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Smarter Perspectives: Corporate finance

Podcast: Signs Suggest Increased Restructuring Activity in 2023

Guest - Geoff Frankel Host: Steve Katz

On this podcast, Geoff Frankel of Hilco Corporate Finance discusses how adverse market date accumulated throughout 2022 is indicative of a potential surge in restructuring in the coming year.

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Steve Katz:

Hi everybody, and thanks for taking time out of your busy schedule to listen in on our Hilco Global Smarter Perspective Podcasts. As returning listeners know by now, I'm your host, Steve Katz. And if this is your first time with us, well then as always, welcome. We always say that to our first-time listeners. We're glad you could tune in. It's great to have you with us. Today we will be talking about recent signs of financial distress in the US and whether those are indicative of a likely surge restructuring and special situations activity over the course of the next several months. And if so, which industries really seem to be most at risk based on what we know today? And with us for that conversation is first-time podcast guest Geoffrey Frankel, who's CEO and senior managing director of Hilco Corporate Finance. Geoff, welcome to the podcast. I know this is a really busy time for you and the team, so thanks for breaking away for a few minutes today to share your insights on the topic with our listeners.

Geoffrey Frankel:

My pleasure, Steve. Great to be with you.

Steve Katz:
All right, as are we. So let's get started. I think a good place to begin is with historical data. When you look at that history, it's clear that restructuring upcycles have been fewer and shorter in duration since the great recession of 2008. Can you explain why that's the case?

Geoffrey Frankel:
Look, there's no shortage of theories as to why that's the case and really no single explanation. But I think the one that most people would agree with is that during the Great Recession, it seems like the Fed and politicians perfected the art of suppressing interest rates to stimulate the economy. And a big reason why this didn't turn into inflation is that labor costs never really kept pace with that increase in economic activity. That is until the last couple of years with Covid, but that's something we can talk about later on. But I think that the major reason for the lack or suppressed level of restructuring activity has been that as a result of low inflation, borrowers who might otherwise have faced distress have been able to borrow their way out of challenges for their liquidity.
In addition to that, we have seen over the last 15 or so years an explosion of the availability of private capital to middle-market businesses and a lot of competition amongst lenders to deploy that capital in ways that drive down the pricing and relax the underwriting standards. And that has more than just on the margin, enabled a lot of troubled borrowers to really kick the can down the road.

Steve Katz:
Yeah, okay. Well, makes a lot of sense. So what has changed now? Why do you think that trend may be shifting in the coming months?

Geoffrey Frankel:
Well, look, I've been through several cycles in my career, enough to have become very wary of trying to predict booms and busts and restructuring activity. But this time it definitely does feel different to me and really nearly everybody I've spoken to. It seems that a near-term wave of restructuring activity isn't just wishful thinking on the part of those who advise in that arena. Primary reason for this is that for my feeling about it is that we're listening to our clients, and what they're telling us is that the near-term future is much less certain that it's been in the past. Even those who are doing well seem to have a lot of doubt about where things are headed next year and they're fearful that their opportunities may not be heading in the right direction.
We've also taken note of our own mix of business and we have seen significant migration from healthy M&A advisory activity and healthy capital-raising activity towards selling and raising money for companies that are in distress or in bankruptcy, et cetera. So we're looking at that. And then finally, we have looked at a lot of macro data, both in terms of the overall economy as well as in various sectors, and most are all of the leading indicators that we would normally see as predicting a wave of restructuring activities seem to be in place right now.

Steve Katz:
So you've got that client input, your own experiences as an organization working with these companies in the industry, and then the data. Can you talk a little bit more in detail about what specifically you've seen occur in the second half of this year that is shaping the thought process that we're likely to see restructurings increase in the first half of '23?

Geoffrey Frankel:
Sure. A couple of the most important leading indicators in terms of data would be default rates and the volume of distress debt. Both of those have spiked this year. As of mid-year, August 1st, the leverage loan default rate in the US had nearly doubled since their trough during the pandemic, both in terms of the volume of debt and the number of issuers who have defaulted debt. Likewise, the distressed loan volume has steadily increased this year, and it is now nearly four times the level that it was in just mid-2021. So that's leading indicators at a macro level.
In addition to that, we have looked specifically at data, public data, from private lenders, the so-called business development companies or BDCs, who quarterly report their mark to market for their borrowers. What we see there is that an enormous increase in markdowns in a variety of sectors that typically provide significant levels of restructuring and special situation work. Mostly those are consumer-facing sectors, and what we've seen in particular in retail, food, automotive, and healthcare, that we're getting a significant level of markdown from those private lenders in the values of loans in those sectors. So both of those things are leading us to believe that we are on the front edge of a significant level of restructuring activity.

Steve Katz:
Okay, Geoff, so based on all that, how are you working with companies now in the tail end of 2022? What sorts of advisory are you providing to them about how they might approach things in '23 and what are you expecting to see as the year begins to unfold in '23? And how do you suggest companies move ahead?

Geoffrey Frankel:
So as I mentioned earlier, we've seen a migration of deals from a healthy, regular way, particularly capital-raised debt raises to a more distressed environment. And that's certainly the perspective of the lenders in terms of how they're underwriting deals. So the first thing that we've been doing is trying to reset expectations about what the structure in terms of covenants, as well as the pricing, would be for middle market loans, and getting our clients to understand that we're in a new market environment, that we really came to the end of what was before and haven't quite reached the beginning of what's next. But we're in this transition phase and lenders have reset their expectations. And so we're trying to communicate that to get our clients acclimated to a new environment.
We're also helping them to put the best foot forward when it comes to communicating where they're likely to go next year and for the years beyond because there's a higher level of skepticism or risk that's built-in on the part of buyers or capital providers. And so the critical part for us as advisors is being able to communicate the opportunity that a lender or buyer of a business that we're raising money for or selling can expect.
That requires getting people to focus on upside opportunities down the road, even as we move into a more uncertain environment. So those are the two major points that we stress beyond obviously executing transactions. It is still very uncertain, I'd say, how soon or how significant this restructuring wave might be, but all signs to us seem to be pointing to a fairly uneven rough year ahead, particularly as I said earlier, in consumer-facing centers like retail, food, healthcare, and automotive.

Steve Katz:
Yeah, it certainly sounds like it's. Well, listen, we're just about at a time. These are important and timely observations for those in businesses who are operating across a number of industries right now, I'm sure, and also for their advisors and lenders. So thanks for joining us. And I just ask now if you have some contact information you can share with the listeners so they can get in touch with you.

Geoffrey Frankel:
Happy to do that. I can be reached by email at G. Frankel. That's G-F-R-A-N-K-E-L @hilcoglobal.com, and also by phone at (216) 310-3464.

Steve Katz:
Okay, Geoff, thanks a lot. Great to have you on. And listeners, if your business or businesses in your portfolio are experiencing some of the kinds of challenges that we talked about here today, I encourage you to reach out to Geoff to discuss your current situation and how the Hilco Corporate Finance team may be able to assist you in navigating through those uncertain times. And as always, we hope that this Smarter Perspective Podcast provided you with at least one key takeaway that you can put to good use in your business or share with a colleague or client to help make them that much more successful moving forward. And one more thing, please remember that you can check out more great podcasts and articles featuring timely insights from Hilco experts at hillcoglobal.com/smarter-perspectives. Until next time, for Hilco Global, I'm Steve Katz.

 

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