and other political bodies.
However, on the U.S. municipal side of things, Chapter 9 proceedings would seem likely to benefit from the experience and expertise of restructuring professionals in managing and resolving the insolvency process, as well as in improving cash flows and operating efficiencies. That being said, the highly charged political environments surrounding these proceedings may potentially make these opportunities more onerous and less rewarding than the corporate restructuring market. This may be something for political leaders to keep in mind as events unfold — including perhaps how to make environments less onerous so as to perhaps attract the “best and brightest” restructuring professionals.
Will That Happen? Again, Only Time Will Tell
Come what may on the governmental side, there is still a high degree of financial leverage in Corporate America, and companies will continue to need assistance from operating, financial, and legal advisors to work through the current economic stagnancy, irrespective of the venue. The only real question is exactly how and when. As to the latter, looking at both history and the present situation leads us to think that “when” could be a lot sooner than many think.
Thomas Osmun is a managing director and Joseph Mazzotti is a director at AlixPartners, LLP, the global business-advisory firm. For more information, visit www.alixpartners.com.