“WHAT CAN INSOLVENCY PRACTITIONERS EXPECT IN 2006?”
Bettina M. Whyte
Unfortunately, the boom for the insolvency and restructuring profession that I once expected to come in 2006, now seems more like a hope than a reality. Why? Well, to properly set the stage, one first has to spend a few minutes discussing the state of the economy and where I believe it is going.
First, interest rates have not risen as dramatically or as quickly as was once expected. In fact, interest rates are still at a thirty-year average low. While our new Federal Reserve Chief is fiscally conservative, he has already signaled that rate increases are nearing an end, at least in the short term. And, since many companies which are seen as “stable” today, those who practice in this arena recognize that if interest rates increase a few more basis points, these same companies will suddenly be considered “over leveraged”. But, without this driver to put pressure on liquidity, companies are likely to continue to do just fine.
Second, with the decline in the speculative default rate on corporate bonds, the banks and non-bank lenders have become more risk tolerant. As reported in S&P, a survey conducted by the Federal Reserve of Senior Loan Officers in July indicated that there has been a visible easing of lending conditions. In fact, 17% of major banks stated that they have relaxed both covenant terms and extended maturities. This is true for two reasons, first is the obvious increase in competition from banks and non-bank lenders; there is still just too much money chasing deals. Second, because of this liquidity in the lending and equity markets, traditional lenders continue to make their fees up-front and then sell the asset into the secondary market. The long term effect is obvious: with terms easing, there will continue to be fewer defaults in the short term.
Fuel prices could prove to be a major driver for the next wave of bankruptcies if they remain at current highs, according to S&P and anyone who has paid their fuel bill recently. The effect on the airlines has been dramatic, as it has on other transport industries. And, companies that produce petroleum based products are seeing both shortages in raw materials and substantial price increases. However, the consumer continues to spend for Christmas as if energy costs are of no concern. Perhaps this is because they have not yet received their November and December fuel bills and haven’t felt the pain. Or, perhaps it is because price increases in the products they purchase from plastic storage bags to cleaning solvents have not yet made their way to the grocery shelves. But whatever the reason, if energy prices remain at this thirty-year high – and there is much debate on this topic – companies and consumers alike will begin to have to deal with the hole in their cash flow.
Obviously, the ever-increasing reliance of the world economy on both manufactured goods and services coming out of China and India will continue to put pressure on the United States economy. What we have seen in the auto industry, where the Big Three auto makers have lost 13% of the US market over the last ten years, is being duplicated everywhere. China has a massive labor force of over 167 million people, while India has a labor force of 82 million. This compares to a labor force in the US of only 33.5 million. As a result, the US worker’s average hourly rate in over $36.00 while that number is a mere $2.00 in China and just over $1.00 in India. But, with the exception of a potential bankruptcy filing of GM predicted by many for 2006, how long it will take to see the effect of this disparity of costs on US companies is uncertain. I, for one, believe it will be sooner rather than later.
Where will we see the weaknesses centered in the next year? According to S&P, over 50% of the number of distressed bond issues are in the automotive, telecom and consumer products sectors. And, they believe that the media and entertainment industry has the highest level of vulnerability in the near term. Within the industries they reviewed, the companies that are least likely to survive if they experience a default are in the automotive, transportation, consumer products and retail sectors.
What does this mean for insolvency and turnaround practitioners? Well, lenders are still flush with cash and starting to again make their historical mistake of easing terms and conditions to meet the competition. Additionally, over the last year the large banks, work out firms and law firms have slashed headcount in their workout/special asset/bankruptcy groups and vast amounts of talent and experience has been lost. If activity in the insolvency industry does not increase in 2006, the industry will see many of the smaller firms and single shingles exit the business. Even now we are seeing rate reductions from some that define the term “buying the business”. And, we will see more firms turn to India and China to provide them services (claims noticing, vote solicitation, presentation books) to reduce their costs.
We will also see even greater activity and control from the large, sophisticated hedge funds that are now buying to own as opposed to just buying to trade. The second lien positions that they often hold now have enough teeth in them that they can be a controlling party in any negotiation, especially in default or DIP scenarios.
And, we can be assured of seeing much more involvement of the US Trustee due to the provisions in the new Act that requires them to file a motion for the appointment of a trustee if they “reasonably” suspect fraud, malfeasance or misconduct. And, you will see the UST selecting more of these trustees, as well as examiners, from the ranks of the ex-SEC Enforcement Officers because of the SEC’s involvement in these matters.
So, what is the conclusion? Hope I am wrong!
About the Author
Bettina M. Whyte is a managing director of AlixPartners LLC in New York, where she has served as an interim CEO, COO and Chief Restructuring Officer of numerous troubled companies. Ms. Whyte is the immediate past-president of ABI, sits on the board of several companies and is an adjunct professor of law at Fordham University School of Law. She has conducted seminars throughout the country for bankers, lawyers and corporate officers on the topics of reorganizations, bankruptcies, valuations and lender liability, and is a contributing editor to the ABI Journal’s Turnaround Topics column. She has also been featured in BusinessWeek, Working Woman Magazine, The Industry Standard, Boards and Directors Magazine and on NBC Nightly News, CNN, NPR and Sky Radio.