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Businesses of all sizes have faced mounting pressure this year, whether due to tightened lending standards or continually increasing interest rates. Representatives from several turnaround management firms spoke with ABF Journal to explore the factors driving restructuring activity in 2023 and beyond.
How would you characterize turnaround and restructuring activity during the first eight months of 2023?
Howard Brownstein: We are still not seeing much restructuring activity. The impact of Paycheck Protection Program money is still being felt, and we get the feeling that lenders and landlords are being somewhat flexible since they can’t easily replace borrowers and tenants.
Kevin Clancy: Turnaround and restructuring activity has definitely picked up during the first half of this year. We are seeing a significant increase in the number of inquiries we are receiving from both borrowers and lenders seeking help with distressed situations. The continuing pace of rising interest rate hikes is making the refinancing of existing debt challenging, if not downright impossible, and the higher cost of capital is putting the squeeze on profit margins and free cash flow.
Brian Corio: What you’re seeing from stakeholders is a sense of unpredictability and uncertainty in terms of the current economic outlook. That uncertainty continues to grow as the system continues to get shocked by geopolitical and macroeconomic events. This dynamic has created a lack of consensus from constituents on how and when to properly restructure.
Robert Gorin: Some businesses have faced insurmountable difficulties and have had to navigate through restructuring processes, and others have shown resilience and adaptability to weather the storm. Overall, the turnaround and restructuring environment has been quite dynamic this year, with companies proactively seeking financial and operational strategies to stabilize their operations and regain their footing in the market.
Eric Koza: We have been in a very active turnaround and restructuring market during the first half of 2023, and I expect this level of activity to continue through the second half of the year and into 2024. In addition to higher rates, we’re also seeing tighter credit terms and the availability of capital is becoming harder to come by for the more distressed borrowers.
Patrick O’Keefe: Activity has been more robust than it has been in five years, with more liquidations and fewer sales.
Which industries are you seeing the most activity in and which industries are holding up well this year?
Clancy: Commercial real estate is really struggling right now. Investors and owners are walking away from sizeable properties and handing the keys back to the lenders. Healthcare providers, having exhausted their government stimulus dollars, are looking for other options to survive. We have seen an uptick in distressed acute care hospitals, nursing homes, assisted living and skilled nursing facilities. Rising labor and supply costs are outpacing reimbursements.
Corio: On the real estate front, the combination of 20-year high mortgage rates and dramatic increases in the cost of building materials and supplies has caused immense pressure on the demand for new homes. Those high rates have also hammered the commercial sector, making it increasingly more difficult for landlords to refinance as well as fund building improvements to attract new tenants.
Healthcare would be the next sector to watch. In particular, senior living centers have struggled with falling demand as a larger number of seniors are looking for alternatives to assisted living.
Lastly, aerospace, industrials and other companies with complex global supply chains, high degrees of operating leverage and stringent pricing arrangements are continuing to face challenges.
Gorin: We have witnessed a surge in restructuring efforts within the consumer products, retail, education, crypto and real estate sectors. Rapid shifts in consumer behavior and the lingering effects of the pandemic have been significant contributors to the distress faced by businesses in these domains. On the other hand, the technology, delivery services and personal services industries have generally held up well this year.
Koza: Most industries are experiencing the impact of inflation-driven rate increases to some degree. We continue to see heavy activity in retail. We’re also seeing pockets of distress within the technology, media and telecommunications space, including in data centers and telecommunication companies that are generally highly levered, require significant capital expenditures and operate in highly competitive markets.
O’Keefe: Automotive and manufacturing businesses with marginal work, need for capital, equipment and big reliance on debt capital due to overleveraging are feeling it the most. Cannabis companies with prices dramatically declining have also seen financial stress. Homebuilding services companies seem to be doing well.
Simion: The auto industry is holding up well with few traditional restructurings and a focus on profit improvement initiatives. The automotive original equipment manufacturers have seen record profits. The industry has come through the other side of the supply chain issues experienced during COVID-19. Companies are now zeroing in on their individual unique electric vehicle strategies. The OEMS and supplier base have solid balance sheets. While some of their EV products haven’t hit originally projected growth rates, there is no doubt that EVs are here to stay. Industry players are putting a tremendous amount of capital to work to achieve their EV initiatives.
How has turbulence in the banking sector this year impacted turnaround and restructuring activity?
Brownstein: We have observed the impact on banks themselves following the problems of Silicon Valley Bank and others, including at the board level. There seems to be an increase in carefulness and concern about risk, but again, we haven’t seen this result in an uptick in restructuring.
Clancy: The situation with banks today is yet another variable in the mix that is creating uncertainty. Based on how the Federal Deposit Insurance Corporation has been gearing up, I expect there will be more to uncertainty to come. Local and regional banking institutions, especially ones that have tie-ins to commercial real estate, should continue to face challenges.
Corio: As bank credit continues to tighten and yields remain high, companies and sponsors are looking for alternative financing solutions. The open question is whether, and to what extent, that’s going to continue and lead to increased tightening in bank lending over time. Further credit tightening could wreak havoc on the middle market. This is where I think we will see the biggest growth in restructuring activity, assuming the Federal Reserve continues down its current path.
Gorin: Heightened market volatility and potential disruptions to credit availability have created challenges for distressed businesses seeking financing to facilitate their restructuring plans. Additionally, regulatory changes and potential shifts in interest rates have added an element of uncertainty that companies and their advisors must consider when devising turnaround strategies. Nonetheless, these challenges also present opportunities for creative financing solutions and collaborative efforts between lenders and distressed companies.
Koza: The turbulence in the banking sector, while short-lived, was felt far and wide both within the banking industry itself but also within many board rooms that needed to quickly risk-assess their banking partners and plan for downside scenarios. This type of risk management and downside scenario planning was also important for companies outside of the immediate banking sector. What it taught all companies is the importance of knowing where material risks may lie and having the internal processes ready to act quickly when such a crisis occurs.
O’Keefe: The concern of bank liquidity and concentration in deposits is forcing banks to pay attention on where their portfolio risk is that would impair tier one capital ratios. This concern over future regulation will cause a tightening of credit, which will impact businesses’ access to capital. We have seen banks lower unused lines of credit limits. I believe this will cause companies to look for capital from unregulated sources and may cause a short-term liquidity crisis, which will lead to balance sheets restructurings.
Simion: Regional banks in certain areas of the United States continue to perform within their specific focus areas. However, as pressure on providing credit intensifies, it is likely to force middle-market companies to evaluate whether or not it is time to move away from those relationships and work with a larger bank or other forms of financing.
The U.S. economy has seemingly fended off a full-scale recession so far, but when do you think the other shoe will drop and what will it mean for turnaround and restructuring activity?
Brownstein: While the increases in interest rates would normally increase the probability of a recession, that has not proven to be the case so far, and I believe a recession is unlikely for the rest of this year. Different factors could create more turmoil next year, such as the war in Ukraine and political polarization during an election year, and so a recession in 2024 is still a possibility.
Clancy: Beyond the operational and financial challenges companies are facing, they also are contending with significant geopolitical challenges and a forthcoming election year. There is certainly a steady stream of distress right now, but it is hard to predict if there will be the proverbial “pin popping the balloon” at some point.
Corio: I don’t think we’re going to see one big shoe drop but rather a series of smaller shoes as companies continue to work through their upcoming maturities and capital needs. It will largely depend on how aggressive sponsors and lenders want to be with their existing positions. Equally important is how aggressive lenders will want to be with protections on new capital.
Gorin: Recessions can be self-fulfilling prophecies and consumer and business mindsets have not yet evolved to a more positive outlook. When the proverbial “other shoe” drops, it will likely lead to a rise in turnaround and restructuring activity as businesses respond to changing market conditions and reassess their viability in the new economic environment. If a recession occurs, there is a strong chance that it will be mild.
Koza: Although the economy does seem to be on stronger footing, there are lingering issues that many companies face. A lot of companies took on a great deal more debt to get through the pandemic. That gave rise to higher costs of debt service, reduced flexibility and, of course, the fact that at some point that debt will need to be repaid. We are seeing lending standards tighten across the board and we are also seeing a steady stream of companies that are simply running out of liquidity even before their debt matures.
O’Keefe: People have been predicting a downturn for the last five years and it hasn’t happened. Companies have definitely downsized. Stock buybacks have artificially pushed up stock prices. The impact of increasing cost of debt hasn’t impacted capitalization rates dramatically. There is no question there will be a liquidity crisis in commercial real estate, as commercial banks will not have the appetite to take the risk of holding long-term positions in this sector. I think if we see a recession, it will manifest in the fourth quarter, if it is coming at all.
Simion: The economy has been able to weather multiple storms. However, a likely breaking point will occur when liquidity dries up and companies can no longer afford high interest costs under current market conditions. We are at the beginning stage of what’s going to happen. A recession is coming; whether it is a smooth or rocky landing has yet to be determined. 2024 is likely to be a fulcrum year within our economy. This dynamic will be a key determining factor in how busy the restructuring industry becomes for months to come.
What is your outlook for the rest of 2023 and the first half of 2024?
Brownstein: I doubt there will be a recession this year, but concerns about a future recession will continue at least in the background for the foreseeable future. Therefore, companies should have contingency plans ready in case they are needed.
Clancy: Restructuring work should continue at a fairly brisk clip for the remainder of 2023 and into 2024. Looking back historically, whenever you have a boom in transactional activity with inexpensive financing as a catalyst, there will typically be fallout.
Corio: We’ll continue to see steady opportunities as companies assess their capital structures’ needs and refocus on transforming their businesses. Our hope as turnaround professionals is that those transformation efforts lead to broader opportunities to help companies fix their operations and return to profitability.
Gorin: I maintain a “cautiously optimistic” outlook for the remainder of 2023 and the first half of 2024. While challenges persist, the ability of businesses to navigate uncertainties and embrace innovative strategies will determine their success. The potential for further market disruptions, coupled with geopolitical influences, will continue to shape the restructuring landscape. It appears that turnaround and restructuring activity will be modest to strong for the rest of 2023 and into 2024.
Koza: The distress that we see ahead won’t be an onslaught like 2008 or during the worst of the pandemic but more of a steady drumbeat of increased trouble that higher interest rates and tighter capital markets will undoubtedly drive. This will be an active market for restructuring in the coming 12 to 24 months. Companies unable to refinance because new funding is not available or because it’s too expensive are going to be at the forefront.
O’Keefe: With the potential implosion of the Chinese real estate market and the U.S. getting tougher on investment in China, there could be a slight restructuring of U.S. companies’ dependence on the Chinese market. There is a distinct possibility that these macro-economic factors will lead to a recession worldwide, creating the need for more turnaround and strategic advisory on reorganization strategies.
Simion: The level of restructuring we have seen in 2023 is going to continue into 2024. It will be interesting to see if these bankruptcies are pure free falls or [if] restructuring professionals are able to work with all constituents to have a thoughtful and constructive process in place for a successful exit strategy. It comes down to is this: Do these companies have the fortitude to realize they’re in trouble and that they need to do something, or are they already in the ninth inning and they really have no more options?