The Restructuring Remedy

As painful as this reckoning is likely to be, substantial restructurings must occur across several industries on accelerated timelines.
Vincent RyanApril 9, 2020

The COVID-19 pandemic threatens a global economic crisis, unlike any faced in our lifetimes. As a restructuring professional for 38 years, I have lived through my share: the savings and loan crisis, stock market crash, and junk bond crash of the 1980s; the dot-com bubble of the late 1990s; the post-9/11 recession; and the mortgage-backed securities meltdown of 2008.

This time is different.

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It is not just that the triggering event — a virus that has forced most of the world’s major economies into partial or near-complete lockdowns — is different. The challenge today is that the virus has exposed deeper, more persistent vulnerabilities in the way companies do business. As a result, the natural remedies employed during past crises —changes to monetary policy, government bailouts for ailing industries — will fall short of the dramatic measures necessary to stabilize the U.S. economy. And to save what we can.

The bankruptcy process will be an essential part of the cure. In 2009, the chapter 11 cases of General Motors and Chrysler were critical to the rescue of the U.S. auto industry. Bankruptcy enabled both companies to restructure over $60 billion of combined liabilities in separate proceedings that lasted less than 40 days each. (As outside counsel to President Obama’s Auto Task Force, I saw firsthand the role these measures played in our recovery from the Great Recession.)

Given the sheer magnitude of our current crisis, the bankruptcy process will be even more critical: As painful as this reckoning is likely to be, substantial restructurings must occur across several industries on accelerated timelines.

The bottom line is that the economic crisis of 2020 has pushed companies with already weak balance sheets to the brink. The U.S. economy is currently operating under a staggering $10 trillion of corporate debt. Many debt-ridden firms are mere “corporate zombies” — over 40% of companies listed on U.S. stock exchanges in 2019 were unprofitable.

If the quantity of debt is alarming, the quality is even worse. Over the past decade, investors have flocked to the junk bond market in search of higher yields as central banks maintained treasury interest rates at or near zero. The U.S. corporate high-yield debt is now more than 20 times higher than in 1987 when the Dow suffered its largest one-day percentage-point drop ever.

A recent survey by Truth in Accounting found that U.S. states, territories, and municipalities are also under severe economic strain, having racked up approximately $1.5 trillion in unfunded debt. Meanwhile, the latest report on the status of U.S. entitlement programs indicates that Medicare’s hospital insurance fund will be insolvent by 2026 and Social Security reserves depleted by 2052. More than 45 million Americans are burdened with a record $1.6 trillion in student loan debt.

The reality is that even after the housing and banking industries recovered from the last global financial crisis, corporate debt in the United States remained perilously high. Many companies that probably should have gone through restructurings continued in business due to the availability of easy credit. That may result in a higher default risk for these companies this time around. And the default rate could be even worse for specific industries, such as oil and gas, which were experiencing an annual default rate of 13.4% on high-yield bonds even before last month’s oil price collapse.

The economic crisis of 2020 will require the U.S. economy to go through a substantial realignment — much like after 9/11, life will never be the same. Those companies that were propped up by cheap debt may find it difficult to restructure, even with available liquidity. Consolidation in many industries and layoffs will undoubtedly occur. State governments and municipalities — further strained from unprecedented stresses on the social safety net — will need to restructure their own debt, especially large states with high annual deficits and substantial taxpayer burdens.

In addition, our increased capabilities for remote learning deployed during this crisis will challenge the current model for higher education. Students, parents, and universities will reconsider the value and necessity of expensive, on-campus learning.

For healthier companies fortunate enough to survive, the aftermath of this crisis may finally provide the wake-up call they need to reevaluate their balance sheets and return to responsible borrowing and prudent lending practices.

Aside from the economic impacts, the sobering human costs of COVID-19 will linger in our collective psyche and, in turn, this experience will fundamentally change how we do business. Although it is uncertain how our lives will be changed and which companies will become obsolete, markets will continue to suffer if fear takes hold.

The restructuring process — guided by the wisdom of bankruptcy judges within bankruptcy proceedings — will help in this way too: minimizing the impact of fear and providing hope for a prosperous future. In these uncertain times, the markets will need to lean on the restructuring process as we all adjust to our new economic reality.

John J. Rapisardi is a partner at O’Melveny & Myers LLP.