Bankruptcy and Restructuring - Year in review and 2019 outlook January 2019
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Bankruptcy and Restructuring Year in review and 2019 outlook January 2019
Overview
December 2018 marked the 115th month of the current economic cycle in the US, the
second-longest expansion since the Great Depression and yet also the slowest pace
of growth during that time. GDP has grown at an annualized rate of only 2.2% since 2009.
As we approach the record of 120 months set by the 1990-1999 economic expansion,
more and more people are asking “When will the music stop?”
As predicted, the answer wasn’t 2018. The US economy In terms of restructuring activity, we anticipate 2019 to
over the past 12 months was characterized by stable and remain subdued, consistent with the levels in recent years.
steady growth buoyed by tax cuts and historically low, al- But as we look beyond the next 12 months, we are mindful
beit rising, interest rates. In contrast, financial markets were of where we sit relative to the length of historical economic
anything but stable and steady in 2018, and most major cycles and expect that our outlook 12 months from now
asset classes finished the year in correction territory. could be very different. When the economy does slow, we
expect sectors that are already navigating challenges from
Now, as we look to 2019, we don’t see signs of fundamen-
technological disruption, competition and commodity price
tal macroeconomic changes that alter our thinking. That
volatility will experience the most restructuring activity.
said, weakening fundamentals don’t always precede a
Retail, healthcare, automotive suppliers and oil and gas are
recession. Whether it’s an asset pricing bubble, mortgage
the sectors at the top of our watchlist.
crisis or simply the cumulative effect of deteriorating con-
sumer sentiment, recession triggers are rarely obvious to In our outlook, we also consider what may be different
those looking forward. about the next cycle of restructuring activity compared to
previous cycles. Notably, leveraged credit markets have ex-
If forced to predict the next recession catalyst, one could
perienced significant growth over the past 10 years, driven
select from a number of potential candidates, including
in large part by the emergence of non-bank direct lending
global trade tensions, fallout from the Brexit saga, com-
firms. The magnitude of capital chasing deals in this sector
modity price volatility, rising inflation and constricting credit
has created a borrower-friendly environment which has led
markets. The list goes on and on.
to fewer financial covenants and lender protections. This
could change the restructuring dynamic of these loans in
the next cycle and lead to lower recoveries for investors.
US Expansionary Economic Cycles
20%
15%
10%
5%
0%
120 months 115 Months
-5% Longest Current
Expansionary Expansion
Period Period
-10%
1950–1959 1960–1969 1970–1979 1980–1989 1990–1999 2000–2009 2010–2018
Annualized GDP Growth Period of Recession
Source: Bureau of Economic Analysis, PwC Analysis
2 | Restructuring: Year in review and 2019 outlook
2018 in review
Over the last 12 months, we continued to see the larg-
est bankruptcies concentrated in the retail sector, which
accounted for five of the 10 largest Chapter 11 filings. More
iconic retail brands succumbed to the disruptive forces
reshaping the industry. Last year, it was Toys R Us. This
year, it’s Sears. As we look to 2019, we expect more large
national retail brands will be seeking Chapter 11 protection,
and some not for the first time.
Media claimed the second spot for restructuring activity in
2018 in terms of aggregate liabilities, although that is nearly
entirely attributable to the largest Chapter 11 reorganization
of the year, iHeartMedia.
As predicted, the energy and healthcare sectors were also Top 10 Chapter 11 Filings1
among the most active in restructurings in 2018, claiming
Deal Sector Liabilities
the third and fourth spots in terms of Chapter 11 filings
during the year. The challenges facing these sectors show iHeartMedia Inc. Media 20,329
no signs of abating as we enter 2019, which makes us think Sears Holdings Corp. Retail/Consumer 11,339
they may also be near the top of next year’s list.
HCR ManorCare Inc. Healthcare 7,118
By the numbers, the level of restructuring activity in 2018 FirstEnergy Solutions Corp. Energy 3,093
was one of the lowest we’ve seen in the past 10 years.
Chapter 11 filings decreased by 6% to 166, while the liabili- Southeastern Grocers LLC Retail/Consumer 2,625
ties addressed by those filings decreased by 22%. American Tire Distributors Inc. Automotive 2,506
Claire’s Stores Inc. Retail/Consumer 2,414
2018 Notable Sectors Nine West Holdings Inc. Retail/Consumer 1,937
Bon-Ton Stores Inc. Retail/Consumer 1,743
21% Retail / Consumer
27%
Media
Westmoreland Coal Co. Energy 1,432
Energy
13% Total Top 10 54,535
Healthcare
All Other
15%
25%
All Other 36,798
Total 91,333
Source: The Deal, PwC Analysis
Source: The Deal, PwC Analysis
Annual Chapter 11 Filings1
718
700 633 700
600 600
500 500
400 419 400
300 300
277 266
200 226 200
202 175
179 166 176
141 166
100 116 137 100
103 92 116 91
85 89
53
0 0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
No. of Fillings Aggregate Liabilities ($B)
Source: The Deal, PwC Analysis
1 Includes Ch. 11 filings with $25m or greater of liabilities
Restructuring: Year in review and 2019 outlook | 3
Macroeconomic
indicators
In forming our 2019 outlook, we first turn attention to the trending
of key macroeconomic fundamentals:
2018 Federal Funds Rate
Interest rates 3.00% 3.00
Interest rates increased throughout 2018 in response to
four rate increases by the Federal Reserve Board. Mar- 2.75%
2.75 2.75 2.75
kets watched carefully as the US yield curve flattened and
2.50%
approached inversion between the 2- and 10-year notes. 2.50 2.50 2.50
Each of the seven previous US recessions was preceded by 2.25% 2.25 2.25 2.25
an inversion of the US treasury yield curve, and the 2- and
5-year note yields have already inverted. Recent comments 2.00%
2.00 2.00
from Fed Chairman Jerome Powell that interest rates were
1.75%
nearing “neutral for the economy” have signaled a more
conservative posture towards future rate movements. At its 1.50%
Jan Feb March April May Jun Jul Aug Sep Oct Nov Dec
December meeting, the board projected “further gradual
increases” for 2019. Source: S&P Capital IQ
Unemployment Unemployment Rate
In 2018, the jobless rate continued its trend of consistent
11.5%
declines, down from the 10% reached in October 2009 after 10.8
the great recession. At the end of 2018, unemployment 10.0% 10.0
dropped to 3.7%, its lowest point in nearly 50 years, before
8.5%
increasing to 3.9% to end the year. For context, the last
time unemployment reached the levels seen in Q4 2018, 7.0%
it was the year Neil Armstrong walked on the moon. In re-
sponse to the tight labor market, wages increased steadily 5.5%
during the year but remain more or less flat when adjusted 4.0%
3.9 3.7
for inflation. 3.5
2.5%
Inflation 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013 2017
Inflation in the US has increased in each of the past four Source: US Bureau of Labor Statistics
years. In 2017, we saw the rate reach 2.1%, topping the
Fed target of 2% for the first time since March 2012. With Consumer Price Index
inflation reaching 2.9% in 2018, the Fed is balancing an
5.50 %
economic tightrope with a worsening global economic en-
vironment on the one side and its goal of keeping inflation 4.50 %
low on the other. 3.50 %
2.50 %
1.50 %
0.50 %
-0.50 %
-1.50 %
-2.50 %
2000 2004 2006 2008 2010 2012 2014 2016 2018
Source: S&P Capital IQ, IHS Economics
4 | Restructuring: Year in review and 2019 outlook
Leveraged credit
markets overview
The type of participants, scale and structure of the debt capital markets have changed dra-
matically since the last recession. In 2007, before the financial crisis, total leveraged credit
outstanding was $1.3 trillion, roughly half the $2.6 trillion outstanding at the end of 2018.
In the post-financial crisis era the focus on capital require- Leveraged Credit Market ($B)
2,631
ments and restrictions born out of Dodd Frank, Basel III and
the Volcker rule have made it more difficult for regulated Total Leveraged
banks to deploy capital in the leveraged debt markets. Credit Outstanding
These increased bank regulations have caused the lending 1,480
arms of traditional banks to pull back from the leveraged 1,266
lending market.
At the same time, central banks have pursued expansionary 709
907
monetary policies that have flooded global markets with an 84 709
unprecedented level of cheap capital, keeping interest rates 473
244
and yields at historically low levels. Private investment firms 2007 2018
seeking to deploy large amounts of capital in a low interest
Other Leveraged Loan Cov-Lite Loans High Yield Bonds
rate environment were drawn to the private credit markets,
where they weren’t burdened by the same regulations as Source: S&P LCD, PwC Analysis
commercial banks. As a result, private credit fundraising
nearly quadrupled from 2009 to 2017, and the number of
new funds more than doubled.
Global Private Credit Fundraising
This inflow of capital and competition among lenders for 136
170
higher-yield investments has led to an increasingly borrow- 159
149
163
er-friendly environment. As the primary capital provider of 67 96
114 100 97 107
84
leveraged loans shifted from traditional banks to non-bank 63 72 74
41 44
lenders, other structural changes also took hold. Notably, 24
2009 2010 2011 2012 2013 2014 2015 2016 2017
the notional amount of covenant light (or “Cov-lite”) loans
Capital Raised ($B) No. of Funds Closed
outstanding increased tenfold from 2007 to 2018.
Source: Pitchbook
Cov-lite loans are characterized by little to no financial
maintenance covenants. In contrast to the public bond
market, loans in this market are less standardized and
aren’t subject to the same level of broader market scrutiny. Cov-Lite as a Percent of Total Leveraged Loans
As a result, there’s more subjectivity and less transparency 74%
79%
into financial adjustments and add backs that borrowers 61% 63%
55%
are permitted to make in their periodic financial reporting
41%
to lenders. 30%
24%
17% 17% 17%
What implications do these changes have on restructurings 15%
in the next credit cycle? We expect that fewer maintenance 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 *
covenants in the loan market will combine with reduced Source: S&P LCD, PwC Analysis
*as of October 2018
transparency into the financial condition of borrowers to
result in companies restructuring later in the stages of dis-
tress. When restructurings are delayed, companies typically
have fewer strategic options and less financial flexibility
to effectuate a successful turnaround plan, which usually
results in lower recoveries for investors and other stake-
holders.
Restructuring: Year in review and 2019 outlook | 5
Sector outlook for 2019
Retail Senior living operators are also navigating a challenging
Facing perpetual digital disruption and competitive pres- market environment. Demographic trends are favorable for
sures, the retail sector once again remains at the top of our the sector, but population aging, particularly in the key 75
2019 watchlist for restructuring activity. Despite a strong US and older demographic, hasn’t kept pace with the increase
economy and near-record levels of consumer sentient and in new unit construction over the past five years, resulting in
employment, retailers continue to adapt to market pres- a supply-and-demand imbalance that is pressuring occu-
sures with varying degrees of success. pancy and rates. So far, with the exception of HCR Manor-
care, Inc., some of largest operators have been able to nav-
Throughout 2018, the retail sub-sectors of apparel and igate these challenges through out-of-court restructurings
big-box stores continued to use the bankruptcy process in that center on renegotiating MSAs with REIT landlords.
hopes of rationalizing their physical store footprint and re-
ducing unsustainable debt levels. We expect these themes Automotive
will roll into 2019, resulting in another turbulent year for The auto industry is navigating a number of structural
these retailers. headwinds that are expected to reshape the sector in years
to come, including expected production declines from
While it’s expected that consumers will have spent ap-
ride-sharing and autonomous vehicles, trade tariff impacts
proximately 5% more this past holiday season than in
to supply chains, changing consumer preferences, a shift to
2017, retailers can’t rely on continuing strong discretion-
electric vehicles and other technological advances. Coming
ary spending levels and must focus on streamlining their
off a record 17.5 million units produced in 2016, US vehicle
costs and operations in anticipation of future periods of
production volume has decreased modestly. This modest
uncertainty and change. The implications of trade tensions
decrease coupled with trade tariffs has started to trigger
with China, interest rate increases and any slowdown in
some stress in the automotive supplier base where the
economic growth could accelerate future restructurings of
disruption is likely to hit first.
underperforming retailers and eventually trigger distress
amongst otherwise well-performing retailers. In the midst of these challenges, there’s also a shift in US
consumer preferences toward space and utility over fuel
Healthcare economy. While sedans still represent the majority of sales,
Companies, particularly providers, are caught in a multi- crossover utility vehicles aren’t far behind and likely will be
front war, battling structural changes stemming from the number one soon. For this reason, Ford intends to stop sell-
Affordable Care Act, competition from new entrants and ing most of its sedans in North America in the near future,
ongoing regulatory uncertainty. and General Motors is discontinuing the production of six
We expect to continue seeing pockets of distress in health sedans.
services sub-sectors as reimbursement and care transition Finally, there is a longer-term technological shift on the
to value-based models from traditional fee for service. As horizon with the move toward electric and autonomous
these forces play out and the site and type of care chang- vehicles. This disruption, much like Amazon’s impact on
es, we expect to see more winners and losers, as some retailers, will have a profound impact on automakers and
companies are unable to keep pace with the changing their suppliers. As production growth slows, some suppliers
landscape. We also expect more deal activity in the sector, that are heavily leveraged will struggle to make investments
as operators attempt to exit sub-scale markets and refocus and adapt to changing technologies and platforms. This
on regional and super-regional areas of strength. combination of events could spell financial troubles for U.S.
suppliers, particularly those slow to adapt.
6 | Restructuring: Year in review and 2019 outlook
Coal Should this trend continue and we see more franchisees
Continued movement away from coal to cheaper, alterna- seeking bankruptcy, it could have detrimental impacts to
tive fuels is expected to drive distress in the coal sector in the future of these large national brands.
2019 and beyond. The shale boom created a glut of cheap
Oil and gas
natural gas in America, and the costs to deploy wind and
WTI crude prices increased steadily in the first three quar-
solar energy continue to plunge dramatically.
ters of 2018 but fell by more than 30% in the fourth quarter,
In 2018, 14 gigawatts of coal-fired power generating ca- as oversupply concerns arose, driven by the acceleration of
pacity were expected to be retired by year end, according production in West Texas and OPEC nations.
to the US Energy Information Administration (EIA), the sec-
OPEC and Russia jointly agreed to production cuts to begin
ond-highest year ever for coal plant retirements, and anoth-
2019, but production growth in the Permian and Eagle
er 23.1 gigawatts of retirements is scheduled for 2019-2024,
Ford Basins continues to outpace implemented cuts and
according to S&P Global Market Intelligence. As a result,
operational declines elsewhere. This production growth has
US coal consumption in 2018 is projected to decline to its
outstripped available pipeline capacity, increasing pricing
lowest level since 1979, according to the EIA, a staggering
differentials and necessitating the use of less efficient
44% below peak 2007 levels.
transportation methods to get the oil to market. Additional
As a result of these dynamics, coal mining and coal-reliant pipeline capacity in the Permian is expected to come online
power companies will continue to see degradation in their near the end of 2019 and early 2020, which will narrow
businesses. The fallout from declining demand and plant spreads for Permian producers but create pricing pressures
closures isn’t limited to topline reduction. These business in other basins. These forces are expected to continue
typically have to address substantial employee, environ- driving price volatility into 2019.
mental cleanup and remediation liabilities associated with
Drilling activity in the US will continue to be highly correlat-
legacy coal operations that can require meaningful cash
ed with oil prices but is likely to remain primarily focused
outlays. We expect these forces to drive restructurings as
in the Permian and Eagle Ford Basins. Offshore activity is
businesses exit or diversify from these operations.
anticipated to be soft over the near term, resulting in contin-
Restaurants and food service ued pressure on offshore service providers and increasing
Following market shifts to a more “dine out” environment, the likelihood of additional bankruptcies in this sector. Fur-
the restaurant segment has become increasingly saturated, thermore, gas-heavy producers will remain susceptible to
with the aggressive expansion of chain brands and the rise liquidity and cash flow challenges as the supply of natural
of new entrants, particularly in the quick-service restaurant gas exceeds domestic demand, despite construction of
(QSR) and fast-casual space. This heightened competition new and converted gas-fired power plants, keeping natural
has resulted in a significant number of recent restructurings gas prices depressed.
for casual dining brands, including Bertucci’s, Papa Gino’s
Pharmaceuticals and life sciences
and Taco Bueno.
The theme of specialization in pharmaceuticals and life
Regional QSR and casual-dining chains saw some of sciences is likely to continue into 2019, driving continued
the largest declines in sales and stock prices in 2018. industry consolidation and deal activity. There is investor
We expect that fewer maintenance covenants in the loan interest in this sector from financial and strategic buyers
market and reduced transparency into the financial condi- alike, but some sub-sectors remain challenged.
tion of borrowers will likely result in companies restructur-
Specialty drug manufacturers are likely to face growing in-
ing later in the stages of distress. When restructurings are
dustry headwinds more than other sub-sectors, as generic
delayed, companies typically have fewer strategic options
and biosimilar Food and Drug Administration approvals
and less financial flexibility to effectuate a successful
continue to increase. Companies in this sector that were
turnaround plan.
financed through early stage IPOs are at an even higher
While national QSR and casual-dining brands remained risk of failure. Early-stage business plans can hinge on
relatively stable due to their strong brand association FDA approvals or other milestones that can cause drastic
and de-risked franchise model, there have been signs of swings in enterprise value. Ultimately, if business plans
disputes and distress in franchisees, which saw Applebees’ aren’t achieved, the public equity is at risk of being delisted,
second-largest franchisee filing for bankruptcy in 2018. which can trigger defaults under debt agreements.
Restructuring: Year in review and 2019 outlook | 7
Contact information
Steven J. Fleming
US Business Recovery Services Leader
Principal, PwC Deals
+1 917 929 6199
steven.fleming@pwc.com
David T. Tyburski
Author
Director, PwC Deals
+1 347 405 4430
david.t.tyburski@pwc.com
Rajeeb Das
Managing Director, PwC Deals
+1 281 804 6165
rajeeb.das@pwc.com
Brian Koluch
Managing Director, PwC Deals
+1 917 848 0771
brian.koluch@pwc.com
Rob Swartz
Managing Director, PwC Deals
+1 617 530 7949
rob.swartz@pwc.com
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