The restructuring remedy – CFO


The COVID-19 pandemic threatens a global economic crisis, unique in our lifetime. A restructuring professional for 38 years, I have lived my part: the savings and credit crisis, the stock market crash and the junk bond crash of the 1980s; the dot-com bubble of the late 1990s; the post-September 11 recession; and the collapse of mortgage-backed securities in 2008.

This time it’s different.

It’s not just that the triggering event – a virus that has forced most of the world’s major economies into partial or near-complete lockdowns – is different. The challenge today is that the virus has exposed deeper and more persistent vulnerabilities in the way companies do business. As a result, the natural remedies employed in past crises – monetary policy changes, government bailouts for struggling industries – will fall short of the dramatic measures needed to stabilize the US economy. And to save what we can.

The bankruptcy process will be an essential part of the recovery. In 2009, the Chapter 11 cases of General Motors and Chrysler were instrumental in saving the US auto industry. The bankruptcy allowed the two companies to restructure more than $ 60 billion in combined liabilities in separate proceedings that lasted less than 40 days each. (As an outside lawyer for President Obama’s Auto Task Force, I saw first-hand the role these measures played in our recovery from the Great Recession.)

Given the scale of our current crisis, the bankruptcy process will be even more critical: painful as this calculation is likely to be, substantial restructuring needs to take place in several sectors within an accelerated time frame.

Ultimately, the economic crisis of 2020 pushed companies with already weak balance sheets to the brink of collapse. The US economy is currently operating with staggering corporate debt of $ 10,000 billion. Many debt-ridden companies are mere “zombie companies” – over 40% of companies listed on US stock exchanges in 2019 were unprofitable.

If the amount of debt is alarming, the quality is even worse. Over the past decade, investors have flocked to the junk bond market in search of higher yields, with central banks keeping Treasury interest rates at or near zero. US high yield corporate debt is now more than 20 times higher than in 1987, when the Dow Jones suffered its largest single percentage point drop in a day.

A recent survey by Truth in Accounting found that US states, territories and municipalities are also under severe economic pressure, accumulating an estimated $ 1.5 trillion in unfunded debt. Meanwhile, the latest report on the state of compensation programs in the United States says Medicare’s hospital insurance fund will be insolvent by 2026 and Social Security reserves will be depleted by then. 2052. Over 45 million Americans are burdened with a record $ 1.6 trillion in student loan debt.

The reality is that even after the real estate and banking sectors recovered from the latest global financial crisis, corporate debt in the United States has remained dangerously high. Many companies that probably should have undergone restructuring continued their operations due to the availability of easy credit. This may lead to a higher risk of default for these companies this time around. And the default rate could be even worse for specific industries, such as oil and gas, which were experiencing an annual default rate of 13.4% on high yield bonds even before the collapse in oil prices on last month.

The economic crisis of 2020 will require a substantial realignment of the US economy – much like after 9/11, life will never be the same again. Companies that have been backed by cheap debt may find it difficult to restructure, even with cash on hand. Consolidation in many industries and layoffs will undoubtedly occur. State governments and municipalities – still strained by unprecedented pressures on the social safety net – will need to restructure their own debt, especially large states with high annual deficits and large tax burdens.

In addition, our increased distance learning capabilities deployed during this crisis will challenge the current model of higher education. Students, parents and universities will reconsider the value and necessity of expensive learning on campus.

For businesses healthier and fortunate enough to survive, the consequences of this crisis could finally give them the wake-up call they need to reassess their balance sheets and return to responsible and prudent borrowing practices.

Economic impacts aside, the sobering human costs of COVID-19 will linger in our collective psyche and, in turn, this experience will fundamentally change the way we do business. While it is not known how our lives will change and which companies will become obsolete, markets will continue to suffer if fear sets in.

The restructuring process – guided by the wisdom of bankruptcy judges in bankruptcy proceedings – will also help in this way: to minimize the impact of fear and give hope for a prosperous future. In these uncertain times, markets will have to rely on the restructuring process as we all adjust to our new economic reality.

John J. Rapisardi is a partner at O’Melveny & Myers LLP.

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