In an effort to combat inflation, the Federal Reserve (Fed) is raising interest rates. Inflation is a decrease in the purchasing power of our money which causes prices to increase in goods and services over time.  The pandemic has presented added challenges such as labor shortages, the onset of COVID variants, and changed consumer habits adding pressure to deliver goods and services in high demand. As predicted, the Fed recently hiked interest rates by a quarter point percentage in March and again by a half percentage point in May. Rates are expected to climb as high as three percent by the end of 2023. This is the biggest hike in over 20 years.

The logic behind this move by the central bank is that higher interest rates will decrease demand thus allowing prices for goods and services to stabilize and drop back down. Many economists argue that the recent action by the Fed to curb inflation may be too late and the increase in interest rates for corporate borrowing may cause a recession while others believe that our economy is strong enough to curb inflation without crumbling. Regardless of direction, raising rates will likely cause an increase in restructuring agreements.

The State of the Capital Markets and Labor Market

Over the past two years, the amount of funds available to businesses facing challenges has been unprecedented.  The federal stimulus relief funds coupled with lenient lending policies have allowed businesses to survive and sometimes thrive during the pandemic.  As we recover from the challenges of Covid, longer lasting ramifications of our “easy-money” environment may be upon us.  We could be heading into a more turbulent economic period which could ultimately resemble an economic recession. Some companies may need to restructure their balance sheet or operations or both.  To better understand why some companies may be forced to considered restructuring options, let’s look at some key dynamics: the current position of capital markets, supply chain issues, and the status of our labor force. Below is a brief analysis of how the U.S. is faring in these areas just over two years into the pandemic:

• Capital Markets: The economy refers to the wealth and resources of a particular area in terms of production and consumption of goods. Distinguishable from this, capital markets absorb thousands of external data points in real time. Then, these financial markets react accordingly by setting a value to an organization’s equity price. With anticipation of the Fed rising interest rates, stock prices and cryptocurrencies have already dropped. It is safe to say that these markets will experience volatility for a while. Since risk is always factored into the stock market, most analysts expect a quick recovery when inflation gets under control – especially if the economy remains strong.

• Labor Markets: The labor market may appear to be bouncing back, but it is still weakened and in flux. While unemployment numbers have steadily decreased and many organizations are recovering, this is not indictive of the market’s overall strength. Other variables factor in that contribute to slower recovery such as the onset of Covid variants, unknown future spikes, and labor shortages. To retain talent and remain competitive, many organizations are increasing wages which can also add to inflation issues.

• Supply Chain: The pandemic has disrupted every aspect of our global supply chain for raw materials to finished consumer products.  We are now very aware of our supply risks and vulnerabilities as Covid has highlighted these past two years. Companies are looking to build resilience and new sourcing, but some will not be well suited to change models to meet demand.  Forecasts indicate that these challenges will continue through 2022 and possibly beyond.

Corporate Restructuring Predictions

Even if capital markets bounce back and the labor force completely rebounds, restructuring will be necessary for some organizations to survive. Interest rate increases, continued inflation, supply chain issues, and the unstable labor market all will likely contribute to more restructuring activity in general. Trends that are likely to emerge during the second half of 2022 and 2023:

• Many distressed organizations have successfully fended off bankruptcy filings by borrowing funds at attractive interest rates over the past few years. Some also received federal stimulus relief. As interest rates increase, access to the capital markets will tighten making future borrowing or debt amendment difficult. Both the interest rate on loans and fees associated with obtaining loans could be an insurmountable challenge. To remain viable, organizations in this position that have not returned to pre-pandemic operations may need to restructure assets out of court or seek bankruptcy protection.

• Lenders will work with corporate borrowers to find reasonable solutions, but many will look to exercise their contractual rights which include foreclosures and asset seizures. Overall, lenders will be more aggressive than they have been over the past two years. Undoubtedly, work out groups at banks and non-traditional lenders will become more active in assessing the value of businesses in the post pandemic environment.  Any inability to repay secured obligations would likely result in companies seeking an out of court restructuring or a formal chapter 11 proceeding.

While many organizations will remain stable during this time, others will fall into the categories listed above. For those that experienced recent financial headwinds, it is crucial to evaluate financial positions to determine the best path to take in order to thrive.

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