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9Questions is our Q&A series featuring key decision-makers in the corporate credit markets — get in touch if you know who we should be talking to!

This year was an interesting one in the world of distressed debt and corporate restructuring. There was a little bit of everything: courtroom drama in the form of a scandal that erupted in the Southern District of Texas Bankruptcy Court around Judge David R Jones; more instances of lender-on-lender violence that have creditors looking over their shoulders at private equity sponsors; to pressure on the real estate market that’s creating opportunities for private credit firms.

With 2023 winding down and 2024 just around the corner, we wanted to look back at what’s happened so far this year and then look ahead at what’s coming next. To help us do that, we spoke with Cynthia Romano, a senior managing director at FTI Consulting who specializes in restructuring and turnarounds.

1. What would you call out as the most significant trends or developments in the restructuring world this year?

The US economy fared better in 2023 than most predicted, with forecasts moving from “almost certain recession” as of late 2022 to “soft landing” as 2023 draws to a close.  Ironically, relatively few have been fully correct in their prophecies.  As one portfolio manager said recently: “Who would have expected that?” (“that” being everything from Covid to stimulus programs to the 2021 M&A boom to a soft landing).  The fund manager is not alone.  No one has had a perfect crystal ball since Covid. Typically correlated indicators have been disconnected and leading indicators have not been reliably predictive.

When economic data is as confusing as it is now, I give heavy weight to available dry powder. Cash on hand dampens troubling economic realities and also creates opportunities for growth and innovation.  Today, as it was two years ago, dry powder is at historically high levels.  If the 08-09 recession taught us anything, money must be put to work and money at work fixes, at least temporarily, many ills.  With so much liquidity in the market, the future doesn’t look so scary.

How available cash will be used over the next year will drive the restructuring prognosis for the next few years. Three years ago, I looked at truly miserable leading indicators, looked at ridiculously high levels of dry powder, and concluded the restructuring wave wasn’t coming.  It was a highly disputed perspective. Today it appears to be true.  Instead of a catastrophic economic crash as most predicted in late 2020, we have seen and will likely continue to see nothing more than a slowly rising tide drowning only those who fail to focus on the fundamentals of quality revenue, cost optimization, stable and smart management, lowering leverage and maintaining a cash cushion.

2. What are the biggest challenges facing highly indebted companies in 2024?

While the answer might vary somewhat from industry to industry, the biggest challenge facing highly indebted companies in any year is risk.  The greater the indebtedness, the greater the risk: lender or vendor discomfort that drives tightening the reins; rate increases and resulting debt service increases; and going concern opinions if growth and liquidity don’t keep pace with obligations.

In 2024, companies with higher indebtedness should do better than they did in 2023 because rates are expected to drop (lowering debt service requirements), costs are expected to stabilize or drop (as inflation continues downward toward the Fed target of 2%), and the labor market appears to be turning ever so slightly in favor of the employer for the first time in a while.

3. Do any particular industries have it worse than others? How so?

In every economic cycle, there are industry winners and losers even if the domino effect ultimately touches every sector. These are some we are following closely:

Healthcare. Labor costs are rising faster than government reimbursement.  Technology, regulatory and billing requirements are prohibitively expensive for all but the largest and healthiest organizations.  Most systems are facing rising costs related to an increasingly low-income and increasingly aging population. Efforts to create efficiencies through consolidation are met with regulatory resistance.  And private equity funding often results in a culture clash between providers focused on care and fund managers focused on profit.

Real Estate. The commercial real estate market faces numerous systemic challenges including the continued rise of online shopping, high office building vacancy rates caused by Covid and work from home, shedding of healthcare and higher education buildings. Thus far, lenders and bondholders have been willing to “extend” (we have long since passed the pretend portion of that phrase).  But, ~25% of U.S. commercial real estate loans will mature over the next two years. Will continuing to extend remain possible?

Cannabis. Cannabis is not legal at the federal level so it cannot receive federal money (or private money backed by federal money) and it cannot avail itself of federal remedies to restructure, including bankruptcy protection.  The young industry is in need of more professional management, broader funding options, reasonable protection from creditors and enough cushion to withstand the typical agricultural challenges of weather, bugs, et al.

4. Do you think there is an increase in the numbers of “good company, bad balance sheet” situations because of how much unhedged floating rate debt is out there?

Intuitively and from 2022 data, yes.  The 2021 M&A boom was funded at least in part by equity sponsors who over-levered the target.  Floating rate, high-yield private debt provided the funding. The historically low rates in place at the time made levering up almost impact-free. Not surprisingly, corporate leverage and debt to income ratios rose through 2022. We have certainly seen our share of companies with adequate EBITDA which, with rising rates, are now cash constrained. However, consistent with corporate leverage ratios trending downward in 2023, distress almost always involves more than over-levering or the debt slowly gets paid down. While over-levering may create pressure, healthy, well-run companies keep adequate reserves of cash, have operational levers to adjust, drive growth that outpaces cost and either naturally or with some effort successfully adapt and/or have enough credibility to consensually restructure their debt before the water reaches their nose.

5. How do you see companies using in-court versus out-of-court restructuring options in 2024?

In-court restructuring is typically expensive and time consuming. As a result, it is usually the best last option, not the best first option.  In-court restructuring is most feasible for large companies and most useful for: hitting pause on external pressures e.g. litigation or critical vendor threats; shedding past debt when the past, not the present, is the problem; herding large numbers of cats that do not want to be herded; rejecting or renegotiating contracts weighing down the business; reorganizing around a plan that not all constituents agree with; and, selling assets to a buyer skittish about future liability. However, in-court restructurings often leave professionals better off, may or may not leave the company better off and infrequently leave creditors and equity better off.  As a result, creditors and equity familiar with the process are often willing to negotiate settlements out of court. Thus, expect large company filings in 2024 to continue at levels similar to or slightly less than 2023. But, whenever possible, expect that restructuring out of court will be tried first.

6. How has the role of operational advisors changed, and how will that impact the way you advise in these restructurings in the coming year?

Advisors, like doctors, have gone from the distant, singular expert who preaches from on high to smart advocate, partner, external set of eyes, simultaneously at 100,000 feet and on the ground, with deep expertise of their own as well as access to specialists, research, technology and best practices. Now, operational advisors act in a variety of roles: interim management, trusted partner to management and sponsor; therapist to change-averse teams; and, as part of the team, they identify and implement side by side with management.  Their mission: intelligent efficiencies and optimizations, unique business models for growth, competitive differentiation in crowded markets, clarity amidst the latest fad, tight project management to execute with precision and emotional support to change sustainably. Are they thinker or doer?  Today’s operational advisor needs to be both thinker and doer with a dash of counselor thrown in for sustainability.

7. What will be the evolution of liability management exercises?

Liability Management Exercises (“LMEs”) are transactions undertaken by a company to restructure its balance sheet liabilities. Companies of all sizes and structures are pursuing out-of-court LMEs to achieve their capital structure objectives. Because these transactions tend to be customized rather than cookie cutter, they require expert legal and financial support to ensure the company’s goals are met while adhering to the applicable debt restrictions and complying with governing debt documents. The goals of these transactions are similar to those of traditional workouts: extend maturity, reduce cash debt service, create a trading discount/deleverage, augment liquidity and/or relax financial covenants.  Many lenders initially filed suit to block these LMEs, but those suits have decreased over time.  Given prior commentary about the time and cost of alternative in-court restructuring methods, LMEs appear here to stay; while perhaps distasteful, it is likely that lenders will find LMEs more palatable in the long run than the impacts of a free-fall chapter 11.

8. Do you have any other predictions for what we’ll see in restructuring next year?

Expect a focus on fundamentals and an investment of dry powder in sustainability, circularity, visibility, predictability, security and generative AI. The pendulum always swings from get rich quick to get back to basics to get rich quick again.  But aside from the explosion of private debt that has been called the start of the next junk bond wave, the sobering reality of “who would have expected that” has even the most confident prognosticators getting back to basics: creating sustainable revenue, liquidity reserves, supply chain efficiency, cost optimization and investment in technology.

9. I want to change gears for a second in recognition of the season. There’s a lot of debate over whether or not Die Hard is a Christmas movie. What’s your take? And do you have any other hot takes about holiday movies?

My family loves Christmas and always has.  But, after a frenetic month leading up to the holiday followed by a full day of family and food, even my close-knit, tradition-filled clan needs a break at day’s end.  A good action flick after the younger ones have gone to bed fits the bill perfectly as a “Christmas movie.”  As for other hot choices in my family: A Christmas Story, Elf, The Holiday, Love Actually, Lethal Weapon, anything Bond, The Little Drummer Boy and It’s a Wonderful Life.  All, even Die Hard, share a common message of Christmas Spirit: good triumphs over evil, and family and love carry the day.

9Questions — Cynthia Romano, FTI Consulting — Levered companies will go ‘back to basics’ in 2024

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