On the minds of lawyers

Meet our panel

Howard Steel
Partner, Goodwin’s Financial Restructuring Group

Matthew Czyzyk
Business restructuring partner, Ropes & Gray

David Meyer
Partner, Vinson & Elkins’ Restructuring and Re-organisation Group

What is your sense of the state of the distressed debt market? Are there any issues particularly filling up your inbox?

Howard Steel: In today’s distressed debt market, it’s critical to be prepared for volatility. The financial impacts resulting from the pandemic and the war in Ukraine, supply chain disruptions, changes in interest rates and inflation, and ESG-conscious LPs all create both opportunities and risks.

My inbox is filled with intercreditor issues and clients planning for loan extensions, modifications, workouts and restructurings.

Matthew Czyzyk: The distressed debt market has been quiet over the last 12 to 18 months, with historically low rates of defaults and insolvencies: a result of covid-linked government support measures, temporary legislation, huge amounts of liquidity in the market, and loose debt terms.

However, most market participants expect more distressed situations to emerge in the months ahead, as macroeconomic trends and events such as rising input costs, a cost-of-living crisis and the ongoing conflict in Ukraine, start to impact businesses.

For now, our clients remain focused on sourcing opportunities, and that remains a challenge in a subdued distressed market. For many distressed investors, navigating the fast-evolving sanctions regime is also front of mind, whether with respect to existing or to potential investments.

David Meyer: Companies have successfully leveraged the financing and capital markets of the last 12-plus months to navigate many potential near-term covenant and maturity issues that otherwise would have existed. That has limited the number of distressed debt opportunities, increased competition and caused funds to look for other ways to deploy capital.

How have world events, such as covid and the war in Ukraine, affected distressed debt activity?

HS: There is an increased emphasis on understanding the regulatory climate and changes, like evolving sanctions and restrictions. The potential for developments to trigger a cascading series of challenges continues to present risk in the market.

MC: When the pandemic commenced in early 2020, there was a short window of opportunity in the secondary market to purchase debt in good businesses at an attractive discount. Over the following months, much of that debt recovered in price, so investors who identified the relevant opportunities and were able to move quickly, booked strong returns with so-called ‘pull to par’ trades. As we moved through the latter half of 2020 and through 2021, those secondary opportunities were more limited. Many businesses had stabilised, having reached agreements with their lenders on amendments or waivers, benefiting from government support measures, or raising further liquidity with either incumbent or new lenders in a hot primary market.

The recent conflict has created a ripple of distressed debt activity, but we aren’t seeing many investors looking at businesses active in Ukraine or Russia. However, a much broader range of businesses are starting to feel the squeeze as the result of macroeconomic developments, whether that’s increased energy prices, sensitivity to the price or availability of raw materials or products that are commonly sourced in Russia or Ukraine, broader inflationary pressures on input costs, or shifting consumer sentiment as the cost of living rises sharply across the globe. The full impact of those developments on certain businesses may not yet be apparent.

DM: The impact of the war in Ukraine is still evolving. We have seen some tightening in the credit markets compared to the prior 12-plus months. Again, many companies have already addressed potential covenant, liquidity, or maturity issues and there is unlikely to be a significant near-term impact on companies or distressed debt. The war coupled with supply chain issues and inflation could create more turbulence in the second half of the year.

Which sectors and geographies have the most issues?

HS: We have been seeing increased activity in consumer products, senior living, agriculture, automotive and hospitality and leisure. Large global teams are targeting situations in many developed and emerging markets, with an increasing abundance of opportunities in China.

MC: With respect to geographies, it is hard to be specific. European-focused businesses are most heavily impacted by the recent conflict, but covid has had a global impact, and it seems that most of the world is experiencing inflationary pressures. With respect to sectors, almost all have been impacted by world events in some way. Hospitality, retail and travel-related businesses have all struggled over the last two years, as many consumers, particularly in the developed world, have stayed at home. Today, many distressed investors are focused on sectors and businesses particularly vulnerable to global economic headwinds, whether that’s rising interest rates, inflation, energy prices or raw material prices.

What regulations/frameworks are you keeping an eye on?

HS: We’re closely following sanctions and restrictions relating to the war in Ukraine. We’re also increasing our focus on clients investing in distressed debt to acquire ownership or influence management, as well as intercreditor disputes.

MC: Recent years have seen EU member states take steps to reform their restructuring legislation in order to implement the 2019 European directive on preventative restructuring frameworks. Most notably, the Netherlands and Germany each introduced new restructuring processes at the start of 2021. A quiet distressed market has meant that these tools have not been extensively tested, meaning that a shift of some restructuring work away from the UK and its tried-and-tested restructuring toolkit, as predicted by some commentators, has yet to materialise.

The Part 26A restructuring plan, introduced in the UK in 2021, has been put to good use in a number of high-profile cases, and we expect to see that trend continue, and the UK remain the pre-eminent jurisdiction for European restructurings. We also continue to keep a close eye on new sanctions legislation which has been rapidly introduced by governments across the world, and we are spending a lot of time assisting our clients in interpreting these new frameworks.

What sort of special situations are top of mind?

HS: Ever-compressed restructuring timelines, management turnover, opportunistic real estate investment, and the private credit boom are all top of mind for Goodwin and our clients in the distressed debt space.

MC: With limited distressed opportunities in the market, special situations investors are looking to provide a broad range of capital solutions. These include sub-par refinancing transactions, junior instruments, preferred equity and convertibles, growth and fintech-based investments, distressed M&A, real estate financing and acquisitions, recurred revenue financings, asset-backed lending solutions, and looking to monetise new or bespoke asset classes – to name just a few.

Are there any challenges for distressed debt going forward?

HS: Macro uncertainty continues to present challenges for the market. For some time, central banks have all but eliminated distress, putting the distressed debt market on the side lines, but we’re currently in a bouncing back period with increased opportunities across capital structures to deploy capital into creative and supportive solutions.

MC: In a quiet distressed market, perhaps the main challenge for distressed debt investors is finding opportunities that will allow them to deliver their target returns. Many clients are focused on sourcing non-liquid or private opportunities, and we work with fellow advisers to help identify relevant situations.

However, there is an expectation that levels of distress will increase in the months ahead, so it is important for investors to be well prepared to identify and execute those opportunities in short order, as and when they arise. Working with the right advisers and staying up to speed on issues such as sanctions and new restructuring frameworks will be critical to a successful distressed strategy.

DM: We have seen an increase in direct lending as well as shareholder activist positions as a result. In addition, we are seeing a return to some of the creditor-on-creditor tactics (ie, Wesco, TriMark, Boardriders) and likely will see an uptick in litigation between participating and non-participating investors as investors compete for a more limited number of near-term opportunities.