Unit­ed States

Soft Land­ing Appears to be Sticking

• Gross domes­tic prod­uct (“GDP”) grew at a sea­son­al­ly- and infla­tion-adjust­ed 2.4% annu­al rate in Q2 2023, the Com­merce Depart­ment said. The econ­o­my has expand­ed at bet­ter than a 2.0% pace over the past year, fol­low­ing a mild con­trac­tion in ear­ly 2022. Eco­nom­ic growth is rough­ly in line with the rate record­ed in the decade before the pan­dem­ic took hold.
• The slow­down in con­sumer spend­ing from a 4.2% growth in the first quar­ter to a 1.6% growth in Q2 2023 reflects house­hold out­lays of big-tick­et pur­chas­es cool­ing as Amer­i­cans flocked back to deal­er­ships at the start of the year.

Tight­en­ing Under­writ­ing Con­di­tions Pro­vide Evi­dence that the Cen­tral Bank’s Inter­est-Rate Hike Cam­paign is Slow­ing the Nation’s Finan­cial Gears as Intended

• The Fed has raised inter­est rates by 5.3% since March 2022, and its sur­veys and hard data have shown banks have been slow­ing their lend­ing in response. ​“You’ve got lend­ing con­di­tions tight and get­ting a lit­tle tighter, you’ve got weak demand, and … it gives a pic­ture of a pret­ty tight cred­it con­di­tions in the econ­o­my,” Fed Chair Jerome Pow­ell said last week when asked about July’s Senior Loan Offi­cer Opin­ion Sur­vey on Bank Lend­ing Prac­tices (“SLOOS”) results.

U.S. Chap­ter 11 Bank­rupt­cy Fil­ings Jumped 53.6% in Q2 2023 from a Year Earlier

• August marks 13 con­sec­u­tive months that total, indi­vid­ual, and com­mer­cial bank­rupt­cy fil­ings have reg­is­tered month­ly year-over-year increas­es. ​“The con­tin­ued year-over-year increas­es indi­cate the antic­i­pat­ed growth of bank­rupt­cy fil­ings is becom­ing a real­i­ty,” said Gregg Morin, Vice Pres­i­dent of Busi­ness Devel­op­ment and Rev­enue at Epiq, a provider of U.S. bank­rupt­cy fil­ing data. ​“This empha­sizes the crit­i­cal role bank­rupt­cy ana­lyt­ics plays in cre­at­ing effec­tive strate­gies and informed deci­sions when nav­i­gat­ing an evolv­ing market.”
• Bank­rupt­cy fil­ings for small busi­ness, cat­e­go­rized as Sub­chap­ter V elec­tions with­in Chap­ter 11, jumped 55.0% in Q2 2023 ver­sus a year ear­li­er, accord­ing to data from Epiq.

Euro­zone

Busi­ness­es are Under Pres­sure — Signs of Con­trac­tion Ahead

• After briefly shrink­ing at the end of last year, the GDP of the 20 coun­tries that use the euro returned to growth in Q2 2023 at an annu­al­ized rate of 1.1%. That mod­est pick­up mir­rored an accel­er­a­tion in U.S. eco­nom­ic growth dur­ing the same peri­od and con­trast­ed with a slow­down in Chi­na. The euro­zone part­ly ben­e­fit­ed from an out­lier 13.7% increase in Ire­land, whose GDP has gyrat­ed wild­ly fol­low­ing the for­tunes of large U.S. drug com­pa­nies domi­ciled on the island. ​“The near-term eco­nom­ic out­look for the Euro Area (“EA”) has dete­ri­o­rat­ed, owing large­ly to weak­er domes­tic demand,” Euro­pean Cen­tral Bank Pres­i­dent Chris­tine Lagarde said Thurs­day. ​“High infla­tion and tighter financ­ing con­di­tions are damp­en­ing spend­ing.” China’s slug­gish eco­nom­ic activ­i­ty has also damp­ened the Euro­zone with exports to Chi­na in the first five months of this year only 1.2% high­er than the same time peri­od of last year. Germany’s close­ly tracked Ifo busi­ness con­fi­dence index fell in July for the third con­sec­u­tive month. Sur­veys of pur­chas­ing man­agers for July con­duct­ed by S&P Glob­al point to a con­tin­ued decline in man­u­fac­tur­ing activ­i­ty, while the much larg­er ser­vices sec­tor has slowed.

Euro­zone Banks Cut Lend­ing Even Before Lat­est Finan­cial Turmoil

• Cred­it is tight­en­ing con­sid­er­ably at Euro­pean banks which is par­tic­u­lar­ly notable because unlike in the U.S., Euro­pean banks remain dom­i­nant as lenders; non-bank lenders are still emerg­ing as an alter­na­tive to banks, and many remain fair­ly niche.7 The July Bank Lend­ing Sur­vey (“BLS”) released by the Euro­pean Cen­tral Bank (“ECB”) found busi­ness demand for new loans is at a record low, an indi­ca­tion that invest­ment spend­ing is set to weaken.

Recent Case Studies

Baby Food Man­u­fac­tur­er and Food Prod­ucts Toll Pack Provider Secured a Uni­tranche Facil­i­ty and an ABL RLOC from Two Sep­a­rate Cap­i­tal Providers

• Chi­ron Finan­cial (“Chi­ron”) act­ed as the exclu­sive invest­ment banker to a pri­vate equi­ty-owned baby food man­u­fac­tur­er and food prod­ucts toll pack provider (“Baby Food Com­pa­ny”) to assist in an out-of-bank­rupt­cy dis­tressed bal­ance sheet recapitalization.
• The Baby Food Com­pa­ny was seek­ing a cred­it facil­i­ty of < $20 MM to refi­nance the lega­cy debt, fund the CAPEX plan, and pro­vide addi­tion­al liq­uid­i­ty for work­ing cap­i­tal. Chi­ron helped the Baby Food Com­pa­ny secure (i) a uni­tranche facil­i­ty with inter­est rates of SOFR + 3.0% and pay­ment-in-kind (“PIK”) of 5.0% plus (ii) an ABL RLOC facil­i­ty with advance rates of 85.0% on eli­gi­ble accounts receiv­able (WSJ Prime + 7.3%), 75.0% of forced liq­ui­da­tion val­ue (“FLV”) of eli­gi­ble inven­to­ry (WSJ Prime + 10.0%), and a struc­tured over-advance of 10.0% of the facil­i­ty (WSJ Prime + 10.0%).
• Chi­ron con­tact­ed over 400 cap­i­tal providers span­ning from ABL lenders, sub­or­di­nat­ed debt lenders, M&E lenders, and struc­tured cap­i­tal providers. The term sheets Chi­ron gar­nered dur­ing the process pro­vides a sol­id base­line for the cur­rent lend­ing mar­ket for a $20 – 40 MM TEV baby food man­u­fac­tur­er and food prod­ucts toll pack provider. 

Pre­mi­um Choco­late Con­fec­tions Pro­duc­er Under LOI will be Acquired with an ABL RLOC

• Chi­ron act­ed as the exclu­sive invest­ment banker to a pri­vate equi­ty-owned pre­mi­um choco­late con­fec­tions pro­duc­er (“Choco­late Com­pa­ny”) in a sell-side engagement.
• The Choco­late Com­pa­ny will be acquired with a > $20 MM ABL RLOC with advance rates on eli­gi­ble accounts receiv­able of 85.0% (WSJ Prime + 5.0%), inven­to­ry of 85.0% mul­ti­plied by the less­er of (i) 60.0% of cost or (ii) NOLV (WSJ Prime + 5.0%), M&E of 75.0% of the NOLV (WSJ Prime + 5.5%), and an over-advance of 20.0% of the facil­i­ty (WSJ Prime + 13.0%).

Hous­ton-Based Spe­cial­ty Refin­er of High-Vol­ume Inter­me­di­ary Chem­i­cals as well as Renew­able Jet Fuel Secured Post-Peti­tion DIP Financing

• Chi­ron act­ed as the exclu­sive invest­ment banker to a Hous­ton-based spe­cial­ty refin­er of high-vol­ume inter­me­di­ary chem­i­cals as well as renew­able jet fuel (“Chem­i­cal Com­pa­ny”) to assist in a com­pre­hen­sive bal­ance sheet restructuring.
• Chi­ron had min­i­mal time to help secure financ­ing for the Chem­i­cal Com­pa­ny as cash was run­ning tight. The mar­ket­ing process last­ed sev­en days, and in the process, Chi­ron con­tact­ed 17 poten­tial lenders. The term sheet cho­sen by the Com­pa­ny had a facil­i­ty size of < $20 MM with an advance rate of up to 50.0% of the fair mar­ket val­ue (“FMV”) of the real estate, an inter­est rate of WSJ Prime + 6.5%, an orig­i­na­tion fee of 3.0%, and a pre­pay­ment fee of 5.0%. In an analy­sis con­duct­ed by Chi­ron com­par­ing the Chem­i­cal Company’s DIP facil­i­ty to oth­er recent­ly autho­rized post-peti­tion DIP facil­i­ties, the secured DIP facil­i­ty was found to be con­sis­tent across cur­rent mar­ket terms. Con­sid­er­ing the time­frame to con­duct the mar­ket­ing process, the referred to DIP facil­i­ty pro­vid­ed the best avail­able com­pre­hen­sive post-peti­tion financ­ing for the Chem­i­cal Company.

U.S. Head­quar­ters Oil­field Ser­vice Com­pa­ny with Oper­a­tions in Africa Secured A/R Financing 

• Chi­ron act­ed as the exclu­sive invest­ment banker to a U.S. head­quar­tered oil­field ser­vice com­pa­ny with oper­a­tions in Africa (“OFS Com­pa­ny”) to assist in a debt cap­i­tal raise.
• The OFS Com­pa­ny was seek­ing financ­ing to pro­vide liq­uid­i­ty for work­ing cap­i­tal, sup­port future growth from com­mit­ted con­tracts with blue-chip clien­tele, and pay down accounts payable. The < $20 MM fac­tor­ing facil­i­ty had an advance rate of 85.0% on eli­gi­ble accounts receiv­able with an inter­est rate of WSJ Prime + 0.5%, a 0.7% dis­count on the gross invoice amount, and a 1.0% orig­i­na­tion fee.

U.S. Cred­it Man­agers are Tight­en­ing Under­writ­ing Stan­dards Among Every Major Cat­e­go­ry of Lend­ing Activities

• Accord­ing to the July’s SLOOS, tight­en­ing under­writ­ing stan­dards was most wide­ly report­ed for spreads of loan rates over the cost of funds, pre­mi­ums charged on riski­er loans, and costs of cred­it lines. In addi­tion, sig­nif­i­cant net shares of banks gen­er­al­ly report­ed hav­ing tight­ened the max­i­mum size and matu­ri­ty of cred­it lines, loan covenants, col­lat­er­al­iza­tion require­ments, and the use of inter­est rate floors to firms of all sizes. Banks most fre­quent­ly cit­ed a less favor­able or more uncer­tain eco­nom­ic out­look and expect­ed dete­ri­o­ra­tion in col­lat­er­al val­ues and the cred­it qual­i­ty of loans as rea­sons for expect­ing to tight­en lend­ing stan­dards fur­ther over the remain­der of 2023. Major net shares of banks also report­ed a reduced tol­er­ance for risk, dete­ri­o­ra­tion in their liq­uid­i­ty posi­tions, wors­en­ing indus­try-spe­cif­ic prob­lems, increased con­cerns about the effects of leg­isla­tive changes, super­vi­so­ry actions, or changes in account­ing stan­dards, and decreased liq­uid­i­ty in the sec­ondary mar­ket for loans as impor­tant rea­sons for tight­en­ing stan­dards or terms for C&I loans.

U.S. Cred­it Man­agers Report­ed Con­tin­ued Weak Demand for Loans Among Every Major Lend­ing Category

• Though not to the degree report­ed in the pre­vi­ous sur­vey cov­er­ing Q1 2023 when banks said busi­ness demand for cred­it was the soft­est since 2009, the lat­est sur­vey still shows over­all weak demand for loans. The net share of banks report­ing demand from large and medi­um firms was (-51.6%), com­pared with (-55.6%) in the pri­or peri­od and from small firms was (-47.5%), up from (-53.3%). Fur­ther­more, sig­nif­i­cant net shares of both domes­tic and for­eign banks report­ed that the num­ber of inquiries from poten­tial bor­row­ers regard­ing the avail­abil­i­ty and terms of cred­it lines decreased.

EEA Banks Report­ed Fur­ther Tight­ened Cred­it Stan­dards in the July 2023 Bank Lend­ing Sur­vey (“BLS”)

• The cumu­lat­ed net tight­en­ing since the begin­ning of 2022 has been sub­stan­tial, and the BLS results have pro­vid­ed ear­ly indi­ca­tions about the sig­nif­i­cant weak­en­ing in lend­ing dynam­ics observed since last autumn. Against the back­ground of the typ­i­cal lags in the impact of mon­e­tary pol­i­cy trans­mis­sion on the econ­o­my, risks relat­ed to the eco­nom­ic out­look and firm-spe­cif­ic sit­u­a­tions remained the main dri­ver of the tight­en­ing of cred­it stan­dards for firms. Banks’ low­er risk tol­er­ance, their cost of funds, and bal­ance sheet sit­u­a­tion also con­tributed to the tight­en­ing, reflect­ing high­er cred­it risks in the con­text of ris­ing inter­est rates and weak eco­nom­ic growth. In Q3 2023, EEA banks expect a fur­ther net tight­en­ing of cred­it stan­dards for loans to firms, but at a slow­er pace than in the sec­ond quarter.

EEA Firms’ Net Demand for Loans Hits an All Time Low Since the Start of the BLS in 2003

• Since the start of the BLS in 2003, the net decrease in loan demand for SMEs (-40.0%) and long-term loans (-46.0%) was the strongest net decrease in demand record­ed. The net decrease in demand for loans to large firms (-34.0%) and for short-term loans (-22.0%) remained slight­ly more lim­it­ed than dur­ing the glob­al finan­cial cri­sis. The decline in net demand reflects the impact of ris­ing inter­est rates on loan demand and eco­nom­ic growth. Fixed invest­ment also had a strong damp­en­ing impact on loan demand, mir­rored by a strong net decrease in demand for long-term loans. Low­er financ­ing needs for M&A activ­i­ty, avail­able inter­nal fund­ing with improved cor­po­rate prof­its, and, to a small­er extent, debt secu­ri­ties issuance also con­tributed to firms’ reduced loan demand. In Q3 2023, banks expect a fur­ther net decrease in demand for loans to firms, but much small­er than in Q2.

Glob­al Fundrais­ing for Pri­vate Cred­it Hits Sev­en-Year Low in 1H 2023

• Pri­vate cred­it fund man­agers remain qui­et­ly con­fi­dent that the U.S. debt mar­kets can retain investor inter­est, part­ly because high­er inter­est rates have failed to cre­ate the wide­spread dis­tress that many pre­dict­ed – mar­ket sources tend to side with a sur­vey by Kroll Bond Rat­ing Agency sug­gest­ing that a dis­tressed wave was unlike­ly to be build­ing since it would most like­ly have already appeared.
• Sub­or­di­nat­ed and mez­za­nine debt strate­gies are tak­ing a greater share of investor dol­lars. There is also a con­cert­ed push into spe­cial­ty finance areas – either asset-based or asset-backed – with real estate a grow­ing area of inter­est. KKR raised $2.1 bil­lion for its first ded­i­cat­ed asset-based finance fund last year, and accord­ing to a KKR white paper on the sub­ject, the pri­vate asset-based finance asset class is expect­ed to grow from $5.2 tril­lion to $7.7 tril­lion by 2027.
• Jason Strife, head of junior cap­i­tal and pri­vate equi­ty solu­tions at Churchill Asset Man­age­ment (“Churchill”), says its junior cap­i­tal deal flow has actu­al­ly increased from last year as spon­sors are focused on struc­tur­ing deals cor­rect­ly in the high­er rate envi­ron­ment, and in many instances, look­ing for fixed cash and PIK coupons. Randy Schwim­mer, co-head of senior lend­ing at Churchill cites two main rea­sons why spon­sors are look­ing for junior debt. First, the LBO financ­ing that is get­ting done today is for busi­ness­es in ​“good sec­tors”, where pur­chase price mul­ti­ples have stayed rel­a­tive­ly steady, and yet the amount of lever­age that can be put on those busi­ness­es giv­en high­er inter­est rates is much less. ​“The whole cap­i­tal struc­ture has gone in favor of lenders and made it dif­fi­cult for pri­vate equi­ty spon­sors who need to put in more cash,” Randy says. Sec­ond, the fundrais­ing for PE has also slowed, leav­ing spon­sors ask­ing for some junior cap­i­tal to bridge that gap between equi­ty they need to put in and the senior debt.

Chap­ter 11 Bank­rupt­cy Dis­tress Indi­ca­tors Hit Mul­ti-Year Highs, Accord­ing to the Newest Polsinel­li-TrBK Dis­tress Indices Report

• “This is a major devel­op­ment over Q1 2023 and even the past few years,” said Jere­my John­son, a bank­rupt­cy and restruc­tur­ing attor­ney at Polsinel­li, a law firm with a focus on bank­rupt­cies. ​“It demon­strates a mate­r­i­al increase in fil­ings across the board and is a sign of sig­nif­i­cant finan­cial dis­tress in the mar­ket. Sev­er­al [Chap­ter 11 bank­rupt­cy dis­tress] indices had been creep­ing up the last few quar­ters, but the wave of fil­ings we didn’t see last quar­ter is now being reflect­ed in the actu­al data.” ​“The growth in fil­ings is reflec­tive of more fam­i­lies and busi­ness­es fac­ing surg­ing debt loads due to ris­ing inter­est rates, infla­tion, and increased bor­row­ing costs,” Amer­i­can Bank­rupt­cy Insti­tute’s exec­u­tive direc­tor Amy Quack­en­boss said in a statement.
• Real estate con­tin­ues to expe­ri­ence increased dis­tress as the sec­tor has expe­ri­enced the high­est fil­ings in three years. It appears that the long-antic­i­pat­ed real estate dis­tress is now sur­fac­ing. Experts fore­see fil­ing num­bers will con­tin­ue to increase, as there has not been a sig­nif­i­cant reset in com­mer­cial real estate mar­kets and increased inter­est rates will con­tin­ue to put pres­sure on the market.
• The health­care sec­tor has seen its most dra­mat­ic increase in Chap­ter 11 fil­ings in 13 years. ​“Three years past the begin­ning of the glob­al pan­dem­ic, which caused sig­nif­i­cant dis­tress to the health care sec­tor ear­ly on, it is becom­ing clear that the sec­tor has not yet recov­ered and con­tin­ues to grap­ple with the effects of the pan­dem­ic and espe­cial­ly the end of finan­cial sup­port from the gov­ern­ment. The sec­tor is rapid­ly chang­ing, and we are now find­ing our­selves in a sit­u­a­tion where we have an aging net­work of rur­al hos­pi­tals at the same time as tech­nol­o­gy and telemed­i­cine chang­ing how we deliv­er health care. This com­bi­na­tion is ripe for incred­i­ble trans­for­ma­tion, and we are arguably in the midst of the biggest change in three gen­er­a­tions since the Great Soci­ety Pro­grams of the 1960’s that cre­at­ed Medicare and Med­ic­aid,” com­ments Jere­my John­son of Polsinelli.

Banks’ Total Expo­sure to Com­mer­cial Real Estate (“CRE”) Totals $3.6 Tril­lion, Equiv­a­lent to 20% of Deposits

• Banks are in dan­ger of cre­at­ing a sce­nario where loss­es on CRE loans trig­ger banks to cut lend­ing, which leads to fur­ther drops in prop­er­ty prices fur­ther lead­ing to more loss­es. Today’s trou­bled mar­ket, fueled by ris­ing inter­est rates and high vacan­cies, fol­lows years of boom times. Banks rough­ly dou­bled their lend­ing to land­lords from 2015 to 2022, to $2.2 tril­lion. Small and medi­um-size banks orig­i­nat­ed many of those loans, and all that lend­ing helped push up prop­er­ty prices. Over the past decade, banks also increased their expo­sure to com­mer­cial real estate by lend­ing to finan­cial com­pa­nies that make loans to some of those same land­lords, and they bought bonds backed by the same types of prop­er­ties. How­ev­er, the vol­ume of com­mer­cial prop­er­ty sales in July was down 74% from a year ear­li­er, and sales of down­town office build­ings hit the low­est lev­el in at least two decades, accord­ing to data provider MSCI Real Assets. When deals begin again, they will be at far low­er prices, which will shock banks, said Michael Com­para­to, head of com­mer­cial real estate at Ben­e­fit Street Part­ners, a debt-focused asset man­ag­er. ​“It’s going to be real­ly nasty,” he said. Besides banks, lenders such as pri­vate debt funds, mort­gage REITs and bond investors can also pro­vide fund­ing – but many of them are financed by banks and can­not get loans. ​“We are see­ing a seri­ous cred­it crunch devel­op­ing,” said Ran Eliasaf, man­ag­ing part­ner of North­wind Group, a pri­vate real-estate lender.

What­ev­er Lend­ing is Still Hap­pen­ing in the CRE Sec­tor is Occur­ring at the Low­est LTVs in 30 years

• Cer­tain sub­sec­tors such as con­struc­tion lend­ing and office are becom­ing excep­tion­al­ly dif­fi­cult to finance. The degree to which cred­it con­trac­tion has already hap­pened, in advance of the fun­da­men­tal stress­es that are emerg­ing, sug­gests a deep­er and longer peri­od of mar­ket dislocation.

Sources

1. WSJ – U.S. Eco­nom­ic Growth Accel­er­ates, Defy­ing Slow­down Expec­ta­tions

2. Fed­er­al Reserve – Senior Loan Offi­cer Opin­ion Sur­vey on Bank Lend­ing Prac­tices

3. U.S. Courts – Quar­ter­ly Bank­rupt­cy Fil­ings

4. ABLAd­vi­sor – August Com­mer­cial Chap­ter 11 Fil­ings Increase 54% Y/Y

5. Reuters – Bank­rupt­cy Fil­ings Surge in First Half of 2023 in U.S., Epiq Says

6. WSJ – Europe Returns to Timid Growth, but Big­ger Head­winds Loom

7. Ares – Alter­na­tive Cred­it Newslet­ter Spring 2023

8. Euro­pean Cen­tral Bank – Bank Lend­ing Sur­vey

9. Pri­vate Debt Investor – U.S. Report Sep­tem­ber 2023

10. Polsinel­li-TRBK Dis­tress Indices Report – Dis­tress Indices Spike in Q2 – Chap­ter 11, Health Care and Real Estate Reach­ing Mul­ti-Year Highs

11. WSJ – Real-Estate Doom Loop Threat­ens America’s Banks