The economic fallout from the coronavirus is looking increasingly severe and unlikely to quickly subside. Companies that piled on debt in the early stages of the pandemic — thanks in large part to stimulus efforts by the Federal Reserve — may have set themselves up to struggle as the crisis drags on. Houlihan Lokey, Wall Street's top adviser to distressed companies, has changed its outlook: Instead of the sharp but quick downturn they initially anticipated, they're predicting a deeper, prolonged crisis that takes three to five years and pushes many more firms to bankruptcy. "Everybody wanted to save the economy and keep people working, but at some point there's going to be some pain, and it's not going to be quick or easy to work through the implications of all this added debt," William "Tuck" Hardie, a managing director with Houlihan Lokey's restructuring business, told Business Insider. Visit Business Insider's homepage for more stories.
When the severity of the coronavirus began to dawn on the US in March, and the economic world suddenly stopped spinning, most companies had the same reaction to the resulting market crash: disbelief, followed by panic and a mad dash to find extra cash to keep their businesses afloat.
The good news is the debt was cheap. The Federal Reserve made certain of that, slashing its benchmark rates and pledging to buy government and even corporate bonds in order to rev lending back to life.
The bad news is that it worked a little bit too well. Companies piled on record amounts of debt, bulking out their capital structures to weather a natural disaster that's increasingly looking less like a brief but furious hurricane and more like an out-of-control brush fire.
According to top restructuring bankers, who advise companies facing financial distress, the race for liquidity has left companies that had healthy balance sheets pre-Covid in a compromised position and far less equipped to ride out what they estimate will be a three to five year recovery.
"Everybody's initial knee-jerk reaction was to go get liquidity in the form of debt. The reason they did that was because it was cheap and available, and it was something they could do fast to save their businesses," William "Tuck" Hardie, a managing director with Houlihan Lokey's restructuring business, told Business Insider. "What's going to happen when they have to pay it all back?"
Hardie has a prime seat to assess the challenges as a 20-year veteran of Houlihan Lokey, Wall Street's largest restructuring operation with about 240 people, including nearly 50 MDs. Given their breadth, they not only handle the most complex, mammoth bankruptcies — like Lehman Brothers or Enron — but also smaller restructuring mandates down to about $100 million in debt, or even less for long-standing clients.
They have a view into how the crisis is hitting struggling companies throughout the spectrum.
Houlihan, a publicly traded company, changed its own guidance to investors on an earnings call this week. Last quarter, the company had anticipated a quicker cascade of restructuring work as companies succumbed to bankruptcy amid the crisis.
"90 days ago, we would have anticipated a much steeper rise in bankruptcies, but over a shorter time frame," CEO Scott Beiser said this week.
But the government stimulus and relief efforts worked, stabilizing markets and pushing businesses back from the brink.
Global corporates issued $1.9 trillion in new bonds in the first half in 2020, thanks largely to the stimulus packages from the Fed and the European Central Bank, according to a report from Dealogic. That's the most ever recorded, and American borrowers led the way with just over $1 trillion in new bonds, a 92% increase from last year.
"The tiny virus has proved to be the mightiest agitator, capable of pushing bond markets to historic record volumes," Dealogic wrote in the report.
The calculus has changed for Houlihan, which is already working on more restructuring assignments than ever before and earned a quarterly record $89 million in restructuring revenues in the most recent quarter.
With virus cases still ripping through the country, and the US reporting a 33% GDP slump — the worst ever recorded — this week, there's a growing concern among borrowers and private-equity firms, Hardie said in an interview, that the cash raised in spring won't be enough to ride out the economic fallout caused by the pandemic.
Now, Houlihan is expecting that debt binge combined with the trajectory of the virus will result in more restructuring work than they initially imagined — a more widespread crisis but at a slower, prolonged pace.
"This pandemic is not a short-term blip, and it's going to be something much longer and probably more damaging to the economy," Beiser said on the earnings call.
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In a conversation in early May, a senior restructuring banker told Business Insider he was concerned by all the debt being raised —and that companies had put themselves in weaker positions than before the coronavirus hit.
"Why aren't companies doing equity offerings? Why aren't they doing deleveraging? Doing debt-for-equity swaps?" he wondered.
"I think people don't want to sell their equity when it's cheap," he said, answering his own question and nodding to the battered stock markets.
Markets recovered from their nadir in March, and so did equity issuance — which exploded to record levels in May and June. The $244 billion in equity raised first half of 2020 was a record, too, according to Dealogic.
But it didn't erase the debt pile-on, and, moreover, much of the issuance — in the form of convertibles and secondary-share sales — was from companies already performing well in the choppy environment, not companies on shakier ground.
Surveying the corporate landscape, roughly 80% of companies had appropriate debt loads pre-coronavirus, while 10% were overlevered and 10% were underlevered, Hardie explains. Now, that same 80% group of companies is overlevered and set up to struggle, even when the economy returns to 100% of normal.
"It was like throwing gas on a fire," Hardie added. "Instead of throwing water on it, which would be equity capital, they threw on debt, which is the equivalent of gas."
We likely won't start to see a serious rash of defaults until early 2021, because many creditors — given the overwhelming nature of the situation, which Hardie compares to being struck by lightning — have been willing to provide covenant waivers for all of 2020, if not into the first quarter of 2021.
But as the pandemic drags on and the economy recovers less vigorously than anticipated, Hardie thinks "you'll see attitudes harden."
"Everybody wanted to save the economy and keep people working, but at some point there's going to be some pain, and it's not going to be quick or easy to work through the implications of all this added debt," Hardie said.
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