Restructuring trends point to opportunities here and abroad
Debtor defaults, distressed assets in the renewable energy market and emerging restructuring trends in Europe were all discussed at the International Restructuring Conference in New York City, where strategic partners Grant Thornton LLP and McDermott Will & Emery met to cover a wide array of topics. Key takeaways should help identify investment opportunities in the U.S. and European markets and fuel board and partner discussions in 2018 and beyond.
As Jim Peko, National Managing Principal of Grant Thornton, summed up after the fall meeting, “In today’s ever-changing environment, we felt it was important to get people with a pulse on the market in one room to discuss what we are expecting on the restructuring side globally. While questions still remain as we move forward, we did discuss the impact of some of the challenges facing deal makers in the U.S. and abroad.”
Assess the impact of recent trends and what they mean for 2018 portfolio and investment decisions.
American municipal bond market
Defaulting on bonds is nothing new for the United States. “We have a rich history of defaulting, but before we used to bury the debt; now we just refinance it,” said William Smith, a partner with McDermott Will & Emery.
In some cases this is true. However, Thomas Weyl, president of GRB Municipal Finance, pointed out that Puerto Rico, which is facing its worst debt crisis in history, rejected the opportunity to refinance.
Whether debt is refinanced or just “buried,” there are constitutional constraints, including federal bankruptcy supremacy, contracts clauses and limits of receivership that hamper creditor ability to collect on defaults. During the 1933 Arkansas default, as one example, state funding of school, police and fire ceased in order to pay debt. Federal laws have changed to make it possible to default on loans while still keeping critical services available to citizens. But how do the loans get paid?
“It’s great that the citizens don’t suffer, but if a state becomes distressed, there aren’t court-recognized ways to take care of the debt. Creditors run real risks of having an unpleasant situation on their hands should a debtor default,” said Smith.
David Taub, a partner at McDermott Will & Emery, added that there is a patchwork of answers regarding Chapter 9 bankruptcy protection and the requirements, which vary dramatically from state to state. Part of the bankruptcy code that is used to adjust municipal debt, contracts and liabilities, Chapter 9 is available in some form or another in 27 states. In another 21 states, the law is unclear or laws do not authorize Chapter 9 in any form, potentially leaving creditors in a dicey position should things head south.
In Connecticut, the government needs to approve the bankruptcy filing, but Pennsylvania has procedural requirements. “It’s not like other aspects of the federal bankruptcy law. In some states it’s very clear and the filing is voluntary; in other states it’s not,” said Taub.
Chapter 9 has rarely been used, but that is expected to change. Issues like a fall off in investment earnings, the high cost of other post-employment benefits, and the maturation of the public union movement will all play a role in more states potentially filing for Chapter 9 protection. “Governments are under a lot of pressure today, and it’s not getting any easier,” said Smith.
Distressed renewable energy
As the renewable energy market matures, there has been an uptick in distressed assets coming to market. Several companies filed for bankruptcy or entered into agreements to restructure their debt.
Learn the essentials of distressed asset sales and U.S. tax incentives related to renewable energy.
A 363 sale offers the maximum recovery for creditors, and it can also become a great way for buyers to pick up assets at bargain prices. Companies are more frequently opting for 363 sales versus the traditional Chapter 11 process, which can be costly and slow. For example, SunEdison held a 363 sale and sold its solar material business to GCL-Poly for $150 million USD.
This type of sale gives the seller asset protection, and there is no shareholder approval necessary, which expedites the timeline. There are advantages to the buyer as well — assets are transferred free and clear and buyers can cherry pick the assets they want to buy, as CGL-Poly did. “This is a good option for many reasons,” said Darren Azman, a McDermott Will & Emery partner. “You can operate without foreclosure threat and the purchaser can move forward while waiting for bankruptcy court approval. Buyers can acquire assets fee and clear at distressed prices.”
More often than not, the debtor will try to enter the process with one bidder in hand. This “stalking horse” bidder is in the strongest position to win the auction. In theory, this bidder will have had the opportunity to work closely with the debtor and be given superior access to information. They are also in a position to shape the process by offering the minimum bid and negotiating what assets it wants to acquire. The stalking horse bid also has its expenses reimbursed and can get a break-up fee equal to a percentage of the bid’s purchase price. In the end, the best bid will win subject to bankruptcy court approval, which can take into account public issues.
There are some challenges to being the stalking horse bidder, as in cases where losing bidders complain they didn’t get a fair opportunity and a judge will find merit. Also, it’s imperative that bidders understand the potential for regulatory issues that may arise in bankruptcy and the structure of any existing projects and assets, which can be complex. Sellers should look for any selling incentives that may be available to them. “You have to understand the structure and take advantage of the tax credits available,” said Richard Liebman, a managing director with Grant Thornton.
Distressed retail — U.S. and Europe
Retail sales in the U.S. were soft for the first half of 2017 and that could continue into 2018. Bankruptcy filings in the U.S. are creeping up for a number of reasons; the easiest to understand being the success of e-commerce and millennials’ online shopping preferences.
“Retail businesses are challenged and the bankruptcy code is less hospitable to retail and restaurants,” said Nathan Coco, a partner with McDermott Will & Emery. “In bankruptcy court, it can take many years to make a plan and get it into action. These companies do not have that kind of time.”
The challenges in the retail and restaurant sectors in the UK are similar to the challenges in the U.S. “Retail sales are declining and continue to decline,” said Senthil Alagar, a partner with Grant Thornton UK. “In the UK, our gross domestic product is driven by consumer debt. Confidence is down and there are headwinds now.”
The landscape in Germany is a bit different. The economy is still strong and insolvency is at an all-time low. However, there is particularly bad management in the retail arena, leaving room for buyers to pick up distressed retail assets and increasingly use a loan-to-own strategy. “We have a new system similar to Chapter 11 in the U.S. that allows for a loan-to-own strategy with shareholders,” said Matthias Kampshoff, a partner with McDermott Will & Emery. “It’s a unique situation for the German market. Buyers can get into a business in a hostile way by buying a portion of the business.”
Emerging trends in the European restructuring market
The United Kingdom
The number of non-performing loans (NPLs) is high and regulators have yet to set a strategy on how to deal with them. According to Grant Thornton partner Alagar, regulators need to figure out what options debtors can have, how they can work them out and if they have the option to restructure around them. NPLs will be the catalyst for making banks deal with distressed situations.
Health care is a sector that remains under pressure in the UK. For example, Four Seasons Health Care, owned by private equity firm Terra Firma, announced plans to restructure its debt. While the industry is seeing the number of people over age 85 doubling in the next 25 years and the need for health care rising, it is in distress. “It’s hard to make a profit. Smaller operations are going under,” said Alagar.
The economy is strong, but fragile, and money is cheap. The lending market is stretched; when the economy shifts, and interest rates rise, more distressed assets will come to market. Some sectors already showing signs of distress are shipping, hospitals and the automotive industry. “There is not insolvency, but distress is coming. Germany is known for the car industry, but, as preferences skirt toward electric cars, you have to change your model to stay competitive,” said Uwe Goetker, a partner with McDermott Will & Emery.
Ireland is the success story of the financial crisis. Its bail-out program for non-conforming loans in part resulted in sensible decision-making and enforcement, so there are limited opportunities for distressed investing.
Things are changing in Greece, according to Andy Charters, a director with Grant Thornton. There is regulatory pressure and new guidance being set by regulators. That said, the macro economy has picked up and tourism is in a good place, which is helpful. “Political risk is still an issue, but overall things are stable,” said Charters.
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