UBS recently hired Matthew French, a restructuring partner at British law firm Lovells LLP, to head its restructuring group for Europe, the Middle East and Africa. And Goldman, Sachs & Co., which made a splash in the business two years ago, when it lured high-profile bankruptcy lawyer James Sprayregen from Kirkland & Ellis LLP, recently opened a restructuring shop in Sydney, moving insider Lachlan Edwards from London to run it.
These big firms join a coterie of Wall Street boutiques, including Lazard, Blackstone Group LP, Rothschild and Miller Buckfire & Co. LLC,
that have long headlined the restructuring advisory business. For
years, a U.S. company's traditional investment banker was restricted
from representing that company after it filed for bankruptcy, since the
banker was considered an "interested" party. That allowed boutiques to
dominate the bankruptcy advisory business, since they were more likely
not to have underwritten financing for a company in the three years
before a bankruptcy filing. The Bankruptcy Reform Act of 2005, however,
eliminated the provision that effectively had disqualified a company's
longtime investment banker from being its bankruptcy adviser.
Despite the legal change, the bulge-bracket firms aren't looking to
displace boutique restructuring firms, at least for now. One reason is
that the boutiques are often clients of the bigger banks. For example,
when independent power producer Calpine Corp. filed for Chapter 11 protection in 2005, its financial adviser, Miller Buckfire, turned to Credit Suisse Group, Goldman Sachs, Deutsche Bank AG
and Morgan Stanley to provide $7.3 billion in exit financing. And while
the 2005 bankruptcy law loosened the definition of "disinterested,"
investment banks still have to make a choice when a client enters
bankruptcy: Either finance the company or advise it, but not both. Even
under the new law, "you can't be the provider of capital solutions and
be the bankruptcy adviser," says Deutsche Bank's head of restructuring,
Mark Cohen. "You have to be on one side or the other."
So instead of competing head-to-head against the boutiques, most
larger firms are carving out advisory roles that focus on providing
capital solutions to distressed companies before they file for
bankruptcy. Firms including Deutsche Bank and Lehman Brothers advise
companies looking to deal with looming covenant issues or nearing
maturity dates, as well as those seeking strategic alternatives,
including asset sales or a sale of the whole company. Deutsche Bank,
for example, recently engineered a $193.1 million rights offering for
auto brakes maker Hayes Lemmerz International Inc. as part of
its balance-sheet restructuring. And Goldman and Lehman Brothers
packaged a $400 million exchange offer for amusement park operator Six Flags Inc. in June.
Once a company's problems have gone beyond such remedies, the larger
banks tend to operate as a source of financing, providing liquidity
with debtor-in-possession loans, exit financing and the like. Goldman
and UBS say they do both out-of-court and in-bankruptcy advisory work
but focus mostly on out-of-court advisory. "We tend to do more exchange
offers, prepackages or prenegotiated deals," says UBS' Smith, though
the firm is now engaged as an adviser to bankrupt printing company
Quebecor World. Goldman, meanwhile, was sole financial adviser on
relocation services company Sirva Inc.'s $563 million
prepackaged bankruptcy filing in February, which, hopefully, will work
to prevent a protracted bankruptcy. Sirva, owned partly by Clayton, Dubilier & Rice Inc. and ValueAct Capital Master Fund LP, got its DIP and exit financing from prepetition lenders led by J.P. Morgan Chase Bank NA and J.P. Morgan Securities Inc.
Still, not all the big Wall Street banks have jumped on the distressed advisory bandwagon. Firms such as Credit Suisse, Citigroup Inc.
and J.P. Morgan are content to simply provide financing to distressed
companies, veering away from offering restructuring advisory services.
In fact, Credit Suisse has actually spent five years exiting the
business of advising distressed companies. Phil Jacob, the firm's
co-head of restructuring, says it would rather have distressed
advisers, whether boutiques or bulge-bracket firms, tap Credit Suisse
for their restructuring finance needs than compete against it for
advisory work. Richard Banziger, managing director and head of
asset-based finance at Citigroup, agrees. "Restructuring financing is a
profitable business for us," explains Banziger. "It wouldn't make sense
for us to impair those opportunities" by getting into bankruptcy
advisory. Last month, Citi, along with J.P Morgan, Bank of America Corp. and Royal Bank of Scotland Group plc, led a $60 billion refinancing, the biggest ever, for GMAC Financial Services and its troubled mortgage unit Residential Capital LLC.
But it's more than safeguarding their restructuring finance
businesses that keeps some large firms from going head-to-head against
the restructuring boutiques. "Bankruptcy ... has its legacy customs,"
Deutsche's Cohen says. Though the legal code that kept a company's
investment bank from providing bankruptcy advice is essentially gone,
its spirit remains. Many companies facing a bankruptcy filing would
rather go with a tried and tested restructuring adviser than gamble on
someone new to the game. Thus many distressed companies may engage a
large investment bank for capital advisory work but will still hire a
specialized restructuring firm once bankruptcy becomes a real
possibility.
"So far, we haven't seen any big corporate bankruptcies go
exclusively with a bulge-bracket restructuring adviser in a bankruptcy
context," says Cohen. "Time will tell, but I think we'll only see
shifts around the margin."
Indeed, financing remains the largest part of the restructuring
business even for large investment banks that engage in bankruptcy
advisory. Goldman, for example, still does more financing than advisory
work. So why are firms taking the trouble to enter the advisory
business at all?
They are simply following the money or, more specifically, the capital structures, of their corporate clients.
Corporate America, having gorged for years on free-flowing capital,
is highly levered. Many companies carry debt with few covenants,
benefiting from the cov-lite mania that swept Wall Street before the
credit freeze.Meanwhile, the credit markets remain chilled, with no end
in sight. According to research firm Dealogic, U.S. debt
refinancings, for both distressed and healthy companies, plunged 80% in
the first half, to $67 billion, from $338 billion one year ago. That
means there will likely be less new bank money chasing bankrupt
companies, as lenders who aren't part of a company's capital structure
before bankruptcy won't want to get in during bankruptcy.
So the lenders are pursuing advisory work. After all, it's only in
bankruptcy that investment banks can't advise as well as finance.
Before a filing, they can do both, though if a bank wants to provide
DIP or exit financing to a bankrupt client, they would be wise to avoid
the advisory mandate.
By entering the advisory business, some full-service investment
banks look to leverage their expertise in the capital markets as well
as the Rolodexes of their top-flight bankers. At Bear Stearns Cos.,
former head of financial restructuring chief Daniel Celentano boasted General Motors Corp. as a client. When the firm imploded, Evercore Partners Inc. snapped
him up. At Evercore, Celentano joins co-heads Bill Repko and David
Ying, who are also big-bank alumni: Repko was the former head of
restructuring at J.P. Morgan Chase and Ying ran Donaldson, Lufkin &
Jenrette's restructuring group.
Another reason for the restructuring push on Wall Street is the
downturn in other investment banking businesses. "When M&A and
private equity go south or constrict, [investment banks] look for new
revenue streams," says restructuring lawyer Harvey Miller of Weil, Gotshal & Manges LLP.
Banks, always looking to bump up fees, are even hungrier now. Though
the economic forecast is gloomy, giving financial advice to companies
in distress can generate fees.
The scramble for restructuring talent, particularly on the advisory
side, reflects that. "Restructuring bankers are very much in demand,"
says UBS' Smith. "I do know our competitors are searching." In this
downsizing climate, restructuring is one of a few banking areas with a
reason to expand, through new hires or transfers from other parts of a
firm.
Headhunters' calls, though, will most likely go to those whose
expertise lies in distressed advisory work, rather than financing.
Morgan Stanley, for example, lured O'Dowd from Lazard strictly to
ignite its restructuring advisory effort; the firm, like others on Wall
Street, has enough financing expertise in house. Indeed, many big
investment banks house their restructuring groups within their
leveraged finance efforts, putting together two products that are
countercycle. Credit Suisse's current restructuring group, for one, was
formed in 2006 as a combination of its leveraged finance origination
group and its restructuring group, which had been around since the bank
acquired DLJ. At UBS, restructuring head Smith is also head of global
leveraged finance.
At Goldman, the ramp-up has been a few years in the making. Four
years ago, the firm began to shift from doing restructuring work on an
opportunistic basis to what its co-head of restructuring, Dhurv Narain,
calls an all-weather strategy. "In 2004, in the midst of a bull market,
we started preparing ourselves for all markets," says Narain, who
joined that year from Credit Suisse. "In the past few years, the group
has grown," adds co-head Sprayregen.
But even as firms bulk up, they are still awaiting a
long-anticipated surge in corporate defaults. One of the surprises of
this economic downturn has been the dearth of defaults and, therefore,
fewer than expected restructurings. According to Moody's Investors Service,
defaults are up this year -- the U.S. speculative-grade default rate
ended the second quarter at 2.4%, up from 1.8% in the first quarter --
but much less than anticipated. In the last two economic downturns,
1990 through 1991 and 2002 through 2003, default rates reached 10% to
12%. During the boom years of 2005 through 2007, default rates hovered
at about 1%. Those times were also record years for refinancing.
"Anyone who could, did," says Goldman's Narain.
With banks eager to lend, many borrowers got more liquidity than
their businesses warranted and no covenants to trigger in their loans.
The default rate became artificially depressed and borrowers that in
normal times would have retooled their balance sheets, managements or
business models were given a free ride. "A number of companies were
able to get a greater degree of flexibility from the capital markets,
and they are making use of that flexibility now," says Sprayregen.
"Some will use the time intelligently, some will not use it as wisely."
In the meantime, the leaders of Wall Street's restructuring groups
say they are busy. "Very busy," says Goldman's Narain. Adds Credit
Suisse's Jacob, "We've done very well this year in what we categorize
as restructuring finance, which is rescues, DIPs and exits.
Notwithstanding the lousy market conditions for new issues, we are busy
and expect to get busier." At UBS, Smith says his group is active due
to "pockets of issues" in sectors including housing, auto suppliers and
airlines.
Experts predict default rates will spike, probably as we near 2009,
though they are not likely to reach the levels of past downturns. "For
me, personally, unless the economy deteriorates more than I expect,
we'll see 5 to 6%, rather than 10 to 12%, which seems awfully high,"
says Smith.
Adds Deutsche's Cohen: "Even absent a credit crisis, we would see an
increase." The most likely areas for distress include all
housing-related companies, of course, and those driven by consumers,
such as restaurants, retailers and packagers as well as commodities,
industrials and trucking companies. And "everyone is getting hurt by
the high price of oil," adds Goldman's Narain.
Bankruptcy rumblings so far have mostly been contained to the middle
market, often the first set of companies to veer into trouble. Being
smaller, they are more vulnerable to the undertow of a downward
economy. They have fewer assets to sell off, tend to have more
concentrated customer bases and less market power with vendors and
lenders. But if the weakness in the economy continues or worsens,
expect to see defaults among bigger companies as well.
"Leverage levels eventually will catch up with people," UBS' Smith
adds. "It's inevitable that some of these companies will succumb to
restructuring."
The flexibility of more leverage and fewer covenants might give some
companies time to bounce back, especially if the downturn is a short
one. But companies could deteriorate more steadily because there is no
trigger to start a restructuring. "It cuts both ways," says Sprayregen.
Even with no covenants, companies that run out of money will
default, as they fail to make principal payments or meet looming
maturity dates. AbitibiBowater Inc. is one example. Hit hard by
declining demand for forestry products, AbitibiBowater has struggled
since it was created through a merger of Canadian forestry giant
Abitibi-Consolidated Inc. with rival Greenville, S.C., Bowater Inc.
last year. With its senior notes maturing on April 1 and June 20,
AbitibiBowater in May refinanced $1.456 billion of debt, led by Goldman
Sachs.
The covenant-lite era will leave its mark on the restructuring
process, bankers say. The benefit of covenants was the possibility to
help address a company's problem before it worsened. "Ignoring the
debtholders' advice is like pretending the lump on your neck will go
away," says one restructuring pro.
So some distressed companies, with few or no covenants, will wind up
in creditors' hands having destroyed more value than bankrupt companies
historically. The era of increased leverage has also left companies
holding more secured debt, and so companies may find it harder to raise
new debt, since they have few unencumbered assets to pledge in
exchange. Ultimately, the salvage value of the companies might lessen,
weakening the creditors' potential to recoup their investments.
In addition to increased leverage and fewer covenants, the capital
structure of many corporations has changed. The market experienced a
greater shift to first- and second-lien secured debt facilities over
the more traditional secured debt plus bond financing. The different
types of capital structures popular today will pose a new set of
problems for distressed companies in this down cycle, and for their
advisers.
"The flavor is going to be different," says Sprayregen. Experts
foresee quicker sales of bankrupt companies, first- and second-lien
fights among creditors and higher financing costs. And then there are
the hedge funds, which have become more prevalent players in capital
structures. With their different strategy and process, hedge funds may
make restructurings more contentious, resulting in more valuation
fights.
"It won't be dull," says Smith. "That's one thing I know about this cycle."
Jobs are being slashed, consumers are losing confidence, corporate profits are being squeezed, financial institutions are announcing huge write-downs and talk of a recession gets stronger every day. Against this backdrop, Wall Street's big investment banks are building their restructuring departments in a bid to provide financial advice and financing to companies in distress -- and to earn fat fees along the way.
