PETITION: In the most recent Gavin/Solmonese newsletter, "The Next Chapter," you provide a solid macroeconomic summary in your "2019 Outlook." You conclude, "...the U.S. benefited from strong growth in 2018 that could continue into 2019. However, threats to growth far outweigh potential for simulative surprises. In short, prudent corporations in or nearing distress should undertake corrective action soon, while opportunity still permits." To what degree does the tweet below — particularly combined with the recent disappointing February job numbers — affect your 2019 outlook, if at all?
In the words of Douglas Adams, “Don’t Panic!” one month of data—particularly erratic data—does not make a trend. Yes, nonfarm payrolls grew 89% fewer jobs than expected. This could very well be just a “fluky” result. Since the end of the government shutdown, there have been a number of recent economic surprises (see the Citigroup Economic Surprise Index). This could simply reflect government agencies challenged to catch-up following a historically long shutdown. If true, expect data revisions in upcoming months to smooth out “fluky” reports.
Flukes aside, there are some interesting takeaways to glean from the labor market. In January, U.S. job vacancies hit an all-time high. Curiously, Europe is also facing labor shortages despite an economy that is slowing more rapidly than in the US, notably in the UK and Germany. This suggests that baby boomers are retiring faster than millennials are entering the market. Further pressures come from the February jobs report, which showed that wages grew at their fastest pace since April 2009.
Continued wage increases could lead to higher consumer purchases, a harbinger for inflation, and ultimately Fed rate hikes. How likely is this scenario?
On March 20, the Fed said it would not raise rates anytime soon. They lowered guidance for GDP growth and inflation while raising their guidance for unemployment. The following day (and for the first time since 2007), the Treasury yield curve fully inverted, a widely recognized signal for a recession. The market, through Fed Fund futures, is reflecting a zero probability for a rate hike in 2019 with a 31% probability for a rate cut.
This sets up an interesting dynamic. Economic data is signaling high inflation but the Fed and markets are anticipating lower GDP growth. Periods of sluggish growth coupled with high inflation lead to stagflation, a serious economic condition that historically has challenged central bankers.
Academic theory aside, the message to distressed debtors remains the same: reach out to your advisors and take corrective action asap. The reasons for an end to the recent boom cycle is secondary to the fact that the sands of easy credit are quickly slipping through the hourglass.
PETITION: What kinds of corrective actions have you found yourself recommending to clients lately? What, if anything, are you hearing from clients (or just generally in the marketplace) that you weren't hearing just 12 months ago?
The middle market appears to be relatively unchanged during the last year. We are hearing more general chatter about when the next recession might start. In cases where we are selling a client’s assets, we have seen prospective investors express more concern about how our client’s assets will perform in declining economic conditions. Our job has been to kick the tires harder during due diligence and to be more proactive in supporting rationale for upside projections. In some cases, that means helping our clients understand they may need to temper aggressive forecasts.
PETITION: What is the biggest inefficiency in the restructuring process? If you had the opportunity to lobby to change one thing, what would that be and why?
Professional fees are easily a huge disadvantage to the bankruptcy process, which many would argue is an inefficiency. However, the professionals are largely present for good reasons and are working to help their clients.
Larger debtors are often able to absorb these costs and still emerge from bankruptcy. The challenge for smaller debtors can be much more formidable. These firms may have similar professional needs but have less cash or profitability to cover their costs. The result is after budgeting for debtor professionals, a creditors committee may find they have less than adequate funds to pay for their professionals. Certainly lenders have little desire to amply fund a potential adverse party.
There is no easy solution to this issue. The debtor has the greatest need for professionals, yet there has to be a balance. In many cases, unsecured creditors could posture that the debtor only is able to pay its professionals because unsecured creditors have not yet been paid. Fundamentally, this creates a systemic problem – by making chapter 11 too costly for the smaller end of the middle market, these companies delay seeking relief so long that many options for recovery are foreclosed upon by the passage of time. The system needs to be more accessible to smaller companies, and the only way to accomplish that is through procedural and structural changes.
PETITION: One of the great things about PETITION is that we have the senior-most professionals at certain firms that read us AND we have a lot of law and business school students that read us. Thinking about the latter, what is one book that you've read that's helped you become a better professional? Thanks for participating.
Without question it’s been Sun Tzu’s The Art of War. While there are many comparisons of how TAOW can be applied to business, there are similar comparisons to medicine which I find very applicable to the distressed space.
Being the first boots on the ground of a distressed company is akin to being an emergency room doctor (not to diminish the tremendous credentials required by actual medical professionals). From the outset, professionals need to question if they can make a difference or if the patient is too far gone (TAOW: Move not unless you see an advantage; use not your troops unless there is something to be gained). We next read vital signals of our patients through financial reports and analyses (TAOW: know your enemy). Often plagued by a host of problems, we triage to address the most critical issues first (TAOW: ponder and deliberate before you make a move).
The parallels go on but really cement the similarities between human and corporate health. The very positive takeaway is that corporations, like humans, are wired to survive and will fight tenaciously to do so. It’s in this context that we as turnaround professionals can feel truly blessed to work in this field where we support those fighting, in many cases, the battles of—and for—their lives.
PETITION Note: The Art of War is becoming a recommendation of choice from the various members of our community who’ve made a Notice of Appearance. While there’s a social commentary there, we will, for once, just leave it alone. 😉