The long-anticipated rise of corporate restructurings and insolvencies is afoot, as vaccine programmes across the globe are allowing society to open up and government support to be unwound. The ability of zombie companies to plod along courtesy of the coffers of the state is dissipating.
Unlike the swathe of insolvencies and restructurings that followed the global financial crisis, this next cycle is more existential in that no specific part of the market has created it. In 2007-9, risky behaviour and the misuse of certain financial technologies to juice returns were the major fault.
This time around there has been no such foul play, with access to money and the sources of lending also offering a different dynamic.
No GFC replay
As the scale and scope of the pandemic dawned on policymakers, most developed nations – and some emerging ones – invoked rapid support for industries that were forced to shut down, including furlough schemes and emergency loan programmes. Supply of money is also the cheapest it has ever been, with central banks cutting interest rates to near-zero.
There is also a lot more direct lending available now that risk management is more sophisticated. Indeed, in our recent research report ‘Navigating CovExit: searching for value in the debt markets’ which surveyed capital markets professionals, 57% of respondents said they are looking to expand their direct lending strategies.
Whilst shutting down the economy has clearly had an immediate, detrimental effect, it is too early to assess the true extent of the damage. Rather, as pandemic ‘life support’ for companies is withdrawn, it will likely expose the weaknesses in certain industries that otherwise would have been there.
Where is the distress?
We have seen a lot of distress in aviation structures in our portfolio, despite having received government support guarantees and benefitted from the goodwill of institutional lenders. Retail was already under pressure from online competitors, and much of the high street is on life support.
In real estate, covenants are being tested, particularly around lending. There is more resiliency in retail and residential, certainly in the UK, which will likely present a relatively interesting investment opportunity.
The doom-mongering around the hospitality trade may be overdone, as some of the big UK players, such as Mitchells & Butlers and Whitbread, have mixed business models, affording them some resilience.
Importantly, distressed cycles play out differently across regions. East Asia is by far the most accepting of societal restrictions associated with pandemics and recoveries there are accelerating, with China showing strong growth not seen in the last ten years. Likewise, the US is looking to spend its way out of the crisis with President Biden’s multi-trillion-dollar stimulus plans and only moderate tax rises to pay for it. However, the spectre of rising inflation and its effect on the equities market may put a brake on recovery.
Europe, on the other hand, is on course for a slow recovery in line with its sluggish vaccine rollout, whilst the UK, with a surprisingly coherent vaccination plan, will likely spend its way into recovery under the government’s “levelling-up” agenda.
Restructuring in distress
A staggering 92% of our survey respondents expect corporate insolvencies and restructurings to present opportunities to them over the next 12 months, but navigating a corporate restructuring successfully in a distressed situation is hugely challenging for all stakeholders. We believe policymakers should incentivise the use of securitisation to be part of the solution, rather than seeing it as part of the problem.
A common mistake is not engaging early enough, failing to acknowledge or voice concerns in good time. Instead, stakeholders should engage early with lenders to explore the viability of amendments, extensions and waivers to help avoid insolvency or avert a full-blown restructure.
Compliance and risk systems, frameworks and procedures have become more robust since the last financial crisis and we hope lessons have been learned from those events to prepare companies, their investors and advisers, for the effects of the pandemic as they begin to emerge.
Ocorian’s recently published research report ‘Navigating COVEXIT: searching for value in the debt markets’ can be downloaded at www.ocorian.com/act-with-clarity.