7 Reasons Why The Insolvency Business Has Fundamentally Changed
By Dan Dooley, CEO
Has the insolvency business fundamentally changed? I am asked this question all the time. My answer is ABSOLUTELY!! Here are seven reasons why, and their implications for our industry:
1. The Stigma is Gone From Financial Distress and Bankruptcy
Owners and executives now actually seek input and opinions from trusted friends and professionals when their business experiences trouble, although that input doesn’t often translate into action. Not that long ago, distressed professionals were almost ushered in the back door at prospective clients. Business distress and bankruptcy are no longer taboo subjects. The distressed industry is maturing and becoming more of a mainstream business.
2. Distressed Expertise is No Longer a Professionals-Only Game
A few years ago, we had a secret language with 363 sales, DIP financing, administrative insolvency, preference payments, etc. Today, many more parties know the secret language (investors, suppliers, bankers, etc.), so distressed professionals now must be really good at what they do and not just know the buzzwords. Standards of performance for distressed professionals have been elevated.
3. Distressed Debt Capital is Increasingly Coming From Non-Banks
This is because regulated banks simply cannot afford to hold onto distressed company debt for periods much longer than one year. The distressed debt market has mushroomed from its roots in public company debt into the previously illiquid world of private company debt. Buyers of distressed debt are quick to take action, often fearless on lender liability risks, and quick to assert control if management isn’t moving fast to enough right the ship. Therefore, distressed transactions are now moving to a permanent solution much faster today.
4. Bankruptcy is Now Viewed From a Cost/Benefit Lens
The professional fees in bankruptcy used to be viewed as a cost of doing business, regardless of how much when compared to the size of the case. There was no cost/benefit lens at all. Perhaps this was a contributing factor to what most of us agree is the ridiculously high cost of a middle market bankruptcy case. Today, at least in the middle market, all cases are subjected to a cost/benefit analysis by the secured lender and often ownership to determine whether the benefits of bankruptcy justify the costs. Therefore, we have seen a significant increase in alternatives to bankruptcy (i.e. receiverships, ABC’s, Article 9 sales, out-of-court wind downs) in recent years as a cost-efficient response to the high expense of professional fees in bankruptcy cases.
5. The Banking Industry has Fundamentally Changed
Commercial banks simply can’t stay in distressed loans for multiple years anymore, for several reasons. These include pressure to downgrade loans from the OCC, the fact that bank non-performing assets are a closely watched public metric that directly affects a bank’s stock prices, and banks have a relatively new option to sell off distressed loans, no matter how small.
6. Acceptable Standards for Financial Leverage Have Changed
Companies are leveraged one to two times more today (defined as debt divided by EBITDA) than a decade ago. That’s because of the abundance of capital and the creativity of financiers in developing increasingly sophisticated financial structures. Highly leveraged companies that are the norm today have less time and fewer options available to deal with issues of financial distress.
7. Insolvency Law has Changed
The 2005 Bankruptcy Code Revisions (BAPCPA) made Chapter 11 more expensive and made it less likely that a middle market company could successfully execute a plan of reorganization to get a second chance at survival. Then the Stern v. Marshall case decision came down, and this has called into question in what situations bankruptcy courts can rule on issues of state law. The practical result is that alternatives to bankruptcy are on the rise and the bankruptcy cases that are filed are much shorter in duration.
What Does all This Mean for Distressed Work?
In my view, this translates to a comprehensive and “permanent” reduction of the market for distressed company professional services. Overall the number of cases may be generally unaffected by the above factors, but the scope and size of cases have been significantly and permanently reduced.
Now this doesn’t mean that the insolvency industry is dying; rather it means that the new normal is fewer hours of work and fees per case. In my estimation, the market size as measured by fees for distressed company professional services has been permanently reduced by about 30%.← News & Insights