1. Companies are dealing with the war in Ukraine, inflation, supply chain issues, rising interest rates, labor shortages, and the prospect of a recession. Are we about to see a huge spike in restructuring cases?

That is the question we are all pondering at the moment. It has been five months since global turmoil set in, yet we have only seen a moderate uptick in restructuring activity from dismally low levels in late 2021 through early 2022, with current activity levels remaining below average.

However, it typically takes six to nine months for economic adversity to become evident in restructuring activity, so it’s a bit too soon to panic over relatively subdued levels of restructurings. Activity certainly will be picking up in the second half, but it may not be the surge that some in our profession are expecting. 

Many stressed companies were able to borrow a ton of money in 2021 and that liquidity will likely get some through this challenging period, provided we don’t have a hard recession — which is a possibility, but not the most likely scenario. Credit markets and the rating agencies aren’t signaling a spike in restructuring activity by year-end.

2. The pandemic has radically changed consumer patterns and lifestyles. With that in mind, what do you think the future holds for sectors such as entertainment, transport and commercial real estate?

That’s a big question that can’t be answered succinctly. COVID impacts still linger even though the worst of the pandemic is behind us, for a variety of reasons — not necessarily due to the virus itself.

Just look at subway ridership in NYC, which is still 35% below pre-COVID levels, with the MTA saying that ridership will be permanently lower by 20%. But it’s a mixed bag. Some industries and businesses hard hit by COVID will get back to pre-COVID performance soon (if they haven’t already) while others won’t for a while, if ever, and so the challenge is to discern between the two.

Summer leisure travel activity for airlines was close to pre-COVID levels and it’s clear that most people have few qualms about getting on a plane for vacation. Cruises will take longer to come back, given the older age skew of typical cruise-takers. Movie attendance is still down more than 30% versus pre-COVID levels with little sign that pre-COVID box office revenue is achievable for the foreseeable future. Lodging occupancy remains below pre-COVID times, but substantial room-rate hikes are more than offsetting softer occupancy.

This last point is an interesting development since COVID, with the consumer services sector learning to more than offset below-COVID volumes with substantial price hikes. It’s happening in the airline, lodging and auto rental sectors, and they have realized this is a winning formula even though it prices out some people from these markets. While many Americans are hurting financially, a sizable cohort are doing well and are willing to absorb these price hikes.

It’s also looking increasingly unlikely that office workers will be back in the office five days a week any time soon, though most are back a few days weekly. Some large employers may not be thrilled with this arrangement, but it is potentially a “win-win” if companies ultimately can reduce their real estate footprint. This has negative long-term implications for commercial real estate in major markets and the ancillary businesses that depend on daily office workers.

Lastly, it’s worth noting that many of these lingering effects are not due to COVID per se, but to lifestyle changes caused by COVID that may be permanent.

For instance, business travel won’t likely ever be what it was prior to the pandemic—not from fear of COVID but because so many road warriors realized during COVID they didn’t need to be on the road so often to be effective. Similarly, low movie attendance is more likely due to the enduring preference for streaming movies at home rather than COVID concerns. Such types of changes are likely to be lasting.

3. Cannabis occupies a legal grey area in the US - how is FTI dealing with this sector as more distressed cannabis companies emerge?

Stress and distress among cannabis companies is widespread among growers, manufacturers and retailers.

The industry is being hampered by three major obstacles: crippling taxation via Internal Revenue Code Section 280E and high state rates; a supply glut (including a thriving black market); and a lack of ready access to the capital markets. Many of these pressures will decrease when some form of federal legalization happens, and states crack down on the black market.

FTI’s dedicated cannabis practice has been playing an important role in helping companies in the industry with streamlining operations, savvy deployment of limited investment dollars, and mergers and acquisitions. The industry had hoped cannabis decriminalization and removal from the Controlled Substance list might have moved faster under the Biden Administration, but it hasn’t, so these companies must be in the best shape possible to survive until then.

4. Crypto is in a bad way. How are you thinking about this sector in terms of distress and potential restructurings? For example, how would you measure the recovery value of assets like crypto in a bankruptcy scenario?

Nobody was talking about crypto restructurings until a month ago and now that’s all anybody is talking about. The three big crypto filings of the last month are related to some degree; they have exposed the interconnectedness of crypto lending platforms with broader crypto markets and large crypto players, and shown the high leverage these platforms employ and the fragility of this ecosystem when there is a “run on the bank.”

This all started when a stablecoin that was theoretically bulletproof became nearly worthless within a week, followed by some large aggressive crypto bets gone wrong, blowing a hole in these balance sheets, and setting off a panic of sorts among customers, lenders and investors who couldn’t conceive such outcomes were possible. While these three crypto bankruptcies set off the discussion, we have yet to see other knock-on filings or filings in other areas of crypto, such as miners, but those could come if cryptocurrency prices remain weak.

Given how unregulated crypto markets are currently, bankruptcy courts will decide the treatment of crypto liabilities in these Chapter 11 cases, and whether customer accounts are treated as general unsecured claims (GUC) that are last in line, or more akin to custodial accounts that don’t get lumped in with GUC. In addition, unwinding the complex financing arrangements across affiliated and unaffiliated counterparties, and determining whether values will be set in crypto token or fiat currency (and at what point in time), will need to be determined by the judges overseeing these cases.

Whatever decisions are ultimately made by the courts in these cases, there will be large losses; the only question to be decided is who absorbs them. As for valuation of crypto assets for plan feasibility purposes, the largest cryptocurrencies trade in relatively transparent markets where observable market prices are likely to be deemed indicative of fair value. As for the hundreds or thousands of obscure cryptocurrencies and tokens that trade in opaque and illiquid electronic markets, well, it will be challenging to get creditors’ buy-in and court approval with those valuations when it comes to plan feasibility, given how volatile and murky these asset prices can be.

Going forward it seems certain that crypto trading and investing platforms will become more regulated, with some clearly defined rules around crypto trading activities and the nature and treatment of crypto assets and liabilities. Additionally, it is likely that the industry will see new regulation to enhance risk management, disclosure, and other consumer finance measures to protect the retail investors. This ultimately should benefit the industry by reducing the many uncertainties that now exist regarding cryptocurrency trading and investing, and the classification and treatment of these assets and liabilities for regulatory and reorganization purposes.

5. More and more issuers are choosing private credit over the broadly syndicated market, and it doesn’t seem like this trend is going away. How do you think this will impact restructuring negotiations in the future?

Private credit has become a huge source of capital in recent years and an attractive alternative to large syndicated loans (LSL) for borrowers in leveraged credit markets.

For years, private credit was viewed strictly as a middle-market lender, but recent credit funds and deals have become huge and now can compete with LSL in many instances. The primary argument made by private credit is that they typically stay in a loan for its duration (unlike many large bank lenders) and therefore know their credits better and monitor them more closely, resulting in better credit decisions, fewer defaults, and better returns. 

However, without a bona fide default cycle since 2009 (the COVID-induced recession of 2020 was very brief and did not result in a typical default cycle), it’s hard to know if these arguments will hold up when truly tested.

Having more liquidity providers to non-investment grade borrowers isn’t beneficial for restructuring activity, so private credit has likely suppressed such activity by providing capital to riskier borrowers that commercial banks aren’t fully servicing. But they have also helped ratchet up total leverage within the corporate sector, so that is potentially an opportunity for more restructuring activity down the road when a real recession hits.

6. You were involved in the Chapter 11 of Energy Future Holdings, which was taken private during the pre-crisis LBO boom of 2007, and is still among the largest ever buyouts. What lessons can today’s leveraged finance community learn from that past credit cycle?

The obvious takeaway from that deal and time period is that mega-sized LBOs are indicative of top-of-the-cycle deals. It’s the ringing bell that signals a market top. 

It wasn’t just EFH; the iHeartMedia (f/k/a Clear Channel Communications) and Caesars Holdings mega-buyouts, which also subsequently restructured, were also completed in that 2007-2008 period, which in retrospect was the height of financial markets craziness. Time will tell if this holds true for some large buyout deals done in 2021.

7. Given your extensive experience in bankruptcies and restructurings, what do you believe is the biggest problem the industry faces right now, and how do we solve it?

More than ever, it seems the paramount objective of a filing is to get a debtor through the Chapter 11 process as quickly as possible – our Emerge to Grow Report highlighted this phenomenon.

Tight milestone deadlines tied to debtor-in-possession (DIP) and exit financing and other events in Chapter 11 make this especially true in recent years. A quick Chapter 11 process is an admirable goal, but a very speedy reorganization often precludes a debtor from addressing and fixing underlying issues that made the business uncompetitive to begin with. 

Consequently, Chapter 11 often has been a process to quickly right-size a balance sheet and reject unfavorable executory contracts. Whether a debtor emerges from the process as a competitive business within its industry is less clear, and it has become somewhat naïve to believe that the Chapter 11 process can or should accomplish this.

Other than this, venue shopping by debtors in courts more likely to rule favorably regarding specific issues or events, such as mass tort liabilities, is probably as pervasive as ever, with some critics going so far as to say it is arguably an abuse of the bankruptcy system in some instances.

8. FTI’s corporate finance and restructuring division has expanded a lot over the last two years, including a push into continental Europe with the acquisition of BOLD. Why expand there, and what else is on the cards for 2022?

We don’t necessarily look to expand into particular markets or regions, but we always look for the opportunity to acquire great talent with established relationships and books of business. We’ve recently added a team of experts in Italy and are growing our capabilities in France. 

Advisory work is ultimately a talent-driven business and in recent years we have more often expanded by bringing on smaller teams of great people rather than buying entire businesses. But as you note, our purchase of BOLD, as well as Delta Partners and the CDG Group previously, indicates our willingness to make whole acquisitions when the opportunity is there. 

Much of our talent acquisition hasn’t been strictly in the restructuring arena, but in areas tangentially tied to restructuring activity that can still thrive when the cycle is unfavorable for bankruptcy filings.

9. Debt restructuring is a tough business. What’s your favorite way to celebrate/unwind after a big deal?

We’re not a super celebratory bunch when it comes to these things. A big dinner with the deal team is about as wild as it gets, maybe with some better vintage wines. We can’t help it — we’re mostly accounting and finance folks.