As the world continues to “flatten” in so many ways, some common themes are emerging globally in the world of restructuring, too. Some of these themes are helpful from the troubled company’s point of view, like increasing liquidity. However, others present even more challenges than in the past, such as the explosion in recent years in the sheer number of stakeholders that must all be appeased during the restructuring process.

What are restructuring advisors to do? Interestingly, most advisors today are focusing on the same basic things they always have. Yet at the same time, advisors who want to stay ahead of, rather than be trampled by, change must be prepared to understand and leverage the latest trends in today’s new, more complicated environment.

There are three key trends that are becoming increasingly apparent.

Trend #1: Increasing Consensual Restructuring

Debtor-led consensual restructuring is being supported by legislative changes in the key markets around the globe, particularly France, Germany, Italy and the US. Some landmark consensual restructurings recently include the turnaround of the German cable company ish GmbH, Norway’s drilling business Stolt Offshore (now Acergy S.A.) and the UK infrastructure services provider Jarvis plc. These restructurings have established new benchmarks for creative rehabilitative solutions, and we believe they will drive the frequency and pace of such turnarounds globally. That’s certainly been the case in America. In the early 1990s, only around 7% of US bankruptcy cases were out-of-court settlements. Between 2001 and 2005, more than 20% were “pre-negotiated.”

What’s behind this trend? Consensual, out-of-court restructuring, rather than formal in-court bankruptcies, are, simply put, driven by what is often the creation of more value for the company and its stakeholders. Today’s climate of easy access to liquidity encourages an out-of-court approach, as does the increased flexibility that this type of agreement offers. Lenders worldwide are increasingly comfortable with stand-still situations, where debt and interest payments are suspended whilst the company prepares a business plan for the way forward.

At the same time, balance sheets today have become more complicated with many different types of debt – senior, unsecured, overdraft, asset-backed, loan notes/bonds, high yield, off-balance sheet, first lien, second lien, and mezzanine – being applied to any one deal. Each debt type has a different level of security and claims, further demanding that consensus will be needed to find the right way to a solution to create the most economic value.

This sheer increase in the number of parties and complexity also lends a vote to the idea of the consensual route being the best way to create value for all concerned. For example, the increasing involvement of hedge funds in recent years in funding companies in distress, replacing in part or even in total traditional senior bank debt, is a prime example of this brave new world. Hedge funds, by design, are looking for fast returns, and they are placing increasing pressure on companies to move fast and get on quickly with their operational restructurings, as well as their balance sheet restructurings. As an example, after Goldman Sachs invested in the debt of major retailer ihr Platz GmbH in 2005, Platz used Germany’s new legal provisions to reorganise in around four months. The speed and success of the restructuring shocked German insolvency experts.

Other new parties at the restructuring table today – also adding to the case for consensual restructurings – include the increasingly empowered Pension Trustees and Pension Regulators particularly in the UK. Their needs and concerns are as valid in the restructuring discussion as any other parties’. In the recent case of restructuring MFI plc, a $2 billion sales UK kitchen wholesaler and retailer, the business was refinanced with a switch from traditional bank debt to asset-backed lending. At all stages of the refinancing process, the needs of the Pension Trustee and Pension Regulator had to be taken into account.

Likewise, credit insurers – who provide insurance to suppliers of companies – are increasingly more important to the turnaround process where continued trading is dependent on the goodwill and understanding between the credit insurer and the company at times of distress. They, too, are often best dealt with in a consensual, rather than in a traditional, format.

Trend #2: High Levels of Available Liquidity

Never before have companies had so much access to so much money at sensible prices from so many different sources than now. What’s more, most experts do not see this liquidity is unlikely to dry up this year – and maybe not even next.

Nevertheless, many financial institutions providing this liquidity clearly believe that the number of restructuring opportunities will grow in the relatively near future, as demonstrated by their hiring of restructuring professionals to create new restructuring teams, as demonstrated at Goldman Sachs over the last few months. These teams are the client-facing arm for selling increasingly sophisticated refinancing products.

There is already much less use of traditional bank lending (where economic value is created through the use of a bank’s balance sheet). Although companies today still approach banks for debt, banks, instead of holding that debt, syndicate it out to all kinds of institutions (the banks’ own economic value now being created through underwriting and syndication fees). The new lenders are other banks, hedge funds, private equity funds, and collateralised loan obligations (CLOs), funds that acquire corporate loans and repackage them as asset-backed bonds, which they then sell, mostly to banks and insurance companies. In 2006 global collateralised debt proceeds rose 100% compared to 2005. Over the same period of time, global high yield debt rose 55%, with the last quarter of 2006 being the biggest quarter in record.

As a result of the proliferation of new lenders, there has been a flood of capital into the lending market. The US leveraged loan market is likely to exceed $700 billion this year. Standard and Poor’s estimates that European leveraged loans for LBOs rose from $19 billion in 2003 to over $100 billion in 2006. Now it’s not unusual today to see over half of the debt in an LBO in the form of loans rather than bonds.

Asset-backed lending has also begun to increase as an alternative to bank debt and hedge fund money, but in developed markets there are fewer and fewer fixed-asset-based companies and more service-based industries. Whilst receivables may provide a good asset in times of strong trading, they may come under pressure during more demanding times. Nonetheless, we believe asset-backed lender influence will increase in the next economic downturn when private equity and hedge funds become more risk-averse.

Banks like these kind of market changes because, instead of holding, say, $500 million in one single company, they can syndicate the risk and reduce their exposure to as little as $20 million. As a side note, the financial system also benefits. At the end of the 1980s, credit risk was very heavily concentrated in banks, meaning that the crisis in developing country lending and the real estate crash of that time brought several close to collapse. Today, the wide distribution of loans means that no one institution is likely to suffer a catastrophic loss when something goes wrong at a company that has borrowed significant sums.

A potential negative effect on companies of this new money is that balance sheets get restructured or shorn-up, but without the business fundamentals of the company necessarily being addressed, too. There is greater pressure on operational turnarounds to service more expensive and more complicated debt structures. The new providers of capital will soon learn, however, that it’s not sensible to simply financially restructure all companies. When some funds’ new-found enthusiasm doesn’t always bear fruit, we believe they will definitely become more “real world” in their approaches.

Trend #3: Increased Trading of Debt

In the last few years, the amount of debt traded has increased dramatically, with for example US secondary debt trading volumes increasing from $145 million in 2003 to $240 million in 2006. Today the market is unregulated – but that may well change. The market is being fuelled by the fact that one man’s problem (debt lender to troubled company) is another man’s opportunity (debt trader). Some see the recent G8 recommendation of debt write-off for certain nations as under direct challenge from distressed debt traders who are buying debt at below-par prices yet looking to enforce the legality of the original debt contracts. If the financial stability of countries is threatened by distressed debt traders, it would be natural for these countries to more actively consider regulation of these markets as a whole. Governments around the world may well tire of individual companies and traders taking advantage of these arbitrage opportunities.

The combination of so many being so eager to lend and the fact that loans are now as tradable as bonds does have some potential downsides. For example, it has become common for restructuring professionals who have negotiated refinancing packages on behalf of a company with one group of lenders to leave the negotiation room and come back to find that 100% of the debt has traded and negotiations need to start afresh with a totally new group of stakeholders. Not only does this add cost to the restructuring, but it distracts the company from its key objective of sorting out its operational issues.

Another potential deleterious affect is apparent in the fact that hedge funds and private equity have a huge influence in fixing the terms of loans. Any resisting bank is likely to be replaced by another that is keen to pick up the underwriting fee. As a direct result, covenants, which are intended to stop borrowing companies from getting into financial trouble without bank intervention, have loosened to the degree that we know of cases where loans being made with no covenants attached at all. Plus, regardless of what the terms are, fewer lenders seem to pay attention to them as a result of the knowledge that they can trade the debt if the company appears to be getting into trouble.

Another direct consequence of the increased frequency of debt changing hands is an over-active rumour mill. Some argue that commercial providers of loan pricing and trading information facilitate the manipulation of the market pricing of debt.

What Does This Mean for Troubled Companies?

Is the restructuring industry set on a course that will see an increase in all of these trends?

No doubt for the foreseeable future there will be continued high availability of liquidity with major institutions still dominating, but with an increase in the number of faceless lenders. Debt will be traded, not only because the economics make it attractive, but because increasing numbers of institutions want to own, control and influence. Capital structures will continue to grow in complexity.

However, while we should all understand these three new trends and strive to stay one step ahead of them, the troubled company and its advisors nonetheless need to remain focussed on the same, basic things as always:

• Stabilising the business and keeping it running as well as possible
• Creating predictability with respect to forecasted financial performance to build stakeholder confidence
• Focussing on the balance sheet and the profit and loss statement, i.e., combining financial and operational expertise to achieve the turnaround
• Actively managing all the stakeholders

Wicks Hewish, Johnston, and Cavin are in the London office of AlixPartners, the global turnaround and consulting firm.