Bankruptcy and restructuring year in review and 2020 outlook

Overview of 2019 restructuring activity

Restructuring activity in 2019 remained subdued, as it has for the past 10 years following the fallout from the Great Recession. Activity was concentrated in a few active sectors, including energy and energy services, communications, pharma and life sciences (PLS), and retail. Last year was also characterized by many large and high-profile Chapter 11 filings. In fact, the eight largest companies that filed for Chapter 11 accounted for nearly $93 billion of aggregate liabilities, more than all of the companies in 2018 combined.

The restructuring activity in 2019 reflects a resilient economic environment that has fostered the longest US expansion in history. Our outlook for 2020 and beyond, however, is at best uncertain. A potential economic slowdown, lingering trade tensions and growing unrest in the Middle East all threaten to hinder growth, with a downturn possible. The slight uptick in Chapter 11 filings over the course of 2019 may be a sign of what’s coming in 2020 and 2021.

In our outlook we predict the five sectors that could see the most restructuring activity this year. We also discuss how the magnitude of capital available to opportunistic investors could reshape the next downturn and what the increase in lower-rated investment-grade debt could mean for lower-tier high-yield bond borrowers.


Energy

Lack of capital market access will continue to constrain upstream producers and ultimately hit service providers hardest, and increasing risk of conflict in the Middle East may drive higher volatility.

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Retail

Senior lenders are increasingly seeing liquidations as the lower-risk alternative to lengthy restructuring plans. That is forcing companies to develop fast-tracked turnarounds to have a chance at remaining a going concern.

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Specialty pharma

PLS is expected to remain challenged as specialty startups strive for scale in a competitive market. The continued fallout from the opioid crisis will likely force additional restructurings in that segment.

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Auto suppliers

Decreasing production volume coupled with the considerable investments needed to keep pace with the technological shift towards electric and autonomous vehicles continue to strain OEMs and their suppliers.

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Dining and food service

Statutory increases in hourly labor costs, increasing commodity prices, high rent costs and rapid growth of costly third-party delivery continue to challenge the industry and could drive increased financial distress.

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2019 in review

Overview

Restructuring activity in 2019 was notable for the size of companies that filed rather than the volume of activity. The number of filings increased by only 2.4%, while the aggregate liabilities addressed in those filings increased by 55.9%.

Pacific Gas and Electric (PG&E) was by far the largest contributor to that increase with more than $55 billion of liabilities. But even after adjusting for PG&E, liabilities still rose 36% year over year.

Largest restructurings of 2019

The top 10 Chapter 11 filings accounted for two-thirds of restructured liabilities during 2019, and more than half of the $97.6 billion in liabilities addressed in the top 10 are attributable to PG&E.

The PG&E bankruptcy is a landmark restructuring in terms of subject matter, size and complexity, and it will take years to fully resolve.

Despite having the third-most Chapter 11 filings in terms of numbers, retail occupied only one spot in the top 10.  For several retailers that filed in 2019, it wasn’t their first trip through Chapter 11, and we expect that trend to continue.

Sector insights

There were three clear standout sectors in 2019:

  • Energy and utilities again topped the list of distressed activity, with more Chapter 11 filings than any other sector.
  • Recent healthcare restructurings are increasingly concentrated in the PLS sector and accounted for roughly half of the healthcare filings.
  • Retail was notably underrepresented from the largest filings, with only one spot in the top 10 versus 2018, when five of the 10 largest filings were retailers.

Please note: The Chapter 11 calculations and analysis only include Chapter 11 bankruptcy filings with $25m or greater of liabilities.

Outlook for 2020

Availability of capital

US corporations, private equity firms and non-bank direct lending institutions have trillions of dollars of capital available and ready to deploy. Companies and investors who have the risk appetite to be opportunistic even when there is uncertainty will be well-positioned to take advantage of the market dislocations that accompany a slower economy. Direct lending firms are setting up distressed strategies to target the anticipated growth in stressed and distressed borrowers. We expect this sector in particular to play a meaningful role in the next downturn.

Downgrade potential

One potential factor in a downturn is the increase in BBB-rated debt. Over the past decade, BBB-rated debt has ballooned to more than $3 trillion, accounting for roughly 40% of corporate debt securities.

In past recessions, an estimated 7% to 15% of investment-grade credits have been downgraded to high-yield or “junk” status. In today’s market, that could mean $550 billion to $1 trillion of investment-grade securities downgraded to junk status in the next downturn.

The newly downgraded companies can likely expect higher costs of borrowing, but it's the existing high-yield issuers that should be most concerned. The influx of new (previously investment-grade) issuers could squeeze out lower-rated borrowers or perhaps drive rates beyond what these marginal credits can bear. If the next cycle follows previous cycles, then the effects of this dynamic could be felt for up to three years following the next downturn.

Sector outlook

Retail

The retail industry remained at the forefront of restructurings in 2019 as retailers made deep cuts amid competitive pressures and the ongoing shift away from the brick-and-mortar business model.

We also saw a growing trend in retail Chapter 22 cases, with Gymboree and Payless ShoeSource going back into bankruptcy to either make more significant cuts or bring about an eventual liquidation. As a result, other retailers are facing increasing stakeholder pressure to develop fast-tracked viable turnaround plans to avoid a similar return trip. Given the relatively high liquidation values of retail stock, many creditors are less willing to support going concern business plans, and they instead view liquidation as the more attractive and certain recovery option. In 2020, we expect distressed retailers to consider deeper restructurings from the outset, hoping to preserve overall value for all creditors.

Automotive

The US auto industry faced another challenging year in 2019, with average industry margin expecting to fall below 7% for the first time in the last seven years. Coming off a record 17.5 million US units produced in 2016, vehicle production volume continued to decline through 2019, losing another 2% of volume to a projected 16.9 million units. This decrease in production volume coupled with the high investment needed to position autos for the longer-term technological shift towards electric and autonomous vehicles are forcing OEMs to partner to take risk off the table.

Credit agencies have downgraded the sector from stable to negative due to the declining sales at a time when many companies are racing to invest in new transportation technology, including self-driving cars, connected cars and advanced safety features. Furthermore, faced with their own margin pressure, many OEMs are pushing supply chain risk down to Tier 1 suppliers by demanding more holistic components at the same time they’re putting cost and margin pressure on the same supplier base. This could increase distress throughout the suppliers as they don’t have the same financial wherewithal as OEMs to weather a prolonged downturn in sales. In general, the industry is facing significant headwinds, with no near-term relief in sight.

Pharma and life sciences

The PLS sector has increasingly been among the most troubled industries in the US economy. This trend has steadily grown over the past three years, with Chapter 11 bankruptcies doubling each year.

The opioid crisis has been one of the most conspicuous causes of recent financial distress in the sector, but our review of recent restructurings points to the specialty pharma sub-sector as the primary driver of disruption. In our review of the 21 PLS in-court restructurings from 2017 through 2019, only four had exposure to opioid markets, while more than 81% identified as specialty drug companies, i.e., developers of high-cost, high-complexity or high-touch drugs.

We expect this trend to continue as upstart specialty pharma players strive for scale in a fragmented and increasingly competitive market. Meanwhile, regulation and guidance on pricing transparency and drug pricing reform will continue to challenge business models of health industry players in 2020.

Dining and food service

The cadence of restaurant restructurings grew in 2019, especially for midsized full-service restaurants that used the Bankruptcy Code to exit underperforming store locations and their underlying property leases.

The competitive landscape remains highly challenging as full-service, casual dining chains continue to see declines in guest traffic due to intensifying competition from the surge in quick-service restaurant (QSR) dining concepts. Consumer preferences have been shifting to fast-casual options as customers seek value. As such, traditional restaurants have faced difficulty reversing same-store sales traffic trends.

The sector as a whole also continues to grapple with many challenges: statutory increases in hourly labor costs, increasing commodity prices, high rent costs and the rapid growth of costly third-party delivery. This makes restaurants a sector to watch for restructuring in 2020.

Energy, oil and gas

WTI prices experienced considerable volatility in 2019 but remained relatively range-bound between $50-$60 per barrel for front month contracts, as production cuts from OPEC+ nations generally balanced out US production growth.

OPEC+ has committed to deeper production cuts in 2020 to support current pricing levels. US production growth is expected to slow in the second half of the year, which should provide additional pricing support for oil. Geopolitical risks surrounding production and transportation of crude in the Middle East, Africa and South America will retain the potential to create short-term supply shocks. Natural gas prices in the US, however, are likely to remain near multi-year lows, putting further pressures on gas-heavy producers.

Capital markets remained largely closed to independent upstream producers in 2019 and are expected to remain so in 2020. As such, spending discipline is returning to the market, evidenced by falling North America rig counts – down more than 25% from prior year levels – and lower 2020 capital expenditure budgets. Producers are being forced to live within existing cash flow from operations, which will result in slower growth or decreases in producing reserves given the steep decline rates for shale wells.

These trends don’t bode well for the oilfield services sector, which will bear the brunt of the decrease in capital spending by producers. Most of these service providers have stacked assets and executed layoffs, but utilization and day rates remain depressed and are expected to continue over the near term. Consolidation in the sector is anticipated to remove capacity and improve pricing power, but lack of capital may drive more liquidations.

Contact us

Steven Fleming

US Business Recovery Services Leader, Principal, PwC Deals, PwC US

David Tyburski

Director, PwC Deals, PwC US

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