What 2017 May Bring for the Restructuring Community
We asked some of our financial advisor colleagues to give us brief readouts on what they felt 2017 has in store for us now that we have gotten beyond the inauguration and into the first weeks of the Trump administration. Their thoughts follow:
We have been seeing a lot of highly leveraged deals that impact the performance of the business. These deals are leading to reduced spending on capital expenditure, marketing, and even experienced management. Once new ownership is in place, these strictures prevent the company from operating with the same efficiency as in the past, let alone growing. Another scenario we have been encountering is companies getting beyond the management ability of the founder as the company increases revenues from $25M to $50M and then to $100M or more. In either case, increasing interest rates will cause dislocation, because it does not take much to push these companies into a zone where they are showing significant financial stress.
That being said, we are also seeing that lenders are still being lenient because it’s really hard to get a full recovery in a liquidation, and appraisal firms always seem to be the first to hedge on their ability liquidate inventory en masse. Also, my sense is that lenders don’t really want to sell their loans to exit a credit as it hurts their reputation. Still, we are finding that lenders keep getting surprised with over-advances for many reasons. When we are called in to assist in such situations, we focus our efforts on trying to fix the operating issues of the businesses and make a reasoned re-allocation of limited resources.
George P. Blanco, Managing Principal, EMA Group | Enterprise Management Advisors, LLC
For 2017, in all likelihood, there will be a significant transformation of macroeconomic conditions under the new presidential administration. The cumulative effects of the modification of NAFTA, abandonment of the Trans-Pacific Partnership, and dismantling of certain Dodd-Frank provisions, coupled with business deregulation, corporate tax cuts, and infrastructure spending, could lead to expansion of credit and inflation. Continued structural disruption by eCommerce of the retail industry will impact brick-and-mortar retailers as well as shopping mall owners throughout the nation. And continuing the trend from 2016, for-profit colleges and the oil-and-gas industry are still subject to their respective business risks.
As for California, our state’s onerous labor laws, such as those governing wage-and-hour rule, independent contractors, and minimum wage increases, will impact a wide swath of industries, specifically retail, restaurants, healthcare, transportation, and what remains of manufacturing in the state. And the inevitable legalization of cannabis dispensaries will create a budding industry for consulting opportunities. Since the Great Recession, hope has been springing eternal for the restructuring community; 2017 could provide fertile ground for such blossoms.
James Wong, Principal, Armory Consulting Co.
2016 saw an increase in the out-of-court workouts and liquidations under state law (Assignments for the Benefit of Creditors) along with some industry-specific Chapter 11 cases related to apparel retail chains, oil and gas, sporting equipment resellers, and educational trade schools, to name a few. These specific industries were hit with decreases in commodity prices, consumer shifts to online shopping platforms, and political and policy changes in Washington.
As we begin 2017 that trend appears to be continuing, with the filing of the Wet Seal bankruptcy, the continuing bankruptcies in the oil and gas exploration field and the numerous general assignment matters happening across the country. We have already seen a significate increase in the ABC/workout related matters since the start of the year, in some respects reminding us of the dot.com era of the early 2000s. In past cycles, corporate liquidations and out-of-court workouts tend to be a leading indicator for the more legally complex Chapter 11 cases to follow. Add the increase in interest rates by the Fed in late 2016 and anticipated incremental increases in 2017, the trickledown effect has already been visible in the businesses that were struggling to make ends meet to survive. Adding increased interest expense to thinly margined businesses will result in a greater number of defaults and loan covenant violations. Finally, the recent change of administration in Washington could lead to instability in the international business markets leading to further insolvency opportunities.
Matthew P. Sorenson, Managing Director, Development Specialists, Inc.
With the new administration taking over in recent weeks, there are still uncertainties as to how the restructuring industry will be impacted. Traditional brick-and-mortar retailers are likely to continue facing financial problems and increased bankruptcy filings as online consumer buying continues to grow. A sector at the forefront of the new administration’s focus is oil and gas. The emphasis on bringing jobs back to that industry and decreasing regulations for environmental reporting and monitoring will stabilize the recently struggling industry in 2017.
The focus on deregulating oil and gas means renewable energy and technology companies may see less investment and attention from the market. California is home to many of the nation’s renewable energy companies and the technology firms innovating within that industry. Coupled with the rise in interest rates and inflation, local retail, manufacturing, tech, and renewable energy businesses already struggling to satisfy loan covenants will turn to in- or out-of-court restructuring.
Kailey Wright, Managing Consultant, Grobstein Teeple LLP
For the distressed/restructuring community, the year of 2016 came in like a lion and went out like a lamb—well, maybe more like an irritable goat. Regardless of what you think of the current administration, there are strong fundamentals speaking to the year ahead being like the one just past.
Bankruptcies and defaults are not expected to increase in 2017 unless other industry sectors experience an appreciable uptick in business adversity and failure, the prospects for which are not apparent at the moment. In 2016, events of default and bankruptcy had their highest annual totals since 2009, but they slowed noticeably after mid-year. Also, last year defaults and bankruptcies were highly concentrated in the energy/commodities sectors (collectively accounting for approximately 50% of all defaults) and likely will moderate in 2017 if oil stays around $50 per barrel.
In terms of the capital markets, the U.S. speculative-grade default rate hit 5.1% in December 2016, compared to 2.8% a year earlier, yet the credit rating agencies expect defaults will decrease in 2017 despite trending higher throughout 2016. Spec-grade corporate credit markets came on strong in the second half of 2016 and new debt issuance was robust heading into 2017, especially considering the volatility in treasury rates and the expectation that interest rates generally will be moving higher. Overall, credit markets for spec-grade issuers remain benign. In keeping with that trend, distressed debt levels plummeted to two-year lows by the end of 2016, as investors aggressively bought high yielding paper across industry sectors and especially energy-related debt.
Regardless of the change in administrations, even the best early-in-the-year predictions are interesting to look at again in December . . . Good luck to all as 2017 unfolds!
Roger Scadron, Managing Director, Corporate Finance, FTI Consulting
The opinions expressed are those of the contributors and not of their respective firms or Greenberg Glusker Fields Claman & Machtinger LLP.