A Yank’s Take on the Rise of U.S. Style Pre-Insolvency Restructuring
As the U.S. system of restructuring and insolvency gains popularity in Australia and beyond, Carlyn Taylor, Global Co-Leader of the Corporate Finance & Restructuring segment of FTI Consulting, provides her perspective on this growing trend in a Q&A presented by the FTI Journal. Taylor first shared her perspective in March at INSOL 2017, the Tenth World Quadrennial Congress of the International Association of Restructuring, Insolvency, & Bankruptcy, held in Sydney, Australia.
FTI JOURNAL: What are some of the trends you’re seeing in the near term with regards to restructuring in the U.S.?
CARLYN TAYLOR: Over the last couple of years we’ve had huge waves of restructuring activity in two industries that are now ebbing. The energy sector went from a torrent of restructuring that was dependent on falling oil prices to more of a ripple recently with the modest rebound of prices. That’s had a notable impact on the overall volume of restructuring. The other is mining, which has largely run its course — that’s true for both the U.S. and Australia, of course. Commodity prices had been near all-time lows, and they have since rebounded as well. So far in 2017 no other industries have seen a pickup in distress sufficient to offset moderating restructuring activity in these two sectors.
FTIJ: Which U.S. industries are attracting more restructuring activity?
TAYLOR: We’re seeing a lot from retail since 2016, which will be a long run story. More brick-and-mortar chains will experience distress as online shopping grabs more market share and consumers change their spending priorities. There’s also healthcare and clean energy. With clean energy, there’s the prospect of government subsidies coming to an abrupt end under the new presidential administration. There was already some natural winding down in the sector because of the departure of the previous administration and that is now causing some distress in the clean energy space.
FTIJ: You mentioned the elephant in the room — the Trump Administration. How much impact do you think Trump’s proposed policies will have on the restructuring market?
The Australian POV
|John Park, Senior Managing Director, Head of Corporate Finance & Restructuring, Australia, FTI Consulting|
|The Australian market is starting to rally behind the U.S. system. Our common law is based on the English system, but we are moving to a more American restructuring market. There is a push behind the scenes at the large restructuring law firms and accounting firms to adopt a process more similar to Chapter 11 — not because the laws are changing (although the Australian government is focused on improving insolvency laws to encourage innovation) but because the firms favor it given the expectation of large inbound capital from outside sources such as the U.S.|
TAYLOR: Good question! I’ve had a lot of UK folks joke with me that the Trump effect is big — far bigger than Brexit even. We’ll have to see whether that’s true or not, but it’s pretty clear that certain industries under Trump are going to be impacted, like healthcare and clean energy, as I mentioned.
Tax reform is another area that could have a major impact on restructuring activity in different industries. Probably the biggest impact in that area is the proposed border adjustment tax by the Republican majority in the House of Representatives — if they do it at all — and what the transition rules will be. That could have an impact on a broad swath of industries: The auto industry and the retail industry are two that readily spring to mind as being particularly vulnerable to such a tax. The problem with tax reform and the border adjustment tax, as proposed under the House plan, is that rather than having a broadly similar impact across the corporate sector, it results in industries that are clear winners and losers. This is especially true with the border adjustment tax, the tax revenue from which is needed to offset much of the tax revenue lost from proposed lower corporate tax rates.
FTIJ: How do you think these proposed policies will play out?
TAYLOR: It’s unclear at the moment. Despite widespread support for tax reform generally within the U.S. corporate sector, these disparate outcomes by industry have caused the issue to become highly politicized. Retailers in particular have been lobbying hard against the border adjustment tax, and President Trump has yet to indicate exactly where he stands on it. But without it, corporate tax reform could be imperiled unless Congress is willing to tolerate meaningfully larger budget deficits, which is unlikely.
FTIJ: Given the wide range of industries, do you see a greater need for specialization these days?
TAYLOR: Very much so. I would say that the more complex industries are the ones where we see the greatest need for specialization. Telecom in the early 2000s was one of the first where specialization was critical, and I believe healthcare is another. Those industries speak their own language, and it’s very difficult to do restructuring if you don’t understand the technology and the complexity of issues. Energy is another — we had nearly 70 restructuring assignments last year globally. I don’t think anybody else came close. We also believe you need to be an expert in agriculture, mining, retail, real estate and chemicals as well to win those assignments.
FTIJ: While formal insolvency appointments remain a cornerstone in Australia, the country is gradually adopting options common to the U.S. What can you tell us about the U.S. system?
TAYLOR: Chapter 11 is generally viewed as a debtor-sympathetic system that favors the rehabilitation of the debtor in contrast to many other insolvency regimes around the world where creditors’ rights and remedies are paramount. The automatic stay feature of Chapter 11 is often cited as primary evidence of such a view. Consequently, Chapter 11 is rightly seen as encouraging reorganization when it’s feasible, with reliable statistics on larger Chapter 11 filings since 1981 indicating that approximately 71% of these cases resulted in a reorganization outcome (62%) or the acquisition of the debtor (9%) while only 29% resulted in the liquidation of the debtor.1 That’s a fairly impressive track record.
In recent years we are seeing a shift from bank lending to non-traditional financing sources in the U.S. with hedge funds and Collateralized Loan Obligations (CLO) among those leading groups. Because of that, we are seeing more out-of-court exchange offers from distressed companies. S&P data tells us that nearly one-third of its debt default events in each of the last two years were the result of a distressed debt exchange.
Another trend is the prevalence of prepackaged bankruptcy filings, or pre-packs, where you negotiate and vote on a reorganization plan before the bankruptcy and then you file. You’re in and out of bankruptcy in 30 to 90 days. Accompanying the rise of pre-packs and pre-negotiated plans in the U.S. is the Restructuring Support Agreement — the RSA, which supports a speedy resolution in bankruptcy court. But in the haste to get things done through an RSA, sometimes companies retain more debt than they should and that can have a deleterious effect down the line. In addition, it’s important to note that RSAs are largely capital markets fixes and generally do not address fundamental business issues that precipitated the company’s distress in the first place.
FTIJ: So the U.S. models are not always ideal, in other words?
TAYLOR: Right. There’s still a need for traditional advisory and interim management roles in bankruptcy as well as formal insolvency appointments to advise the debtors and their stakeholders and help ameliorate operational deficiencies to put the company on the path towards emergence. More time is needed in bankruptcy and insolvency proceedings if you really want to rehabilitate a company and give it a fighting chance to be competitive and effectuate needed operational changes. The recidivism problem of Chapter 11 reorganizations also needs to be acknowledged, with academic studies showing that approximately 20% to 30% of companies that emerge from Chapter 11 need to file again within a few years.
FTIJ: What’s your vision for the restructuring profession over the medium term? Do you think it will contract?
TAYLOR: We see an increasing number of competitive firms fighting for the same deals in the U.S., particularly when it comes to standard financial advisory services to companies and creditors. The uptick in restructurings since 2014 has given rise to new advisory firms, mostly small shops. Despite the increased competition, there is still room for growth. That’s true in Australia as well. For example, there’s need in specialized services such as interim management as well as in industries I mentioned earlier. Certainly, based on the FTI vantage point and what we hear in the market, there are a limited set of professionals that can serve the large, public company with a global presence where you need a Chief Restructuring Officer a CEO or a CFO and other interim support.
FTIJ: Finally, any advice for young professionals in the industry?
TAYLOR: Build your knowledge in a particular area or industry so that you can be sought for your domain expertise. But you also want to be able to pivot — be an industry specialist who can move from restructuring to non-restructuring depending on market cycles. I always tell people to think of the Greek letter pi: It’s wide on top with two stems that go down. You need to be wide enough with the ability to do a lot of things well, with an area or two of depth, or expertise.
1 Altman, Edward (2014). The Role of Distressed Debt Markets, Hedge Funds and Recent Trends in Bankruptcy on the Outcomes of Chapter 11 Reorganizations, p. 26-27