You would not know it from the mainstream media, but the
financial crisis of 2007-09 produced less chapter 11s than the previous
recession of 2000-02. After a 2-or-3-year trough in restructurings, engineered
by the Fed's easy money policies, there are several indicators that activity
will pick up in 2015. Here's why:
Sovereign defaults
As of right now, it appears likely that Venezuela, the
most-mismanaged economy in the world, and Argentina, an
honorable mention in that category, will both default sometime in 2015. And
apparently it's a 50/50 proposition that Greece will default too.
Venezuela will be the most interesting for U.S.
distressed investors and professionals, because, unlike Argentina, it has a
number of state-owned companies that regularly engage in commercial activities
that make for interesting attachment possibilities outside the scope of
sovereign immunity. For example, its state-owned oil company, Petroleos de
Venezuela, S.A., with over $6B of bonds outstanding, sells a good deal of oil
into the U.S., creating dollar-denominated receivables that can be attached
through domestic litigation. As well, there are a lot of US and other North American
companies with large Venezuelan receivables that are substantially in arrears
that could be sold into distressed hands, to enable the buyer to pursue
collection efforts that the strategic holder might not be willing to undertake,
due to image concerns.
I wrote a lot about Argentina in
2013,
predicting all along that it would default for political reasons, and nothing
has occurred since my
last post to change my view.
The Economist's
latest edition captures the points I made back then: the
populist basis of the Kirchner government's hold on power makes it impossible
for that government to knuckle under to the foreign holders. They are better off in domestic politics
having a Yankee enemy to demonize than to maximize the nation's economic
welfare. If some other party comes into
power and does the rational thing of working out a deal, the Kirchners'
political heirs will have a ready-made plank for their next campaign. Argentina indisputably has the means to pay the holdout funds --
it's debt-to-GDP level is one of the lowest in the world (largely because the
dispute's existence has blocked the nation from closing any fnew-money deals in
the bond markets). The nonpayment is strictly a political decision, which is
why the U.S. courts have been in the right to turn the screws on them.
If the ultra-left Syriza party wins
control of Greece's government this month, I expect Greece
will default, for three reasons. One,
the core reason for Syriza's existence is to repudiate the terms imposed by the
"Troika" (EC, ECB, and IMF) as part of the 2011 bailout and restructuring,
so it doesn't really have a politically viable alternative to default, although
I expect there will be an elaborate show of offers and counteroffers between
its leadership and the Troika before a default occurs. Two, even after the massive haircut inflicted
on private creditors back in 2011, Greece was left with an unserviceable debt
load, so it was inevitable it would get to the point of defaulting eventually,
and there is a lot to be said on both sides to get it over with sooner rather
than later, as opposed to the surplus-generating nations in the EU throwing
good money after bad. Last, those
nations have to be worried about emboldening copycat repudiations by ultra-left
parties in larger nations, especially Podemos
in Spain, where there will be national elections in December, so
it makes sense to let Greece make an example of itself that, one hopes, causes
Spanish voters to avoid following in its shoes.
The counter-scenarios are that either (1) the
bureaucrats in the Troika are not politically strong enough to take an action
that effectively throws a member out of the EU, in part because they are
bureaucrats to begin with and in part because France, Portugal, Italy and
possibly Spain may want to see Greece treated liberally so they themselves can
receive similar treatment. In this view,
the Troika will ultimately cave and kick the can down the road a ways, which is
what Syriza's leader, Tsipras, is counting on when he says
"the party’s
program is non-negotiable. 'There will be a negotiation (with the country’s
international lenders). There will be an agreement. And the Memorandum, along
with the Troika, will become part
of the past!'”. The second
counter-scenario is that,
once Syriza comes to power, they will, like many before them, soften their rhetoric, face up to reality and
settle for some easy loan terms if the Troika pushes back hard enough and a
deal will get done. These are very
possible, but at the end of the day, I think that, much like the Kirchners in
Argentina, Tsipras will choose to play to the crowd with a populist
repudiation.
There might be some new muni defaults (Illinois, New Jersey, California being the most likely locations but conceivably an oil-patch municipality could get squeezed by declines in energy-related revenues) but I haven't researched that sector yet.
Macroprudential tightening.
Tighter banking regulations will put an end to
"extend and pretend". One of
the causes of the bankruptcy wave of 2001-02 was the "guidance"
issued by regulators to the banking sector to stop making
"enterprise value" loans to emerging tech companies -- loans that were not
supported by a cash flow cushion or traditional collateral coverage, but were only justified by the
supposed margin of safety provided by the company's equity market cap. Once credit market access became more
difficult, those companies lost the fuel they needed to continue their growth
stories, their stocks rolled over, triggering margin calls that accelerated
further stock declines, and their capital structures just imploded. leading to restructurings.
Last year, federal banking regulators issued new / revised guidance
requiring banks to tighten up the terms of leveraged loans on a variety of
fronts, which will make it onerous for the remaining highly leveraged companies
from the last cycle of LBOs to continue to extend the maturities of their
credit facilities, which will force them into restructuring as soon as the
auditors inform them that they have to add a going-concern qualification to
their report on year-end financials.
In a year-end summary from Thomson Reuters, they state
that banks have begun complying with regulators, such that debt-to-EBITDA
multiples on new leveraged loans came down about 5% in Q4. Busisness Week has a similar story.
Perhaps this realization has something to do with the current
Caesar's restructuring and it may bring Univision to the table sooner than
would otherwise have been the case. Claire's Stores, Clear Channel (iHeart
Media) and Toys 'R Us might also be lumped into this camp as well, judging by
their bond prices.
Interest Rate Hikes
The Fed has signaled it will raise short-term rates
sometime this year. I don't expect it to
be a material factor this year, as there is so much foreign demand for
Treasuries, and not that much domestic demand for credit, to put other pressure
on interest rates. If anything, the end
of QE, coupled with a divided Federal government keeping the fiscal deficit in
check, and the macroprudential and other pressures on bank lending, all mean the money supply probably won't be
growing as much in 2015 as in the last few years, which will keep a lid on the
economy and thus bias rates lower. In
the leveraged loan space, LIBOR floors will also absorb the first 100bps of any
rate hike anyway. So this will be a
small factor against easy money and thus toward restructurings.
Mid to Late Cycle Default Trends
Martin Fridson, a veteran of all the high-yield cycles
that have been, expounds the view that 2015 will bring the beginning of a new multi-year
default cycle that, given the amount of HY bonds outstanding, will set records
for the dollar volume of defaulted bonds.
He has
predicted defaults by over 1000
issuers, respecting as much as $1.6T of HY bonds with losses,
after recoveries, in the range of $752B.
"This
is just a projection of what would happen in a normal cycle" he says (horrible picture,
btw).
Energy Sector High Yield Issuers
As has been well reported, a good portion of the new
high-yield issuance since the financial crisis has been in the energy sector,
with particular concentration in exploration and production and oilfield
services companies which now comprise nearly 10% of the entire HY
universe. The energy sector is the largest
sector in the HY universe.
With the fall in the price of oil in the past quarter, dozens of these
issuers are now trading as distressed credits.
Fridson says
that energy credits now make up almost 29% of the distressed universe, three
times their proportion of the total universe.
Creditsights, a respected credit research firm, projects the
HY energy sector default rate to hit 8% next year.
A representative sampling of energy sector credits with
debt >$1B, bond ratings of Caa1, CCC+ or worse, and recent bond quotes below
75 includes:
American Energy Partners; Cobalt International; EXCO
Resources; Halcon Resources; Midstates Petroleum; Quicksilver Resources; and
Samson Resources.
Were I to loosen those three parameters a bit, as many
people compiling such lists do, more names would obviously flow in to the net. In
particular, a lot of names that have higher bond ratings will probably get
downgraded in the next 3-4 months. The
watchlists I get emailed to me every week have several dozen other names on
them.
Outside of E&P and oilfield services, there are eastern,
mostly metallurgical, coal producers like Walter Energy, Alpha and Arch with
debt at distressed prices for a variety of reasons -- falloff in China demand,
Obama Administration regulations, etc., that are unlikely to disappear from
their horizons anytime soon.
In addition, there will be secondary effects on other
industries from the drop in the price of oil.
For example, solar and other alternative energy companies may be
pressured as oil becomes cheaper.
Further, and to my surprise, because I would have expected chemical
companies to benefit from the fall in the price of oil which is a principal
feedstock for their processes, it turns out some chemical companies make
chemicals from ethane generated by fracking so a diminution in volume may hurt
them. Stocks like Lyondell
Basell and Westlake Chemical have sold off in sympathy
with the energy sector. As well,
aluminum companies may
suffer because reducing auto weight is no longer as important.
So there can be widespread secondary and tertiary impacts on certain sectors of
the econony from a prolonged oil price drop, even as other sectors of the
economy benefit.
Petrobras
Petrobras is a combination of sovereign issuer and
oil-price casualty. And it's a gigantic
issuer, with over $54B outstanding, so I give it its own hybrid category. The corruption
scandal at the company and just general mismanagement of
Petrobras are widely
reported. As the links
indicate, DOJ and SEC have launched criminal and civil probes of the
allegations. Already Aurelius has been alleging
that Petrobras is already in default because the it failed to
deliver its financial statements in timely fashion, due to the need to
re-evaluate the accuracy of its books and records and prior statements in light
of the corrupt practices. Assuming the
story is correct, and subject to any minimum notice requirements in their
indentures, the company has only until early March to generate accurate audited
financials or face a matured, albeit non-payment, default that could give rise
to acceleration. That said, Brazil has
the wherewithal to stave off an acceleration, and I expect it to do so to avoid
tarnishing the nation's global image. Among other resources, there is the state
development bank, BNDES, that just possibly might have been used before for
political purposes. And Petrobras'
leverage is not so great that it can't repair itself as prices recover over
time. But certainly no underwriter outside
of Brazil can market any new Petrobras securities until all that is cleared up. And the stock has just cratered the past few
months. Were it not for the implicit
government backing, it would definitely be a restructuring candidate right now.
The Perennial Contribution from Retail and
Consumer Names
In addition to names mentioned earlier in this post,
companies such as Radio Shack, Guitar Center, Gymboree and Wet Seal are all in
some stage of distress or restructuring. Casino names continue to raise worries
and one maker of casino games, Scientific
Games, is showing bond prices that embed heavy discounts, even
though the issue is recent.
Not all of these names will wind up in chapter 11. Some will get capital infusions, as Linn
Energy recently did, that enable them to postpone and hopefully
avoid restructuring altogether. Others will not be so lucky, but could go
out-of-court or pre-pack.
In any case, business for restructuring professionals -
especially in the oil patch -- seems likely to pick up from the trough of the
past three years.
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