There is a group of bankers for whom “better” means “worse” for everyone else: we are talking, of course, about restructuring bankers who advising companies with massive debt veering toward bankruptcy, or once in it, how to exit from the clutches of Chapter 11, and who – like the IMF, whose chief Christine Lagarde recently said “When The World Goes Downhill, We Thrive” – flourish during financial chaos and mass defaults.
Which is to say that the past decade has not been exactly friendly to the world’s restructuring bankers, who with the exception of two bursts of activity, the oil collapse-driven E&P bust in 2015 and the bursting of the retail “bricks and mortar” bubble in 2017, have been generally far less busy than usual, largely as a result of abnormally low rates which have allowed most companies to survive as “zombies”, thriving on the ultra low interest expense.
However, as Moody’s warned yesterday, and as the IMF cautioned a year ago, this period of artificial peace and stability is ending, as rates rise and as a avalanche of junk bond debt defaults. And judging by their recent public comments, restructuring bankers have rarely been more exited about the future.
Take Ken Moelis, who last month was pressed about his rosy outlook for his firm’s restructuring business, describing “meaningful activity” for the bank’s restructuring group.
“Your comments were surprisingly positive,” said JPMorgan’s Ken Worthington, quoted by Business Insider. “Is this sort of steady state for you in a lousy environment? Can things only get better from here?”
Moelis’ response: “Look, it could get worse. I guess nobody could default. But I think between 1% and 0% defaults and 1% and 5% defaults, I would bet we hit 5% before we hit 0%.”
He is right, because as we showed yesterday in this chart from Credit Suisse, after languishing around 1%-2% for years, default rates have jumped the most in 5 years, and are now “ticking higher”
Moelis wasn’t alone in his pessimism: in March, JPMorgan investment-banking head Daniel Pinto said that a 40% correction, triggered by inflation and rising interest rates, could be looming on the horizon.
These are not isolated cases where a gloomy Cassandra has escaped from the asylum: already the biggest money managers are positioning for a major economic downturn according to recent research from Bank of America. And while nobody can predict the timing of the next collapse, Wall Street’s top restructuring bankers have one message: it’s coming, and it’s not too far off.
However, the most dire warning to date came from Bill Derrough, the former head of restructuring at Jefferies and the current co-head of recap and restructuring at Moelis: “I do think we’re all feeling like where we were back in 2007,” he told Business Insider: “There was sort of a smell in the air; there were some crazy deals getting done. You just knew it was a matter of time.”
What he is referring to is not just the overall level of exuberance, but the lunacy taking place in the bond market, where CLOs are being created at a record pace, where CCC-rated junk bonds can’t be sold fast enough, and where the a yield-starved generation of investors who have never seen a fair and efficient market without Fed backstops, means that the coming bond-driven crash will be spectacular.
“Even if there is not a recession or credit correction, with the sheer volume of issuance there are going to be defaults that take place,” said Neil Augustine, co-head of the restructuring practice at Greenhill & Co.
The dynamic is familiar: since 2009, the level of global non-financial junk-rated companies has soared by 58% representing $3.7 trillion in outstanding debt, the highest ever, with 40%, or $2 trillion, rated B1 or lower. Putting this in contest, since 2009, US corporate debt has increased by 49%, hitting a record total of $8.8 trillion, much of that debt used to fund stock repurchases. As a percentage of GDP, corporate debt is at a level which on ever prior occasion, a financial crisis has followed.
The recent glut of debt is almost entirely attributable to the artificially low interest-rate environment imposed by the Federal Reserve and its central bank peers following the crisis. Many companies took advantage and refinanced their debt before 2015 when a large swath was set to mature, kicking the can several years down the road.
But going forward “there’s going to be refinancing at significantly higher rates,” said Steve Zelin, head of the restructuring in the Americas at PJT Partners.
And as the IMF first warned last April, refinancing at higher rates will further shrink the margin of error for troubled companies, as they’ll have to dedicate additional cash flow to cover more expensive interest payments.
“When you have highly leveraged companies and even a modest rise in interest rates, that can result in an increase in restructuring activity,” said Irwin Gold, executive chairman at Houlihan Lokey and co-founder of the firm’s restructuring group.
So with a perfect debt storm coming our way, many restructuring firms have been quietly hiring new employees to be ready when, not if, the economy takes a turn for the worse.
“The restructuring business is a good business during normal times and an excellent business during a recessionary environment,” Augustine said. “Ultimately, when a recession or credit correction does happen, there will be a massive amount of work to do on the restructuring side.” Here are some additional details on recent banker moves from Business Insider:
Greenhill hired Augustine from Rothschild in March to co-head its restructuring practice. The firm also hired George Mack from Barclays last summer to cohead restructuring. The duo, along with Greenhill vet and fellow co-head Eric Mendelsohn, are building out the firm’s team from a six-person operation to 25 bankers.
Evercore Partners in May hired Gregory Berube, formerly the head of Americas restructuring at Goldman Sachs, as a senior managing director. The firm also poached Roopesh Shah, formerly the chief of Goldman Sachs’ restructuring business, to join its restructuring business in early 2017.
“It feels awfully toppy, so people are looking around and saying, ‘If I need to build a business, we need to go out and hire some talent,'” one headhunter with restructuring expertise told Business Insider.
“In our world, people are just anticipating that it’s coming. People are trying to position their teams to be ready for it,” Derrough said. “That was the lesson from last cycle: Better to invest early and have a cohesive team that can do the work right away and maybe be a little bit overstaffed early, so that you can execute for your clients when the music ultimately stops.”
Of course, if the IMF is right (for once), Derrough and his peers will soon see a windfall unlike anything before: last April, the International Monetary Fund predicted that some 20%, or $3.9 trillion, of the total global corporate debt is in danger of defaulting once rates rise.
Although if and when that day comes, perhaps a better question is whether companies will be doing debt-for-equity swaps, or fast forward straight to debt-for-lead-gold-and canned food…