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SmarterNavigation Loanrestructuringstudy2022 Contents Introduction3 Part1:Frominterestraterisestotightermonetarypolicies, whatwilldriverestructuringactivityinthemonthsahead?4 Part2:Restructuringdebtstrategies8 Part3:Thelong-termoutlook,fromshiftingfinancingoptionstoESG12 Conclusion15 Methodology Inthesecondquarterof2022,Debtwiresurveyed25distressedinvestors,25hedgefunds/hedgeinvestors,25investmentbankers,and25directlenders,allheadquarteredintheUnitedStates. Thebreakdownofrespondentgroupsisasfollows:64%ofrespondentsoverallsaythecurrentvalueoftheirfirm’sassetsundermanagementisgreaterthanUS$10billion,risingto76%amonghedgefundrespondents.Directlendershaveaslightlydifferentmixthantheotherrespondents,withagreaterproportionsayingtheyhaveAUMofbetweenUS$1billionandUS$5billioncomparedtotheothergroupssurveyed. Allchartsshowoverallfiguresexceptwhensplitsbasedonthetypeoforganizationsarestatisticallysignificant. Whatisthecurrentvalueofyourfirm’sassetsundermanagement? 76% 4% 20% 0% 64% 4% 12% 12% 12% 0% 12% 72% 64% 8% 18% 4% 6% 44% 12% 28% 4% 12% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% Lessthan$500m $500m-$1bn $1bn-$5bn $5bn-$10bn 0% Total DirectLender 4% DistressedInvestor HedgeFund/HedgeInvestor 8% InvestmentBank Greaterthan$10bn Introduction Sincetheglobalfinancialcrisis,theUShasbeenthroughaperiodoftheloosestmonetarypolicyinitshistory.Respondingtothepandemicandits disruptiveimpactontheeconomy,theUSFederalReservecutinterestratestothefloor. Moreimportantly,theFed’sbalancesheetexpandedtolevelsneverpreviouslyseen,withitsbondpurchasingprogramupsizedthroughoutthepandemicandreachingalmostUS$9trillion. Buttimesarechanging.InflationexceededexpectationsearlyintheyearandtheFedwasforcedtoact.Bymid-2022,reversinginflationbecamethecentralbank’sprimarypolicytargetand,accordingly,itpumpedthebrakes,bothraisingratesandbeginningtorunoffitsbalancesheetassets. Thiswasaregimechangetowhichthecentralbankwasunaccustomed.Whilemonetarypolicywasgenerationallylooseintheyearsfollowingtheglobalfinancialcrisis,inflationnevermaterialized.Facedwithnovelconditions,theFedhadtoadjust. SpeakingattheEuropeanCentralBank’sForumonCentralBankinginJune2022,FedChairJeromePowelladmittedthat:“Weunderstandbetterhowlittleweunderstandaboutinflation.” Restructuringsloom Debtinvestorssuddenlyfoundthemselvesatacrossroads.Notonlydidrisingrateshaveimplicationsforpricingloans,buttheFedwasreininginmarketsandincreasingthecostof capitalamidslowinggrowth.Manycompaniesthatwereonceproppedupbygenerouspolicyfoundthemselvesswimmingagainstthetide. Giventheincreasinglyvolatilemarketconditions,whatcanthesevulnerablecompaniesexpectinthemonthsahead?Distresseddebtanddefaultshavethepotentialtorisethrough2023ascompaniesstruggletomeettheirliabilities.InJune2022,FitchRatingslifteditsdefaultforecastforUSinstitutionalleveragedloansby25basispointstoarangeof1.5%to2%for2023—thethird-highestyearlyloandefaultvolumeever,althoughstillwellbelowthetotalsin2009and2020.Theagencysaidtheincreasereflectedrecessionaryconcernsandariseintroubledloans. Asdefaultriskrises,sotoowillloanrestructuringactivity,aslendersandborrowersaliketakestepstoeasetheburden.Creditorsshouldbeexpectedtomakeconcessionstoreduceorpostponeinterestpaymentsoftheirdebtorstoensuretheirprincipalisrecoveredplusinterestorrealizevaluethroughequityswapsinsomecasesandwherethecreditorhastheexpertisetoactivelymanageoutthosesituations. Theseareuncertaintimes.However,bypreparingthemselves,lenderscanpositionthemselvesfortheuncertaintythatliesahead. Part1:Frominterestraterises totightermonetarypolicies,whatwilldriverestructuringactivityinthemonthsahead? Inflationisrunninghot,driveninitiallybypandemic-strickensupplychainscoupledwithmonetaryexpansion.Pent-updemandthenledtosoaringenergyprices,aneffectcompoundedbyRussia’sinvasionofUkraineassupplylineshavebeen 1.Howlikelyisawaveofloanrestructuringactivityinthenext12months?(Selectone) 40% furtherdisrupted. TheonlytoolattheFed’sdisposalistocurbdemandbytighteningfinancialconditions.Reducingtheavailabilityoffundingintheeconomyisreining inconsumerspendingandbusinessinvestment.Forcompaniescarryingunmanageablelevelsofdebt,thiswillmeantheircurrentloanarrangementswillneedtoberenegotiatedorfacedefaultandpotentialbankruptcy. Acomfortablemajorityofrespondentsinourresearchnowexpectloanrestructuringactivityto 30% 20% 10% 0% 34% 28% 35% 3% riseinthecomingyear,thoughnoteveryoneagrees onthecauses.Morethanaquarter(28%)believeawaveofrestructuringactivityinthenext12monthsis likely,whileathird(34%)sayitisverylikely. Thischimeswiththeweakenedoutlooksforecastbycreditratingsagenciesforthecomingyears. VerylikelyLikelySomewhatlikelyUnlikely Lenderswillbereadytoprovideloanrestructuringoptionsbecausethereisalsoreducedcreditavailabilitytoconsider. ChiefoperatingofficerofadirectlenderbasedinDenver,Colorado Themostwidelycitedreason,tippedby44%,istherisinginterestrateenvironment,while35%extendthisouttomonetarypolicytighteningasawhole—abroaderconceptencompassingbothinterestratesandtheFedrunningassetsoffitsbloatedb