211 ANNUAL MEETING AND EDUCATION CONFERENCE American College of Investment Counsel New York, NY Weeping Woman - Pablo Picasso 1937 Restructuring Trends in a Recessionary Environment: Lessons Learned and Outlook Thursday, October 2, 211 11:3 a.m. 12:3 p.m. Michael J. Reilly Bingham McCutchen LLP (Moderator) Dewey Imhoff FTI Consulting, Inc. Thomas J. Pasuit MetLife David P. Simonds Akin Gump Strauss Hauer & Feld LLP
ACIC Conference New York, New York October 2-21, 211 Dewey Imhoff
Restructuring Trends in a Recessionary Environment: Lessons Learned and Outlook
Spec-Grade Default Rate Is a Lagging Economic Indicator The corporate spec-grade default rate is generally considered a lagging indicator of the economic cycle. For the last three recessions, the default rate continued to climb well after a recession technically ended and didn t begin to recede until economic growth had already resumed. U.S. Speculative-Grade Default Rate 1 14. 9 8 7 12. 1. 6 5 4 8. 6. in % 3 2 1 4. 2.. Jan-1 Jan-9 Jan-8 Jan-7 Jan-6 Jan-5 Jan-4 Jan-3 Jan-2 Jan-1 Jan- Jan-99 Jan-98 Jan-97 Jan-96 Jan-95 Jan-94 Jan-93 Jan-92 Jan-91 Jan-9 3
Corporate Defaults Are Still Falling Despite Recent Market Turmoil U.S. Corporate Defaults to Remain Relatively Low in the Short Term S&P Ratings Direct, Default, Transition, and Recovery, August 1, 211 (in %) 13. 12. 11. 1. 9. 8. 7. 6. 5. 4. 3. 2. 1.. U.S. Speculative-Grade Corporate Debt Default Rate Jan-1 Jan-9 Jan-8 Jan-7 Jan-6 Jan-5 Jan-4 Jan-3 Jan-2 Jan-1 Jan- Jan-99 Jan-98 Jan-97 Jan-96 Jan-95 Jan-94 Jan-93 Jan-92 Jan-91 Jan-9 Jan-89 Jan-88 Jan-87 Jan-86 Jan-85 Jan-84 Jan-83 Jan-82 Accommodating credit markets, improved corporate operating performance and a sharp decline in corporate debt defaults were the dominant stories impacting the restructuring & turnaround environment in the first-half of 211. The current U.S. spec-grade default rate of 2.1% is less than half its long-term average. S&P and Moody s project a U.S. speculative-grade default rate of 1.6% and 1.8%, respectively, by June 212. These forecasts translate into only 24 U.S. based defaults in the year ahead compared to 55 in 21 and 19 in 29. Corporate defaults are a lagging indicator of the business cycle often peaking months after a recession has ended and bottoming after an expansion has peaked. 4
Corporate Defaults Are Still Falling Despite Recent Market Turmoil # of defaulting issuers # of defaulting issuers 45 4 35 3 25 2 15 1 5 3 25 2 15 1 5 S&P Rated Monthly Corporate Debt Defaults Global U.S. only Aug Jul Jun May Apr Mar Feb Jan '11 Dec Nov Oct Sep Aug Jul Jun May Apr Mar Feb Jan '1 Dec Nov Oct Sep Aug Jul Jun May Apr Mar Feb Jan '9 Dec Nov Oct Sep Aug Jul Jun May Apr Mar Feb Jan '8 12-Month Moving Avg. of S&P Rated Defaults Global U.S. only There have been only 28 rated issuer defaults to date in 211 (19 were U.S. based) compared to 61 rated defaults through the same period in 21 (44 were U.S. based), according to S&P. To put this in perspective, there were 81 global corporate issuers that defaulted in all of 21 and 265 in 29, according to S&P. S&P s base case scenario forecasts only about 25 U.S. issuer defaults in the year ahead compared to 32 defaults in the twelve month period ended June 3. This baseline forecast assumes 2.5% real U.S. GDP growth in 211 and 212. However, this forecast was made in early July, before the U.S. debt ceiling debate, its subsequent credit rating downgrade by S&P, and the ensuing sell-off in global financial markets. S&P s pessimistic forecast, which envisions an economic scenario more similar to the one we are now experiencing,, would produce 62 U.S. based issuer defaults in the year ahead nearly double the current rate of defaults. Aug Jul Jun May Apr Mar Feb Jan '11 Dec Nov Oct Sep Aug Jul Jun May Apr Mar Feb Jan '1 Dec Nov Oct Sep Aug Jul Jun May Apr Mar Feb Jan '9 5
Corporate Defaults Are Still Falling Despite Recent Market Turmoil Base case forecasts for corporate defaults from both Moody s and S&P remain exceptionally low but Moody s pessimistic forecast is considerably worse than S&P s. 16% 14% 12% 1% 8% 6% 4% 2% % Source: Moody's Moody's U.S. Spec-Grade Default Rate and Forecast Historical Baseline Forecast Pessimistic Forecast (in percent) 14. 12. 1. 8. 6. 4. 2.. S&P's U.S. Spec-Grade Default Rate and Forecast U.S. Spec-Grade Default Rate Baseline Forecast Pessimistic Forecast Long-Term Avg. Jul-12 Jan-12 Jul-11 Jul-1 Jan-1 Jul-9 Jan-9 Jul-8 Jan-8 Jul-7 Jan-7 Jul-6 Jan-6 Jul-5 Jan-5 Jul-4 Jan-4 Jul-3 Jan-3 Jul-2 Jan-2 Jul-1 Jan-1 Jul- Jan- Jan-12 Jul-11 Jul-1 Jan-1 Jul-9 Jan-9 Jul-8 Jan-8 Jul-7 Jan-7 Jul-6 Jan-6 Jul-5 Jan-5 Jul-4 Jan-4 Jul-3 Jan-3 Jul-2 Jan-2 Jul-1 Jan-1 Jul- Jan- 6
Distressed Debt Ratio Has Turned Up Notably Since June S&P s distressed debt ratio (1) doubled in August to 13%--and is now close to its long-term average of 16%. About $87 billion of U.S. speculative-grade debt is currently considered distressed compared to only $36 billion in June. Historically, the distressed debt ratio has been a reliable leading indicator of future default activity generally moving about 8-1 months before a pronounced change in default activity. This ratio should tick up well in advance of an upswing in defaults. (in percent) 9 8 7 6 5 4 3 2 1 U.S. Distressed Debt Ratios Spec-Grade Bond Distress Ratio S&P / LSTA Leveraged Loan Distress Ratio Source: Standard & Poor's In billions of $ $4 $35 $3 $25 $2 $15 $1 $5 $ Debt amount (left scale) U.S. Distressed Debt Total distressed issuers (right scale) 6 55 5 45 4 35 3 25 2 15 1 5 # of Issuers Aug-11 May-11 Feb-11 Nov-1 Aug-1 May-1 Feb-1 Nov-9 Aug-9 May-9 Feb-9 Nov-8 Aug-8 May-8 Feb-8 Nov-7 Aug-7 May-7 Feb-7 Nov-6 Aug-6 May-6 Jul-11 Jul-1 Jan-1 Jul-9 Jan-9 Jul-8 Jan-8 Jul-7 Jan-7 Jul-6 Jan-6 Jul-5 Jan-5 Jul-4 Jan-4 Jul-3 Jan-3 Jul-2 Jan-2 Jul-1 Jan-1 Jul- Jan- (1) Note: S&P defines distressed debt as a bond with a yield spread over Treasuries in excess of 1 bps or a performing loan trading at less than 8 cents on the dollar. The distress ratio is the number of distressed issues relative to all speculative-grade issues. 7
Strong Correlation Between Distress Debt Ratio and Future Defaults There s a compelling historical relationship between S&P s distressed debt ratio and future default activity which is shown below (left) after adjusting for the time-lag.. The current distress ratio reading would suggest a default rate of approximately 4.5% by mid-212 a rate well above both rating agencies baseline forecasts. Distress Ratio (%) 9 8 7 6 5 4 3 2 1 Oct-91 Oct-9 Relationship Between Distress Ratio (T ) and Future Default Rates (T +1 ) Distress Ratio (T+) Default Ratio (T+1) Oct-9 Oct-8 Oct-7 Oct-6 Oct-5 Oct-4 Oct-3 Oct-2 Oct-1 Oct- Oct-99 Oct-98 Oct-97 Oct-96 Oct-95 Oct-94 Oct-93 Oct-92 14 12 1 8 6 4 2 Default Rate (%) y =.991x.595 Scatter Plot of Distress Ratio (T ) and R 2 =.7614 Future Default Rates (T 1 ) 16. Default Rate (T+ 1 Months) 14. 12. 1. 8. 6. 4. 2... 1. 2. 3. 4. 5. 6. 7. 8. 9. Distress Ratio (T ) 8
U.S. Corporate Credit Quality Is Considerably Worse Than Other Regions 7 6 Low Rated U.S. Spec-Grade Bond Issuance Issuer Ratings Distribution Rating U.S. Europe Asia Latin America Eastern Europe, Middle East, Africa Ratio of B- & below to total spec-grade issuance by issue count Ratio of B- & below to total spec-grade issuance by par amount Long-Term Average Global Nonfinancial issuers AAA 4.2% 3 6 14.4% AA 3 1.3% 23 32 1 89 2.3% A 249 11.2% 149 119 8 12 571 14.6% BBB 542 24.4% 21 139 65 32 1,53 26.9% BB 439 19.7% 96 73 91 61 81 2.5% B 87 39.1% 128 62 68 98 1,264 32.3% CCC and lower 91 4.1% 8 2 5 9 119 3.% Total 2,225 1.% 68 433 237 213 3,911 1.% Sources: Standard & Poor s Global Fixed Income Research and Standard & Poor s CreditPro. Nearly 63% of rated U.S. corporate debt is speculative-grade, with 43% rated B or worse. After shunning new deep junk (B- or worse) issues almost completely during the Great Recession, high-yield investors became welcoming again. About 35% of new spec-grade issuance in 1H11 was rated B-minus or worse and the trend is clearly upward. It can be argued that the aggressive capital structures and weakened financial profiles of so many U.S. corporate debt issuers today makes them more vulnerable to economic shocks, thereby shortening the time span between default cycles and perhaps intensifying them too. 5 (in %) 4 3 2 1 Jul-11 Jul-1 Jan-1 Jul-9 Jan-9 Jul-8 Jan-8 Jul-7 Jan-7 Jul-6 Jan-6 Jul-5 Jan-5 Jul-4 Jan-4 Jul-3 Jan-3 Jul-2 Jan-2 Jul-1 Jan-1 Jul- Jan- Jul-99 Jan-99 Jul-98 Jan-98 Jul-97 Jan-97 Jul-96 Jan-96 Jul-95 Jan-95 9
High-Yield Bond Market Hates a Recession As one would expect, high-yield issuance grinds to a halt in an economic downturn. New issuance levels don t generally pick up again until the cycle has passed. U.S. Speculative-Grade Bond Issuance 1 $4. 9 8 7 6 5 4 3 2 1 $35. $3. $25. $2. $15. $1. $5. monthly, in billions $. Jan-1 Jan-9 Jan-8 Jan-7 Jan-6 Jan-5 Jan-4 Jan-3 Jan-2 Jan-1 Jan- Jan-99 Jan-98 Jan-97 Jan-96 Jan-95 Jan-94 Jan-93 1
New High-Yield Bond Issuance Hits a Bump New U.S. high-yield bond issuance slowed sharply this summer after setting an all-time high of $16 billion in 1H11. Barely $1 billion of new high-yield issuance came to market in August.. in billions $25 $2 $15 $1 $5 U.S. High-Yield Bond Issuance (Cumulative Annual Totals) 211 21 29 28 27 26 25 $45 $4 $35 $3 $25 $2 $15 $1 $5 $ Source: Reuters LPC U.S. High-Yield Bond Issuance (Monthly issuance, in billions) $ Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan-8 Mar-8 May-8 Jul-8 Sep-8 Nov-8 Jan-9 Mar-9 May-9 Jul-9 Sep-9 Nov-9 Jan-1 Mar-1 May-1 Jul-1 Sep-1 Nov-1 Mar-11 May-11 Jul-11 11
Fear Is Here Again High Yield Bond Spreads Begin to Widen The average spread differential between investment grade and speculative-grade corporate bonds has widened by 15-2 basis points since April. For single-b and CCC rated bonds, yield spreads have widened by 25-3 basis points since late spring. 18 16 14 12 Investment grade U.S. Corporate Bond Spreads (in basis points) Speculative grade 35 3 25 U.S. Corporate Bond Spreads by Rating (Speculative-Grade, in basis points) BB B CCC 1 2 8 15 6 4 2 1 5 Jul-11 Apr-11 Oct-1 Jul-1 Apr-1 Jan-1 Oct-9 Jul-9 Apr-9 Jan-9 Oct-8 Jul-8 Apr-8 Jan-8 Oct-7 Jul-7 Apr-7 Jan-7 Oct-6 Jul-6 Apr-6 Jan-6 Oct-5 Jul-5 Apr-5 Jan-5 Oct-4 Jul-4 Apr-4 Jan-4 Jul-11 Apr-11 Oct-1 Jul-1 Apr-1 Jan-1 Oct-9 Jul-9 Apr-9 Jan-9 Oct-8 Jul-8 Apr-8 Jan-8 Oct-7 Jul-7 Apr-7 Jan-7 Oct-6 Jul-6 Apr-6 Jan-6 Oct-5 Jul-5 Apr-5 Jan-5 Oct-4 Jul-4 Apr-4 Jan-4 12
Fear Is Here Again August was the worst month in secondary trading markets for U.S. non-investment-grade corporate debt since the credit crisis of 28. Secondary market prices have stabilized so far this month. 15. 13. 11. 99. 97. North American HY Bond and Leveraged Loan CDS Indexes 95. 93. 91. 89. 87. Source: Capital IQ CDX North American High Yield Bond CDS Index Series 16 - Mid Price LCDX North America Leveraged Loan CDS Index Series 16 - Mid Price 85. Sep-9-211 Sep-1-211 Aug-25-211 Aug-18-211 Aug-11-211 Aug-4-211 Jul-28-211 Jul-21-211 Jul-14-211 Jul-7-211 Jun-29-211 Jun-22-211 Jun-15-211 Jun-8-211 Jun-1-211 May-24-211 May-17-211 May-1-211 May-3-211 Apr-26-211 Apr-18-211 Apr-11-211 Apr-4-211 13
Corporate Lending Starting to Loose Some Momentum Source: Reuters LPC U.S. Leveraged Lending Leveraged Lending Was Fairly Strong Through 2Q11 in billions $25 $2 $15 $1 Refinancing New Money Leveraged lending picked up considerably since late 21 as institutional lenders returned to the origination market. However, a relatively small percentage of this financing represents new money. $5 $ Source: Reuters LPC $16 2Q11 1Q11 4Q1 3Q1 2Q1 1Q1 4Q9 3Q9 2Q9 1Q9 4Q8 3Q8 2Q8 1Q8 4Q7 3Q7 2Q7 1Q7 4Q6 3Q6 2Q6 1Q6 4Q5 3Q5 2Q5 1Q5 4Q4 3Q4 2Q4 1Q4 4Q3 3Q3 2Q3 1Q3 U.S. Leveraged Lending (Institutional Issuance only) $14 $12 $1 Refinancing New Money in billions $8 $6 $4 $2 $ 2Q11 1Q11 4Q1 3Q1 2Q1 1Q1 4Q9 3Q9 2Q9 1Q9 4Q8 3Q8 2Q8 1Q8 4Q7 3Q7 2Q7 1Q7 4Q6 3Q6 2Q6 1Q6 4Q5 3Q5 2Q5 1Q5 4Q4 3Q4 2Q4 1Q4 4Q3 3Q3 2Q3 1Q3 14
Corporate Lending Starting to Loose Some Momentum Sponsored Lending Soars Through Mid-Year Not So Much For New Deals Loans to PE sponsors soared in 1H11 but only $28 billion of some $21 billion in loans was intended to finance new transactions. Overall lending for M&A purposes (sponsors or strategic buyers) was up modestly and deal volumes remain well below pre-crisis levels. 3Q11 data on sponsored lending and M&A transactions will undoubtedly indicate a sharp slow down in activity. Source: Reuters LPC (in billions) $12 $1 $8 $6 $4 $2 $ U.S. Loans to PE Sponsors Non-LBO LBO 2Q11 1Q11 4Q1 3Q1 2Q1 1Q1 4Q9 3Q9 2Q9 1Q9 4Q8 3Q8 2Q8 1Q8 4Q7 3Q7 2Q7 1Q7 4Q6 3Q6 2Q6 1Q6 4Q5 3Q5 2Q5 1Q5 Source: Reuters LPC in billions $16 $14 $12 $1 $8 $6 $4 $2 $ M&A Lending Volume Americas 2Q11 1Q11 4Q1 3Q1 2Q1 1Q1 4Q9 3Q9 2Q9 1Q9 4Q8 3Q8 2Q8 1Q8 4Q7 3Q7 2Q7 1Q7 4Q6 3Q6 2Q6 1Q6 4Q5 3Q5 2Q5 1Q5 15
Large Corporate Bankruptcies Are Down Only Slightly in 211 In contrast to sharply lower incidents of rated corporate debt defaults in 211, public company bankruptcy filings are on pace for only a fractional decline this year a reminder that this economy is still a challenging business environment for many companies. (Many large companies don t have rated debt.) Public Company Bankruptcy Filings 3 25 Source: BankruptcyData.com 2 15 1 5 1984 1985 1986 1987 1988 1989 199 1991 1992 1993 1994 1995 1996 1997 1998 1999 2 21 22 23 24 25 26 27 28 29 21 211 ann. 16
Moody s Default Rate Forecast by Industry Sector Industry Europe U.S. Industry Europe U.S. Media: Advertising, Printing & Publishing** 7.4% 2.% Wholesale*.2% 3.5% Services: Business 3.5% 1.7% High Tech Industries**.2% 1.1% Telecommunications 1.8% 1.2% Healthcare & Pharmaceuticals.2% 1.1% Containers, Packaging, & Glass** 1.5% 2.7% Metals & Mining.2%.6% Transportation: Consumer**.9% 2.1% Environmental Industries*.2%.4% Retail.9% 1.5% Energy: Electricity*.1% 1.8% Beverage, Food, & Tobacco.7%.9% Media: Diversified & Production*.1%.9% Hotel, Gaming, & Leisure**.6% 3.% Capital Equipment.1%.8% Media: Broadcasting & Subscription.6%.9% Consumer goods: non-durable*.1%.5% Energy: Oil & Gas.5% 1.1% FIRE: Insurance.1%.2% Construction & Building.4% 1.2% Services: Consumer.% 2.4% Automotive.4%.9% Aerospace & Defense*.%.9% Banking.4%.2% FIRE: Real Estate*.%.3% Transportation: Cargo**.3% 3.% Utilities: Electric.%.% Forest Products & Paper**.3% 1.1% Utilities: Oil & Gas**.%.% Consumer goods: durable*.3%.8% Utilities: Water**.%.% FIRE: Finance.3%.5% Sovereign & Public Finance.%.% Chemicals, Plastics, & Rubber.3%.5% * Fewer than 2 issuers for Europe. ** Fewere than 1 issuers for Europe. Source: Moody's One-year default rate forecasts by industry 17
Distressed Debt Ratio Has Turned Up Notably Since June The Media & Entertainment sector accounts for over one-quarter of all U.S. distressed debt. Distribution of S&P's Distress Ratio By Industry Sector Industry Sector (# of distressed issues in parentheses) Industry Sector Distress Ratio (in %) % of All Distressed Debt Total Sector Distressed Debt (mil. $) $-based Distress Ratio (%) Insurance (5) 38.5 2.5 $1,345. 31.4 Transportation (11) 3.6 5.4 $2,762. 18.8 High technology (21) 25.9 1.3 $12,837. 29.9 Media and entertainment (54) 22.7 26.5 $23,428. 23.5 Forest products and building materials (12) 21.8 5.9 $5,555. 27.5 Retail/restaurants (21) 21.6 1.3 $6,325. 17. Aerospace and defense (6) 21.4 2.9 $1,615. 16.9 Chemicals, packaging, and environmental services (9) 1.2 4.4 $2,195. 6.3 Consumer products (9) 9.9 4.4 $2,558. 7.8 Oil and gas (17) 9.8 8.3 $7,929 1.7 Financial institutions (9) 9.3 4.4 $6,44. 9.3 Health care (1) 8.1 4.9 $3,16. 4.5 Capital goods (4) 7.8 2. $785. 4.3 Utility (7) 6.1 3.4 $5,447. 8.8 Telecommunications (6) 4.8 2.9 $4,17. 4.7 Banks and brokers (1) 4.3.5 $2. 2.5 Metals, mining, and steel (2) 3.9 1. $825.. Total (24) 13.2 - $87,431. 11.9 *Standard & Poor's distress ratio defined as the number of speculative-grade issues with option-adjusted spreads above 1, basis points to the total number of speculative-grade issues. Distribution of distressed credits defined as the distribution, by sector, within all speculative-grade issues with option-adjusted spreads above 1, basis points. Outstanding debt amount associated with distressed issues divided by the total debt outstanding of speculative-grade issues. Number of distressed issues in parentheses. Data as of Aug. 15, 211. Source: Standard & Poor s Global Fixed Income Research. 18