NEW YORK, April 13 (LPC) - As the economy rattles toward a recession and defaults are forecast to skyrocket, investors and company executives are seeking advice on how best to prepare for what could be a prolonged downturn.
Moody’s Investors Service and Fitch Ratings expect defaults to more than double in the next year as the coronavirus pandemic weighs on businesses, with supply chains interrupted and retail operations closed, pushing companies to fire workers or put them on leave.
Investment firms and businesses are preparing for the months ahead, but after more than 10 years of growth, many financial professionals have never lived through a downturn and lack the experience of the great financial crisis to lean on. To prepare, asset managers and company executives are reaching out to law firms and financial advisors for a refresher on restructuring and bankruptcy.
According to Leonard Klingbaum, a partner in the finance group at law firm Ropes & Gray, there are a lot of clients who have not been through a downcycle and are asking: how does this play out?
“It is a first time for a lot of people, so there is some historical education,” he said. “Every downturn is different, but a lot of the playbooks are similar, so we are spending time educating people.”
Lawyers at Goodwin Procter have been asked by investors to run ‘Bankruptcy 101’ sessions, about distressed investing and bankruptcy, according to Howard Steel, a partner in the financial restructuring practice at the law firm.
“We’ve had such a long bull market run, that a lot of new participants in the distressed investment market don’t have the experience of a downturn, so we’ve been inundated with distressed investors asking us to do teach-ins,” he said.
Some investors want to learn how bankruptcy works while others are more focused on the nuances of credit agreements. There have also been questions about how best to take advantage of a disruption and how to put cash to work in an effective means, Steel said.
Fitch expects US$80bn of leveraged loan default volume in 2020 and more than US$120bn by the end of 2021. It is now expecting a 5%-6% default rate for loans in 2020 and an 8%-9% default rate for loans in 2021. The leveraged loan default rate ended February at 2.1%.
Moody’s is also forecasting a large jump in defaults. The list of borrowers with a grade from the ratings firm of B3, six steps below investment grade, and a negative outlook or lower rose to an all-time high of 311 companies at the end of March.
With defaults already starting to pick up, advisors are encouraging clients to be proactive.
Before the “outbreak, we had been actively meeting with clients and potential clients to show them ways they could opportunistically look at downturns within various industries, as well as how best to protect their current positions,” Shana Elberg, a corporate restructuring partner at law firm Skadden, Arps, Slate, Meagher & Flom, said in an emailed statement.
Clients should actively monitor their positions and consider their strategic options on a continual basis, particularly in consultation with advisors that can help them either weather the storm or opportunistically take advantage of the situation, she said.
In the coming months, many professionals will continue to lean on colleagues and advisors that worked during the 2008 financial crisis.
“A lot of people are looking back to the ‘08-‘09 recession to see what happened there and trying to learn from those experiences,” said Stephen Zide, a partner focused on bankruptcy and restructuring at law firm Kramer Levin Naftalis & Frankel.
“I lived through it but for those who didn’t, they are trying to understand what happened and how things played out to be helpful for investment decision making (now),” he said. “But this may be much worse than 2008-2009; the jury is still out.” (Reporting by Kristen Haunss. Editing by Michelle Sierra.)