By Jeffrey A. Wurst, Esq.
I was recently asked what I saw coming down the Pike with respect to business economics. Let me start by saying that I am not an economist. In fact, I have never taken a course in economics. My practice, however, does thrive on a downside economy. So, caveat lector (reader beware). That being said, I am skeptical of forecasters. I am especially skeptical of “experts” who forecast because they often fail to seek out reliable indicators.
My grandmother was a great forecaster – of the weather that is. She would watch Tex Antoine (those of you in the New York market may remember him) as he drew his pictures of sunshine, forecasting fair weather. My grandmother would say, “He is wrong. It is going to rain. My bursitis is bothering me and that means it is going to rain.” Grandma’s forecast tended to be much more accurate than those of the experts. So many of us working in the restructuring area have been waiting for that “ball to drop” – whether it be during the second quarter or third quarter or fourth quarter, etc., etc. It does appear that we are seeing signs of a downturn now. Of course, one rosebud does not make a spring. Time will tell if what I think I am seeing actually comes to fruition. Like grandma, I look at what is around me to forecast.
Last month my law firm handled more forbearance agreements on newly defaulted loans than we did in all of 2006. That trend appears to be continuing.
We are faced with a growing crisis in the sub prime market. Although there may be some opportunities for distressed investors, I think it is more significant to look at the opportunities for the broader restructuring industry. Follow me through this scenario: The sub prime borrowers are the lowest creditworthy borrowers we have. So it should not be surprising that we are now seeing a rising rate of defaults amongst those borrowers. What is significant is human nature. The last obligation any individual will default upon is mortgage payments on his home. No one – not even the least creditworthy borrower – wants to see his wife and children thrown out onto the street. Yet that is what is happening. We are seeing the least creditworthy borrowers defaulting. As a result, even their banks – those sub prime lenders – are falling into default and seeking Chapter 11 protection themselves.
Remember “Reagonomics”? The “trickle down” approach? Well I suspect that we are going to see a “trickle up” – the reverse of “Reagonomics”. The least creditworthy borrowers (usually the lowest income sectors of our economy) tend to shop at mass merchants such as WalMart, Kmart, and Target. Thus, doesn’t it follow that with a drop-off in that sector we will see those large retailers start to feel the crunch? Will that effect domino up through the supply chain? If so, then we had better tighten our belts and get ready.
That being said, I suspect that big retail bankruptcies are not likely to occur in this long-anticipated down cycle. As a result of the recent changes in bankruptcy code, retailers no longer have unlimited time to eek out a plan. There are strict limits on their exclusivity period and they only have 210 days – at the most – to determine which leases they will accept or reject (unless their landlords agree to extend that time). I am not ruling out landlords allowing that time to be extended because if things start to slip, they may be content to keep their tenants in the premises rather then having vacant properties.
These changes in exclusivity, as well as the reclamation timing have also changed the climate of retail bankruptcy. As a result, retailers will likely look for new creative methods to obtain relief no longer available under Chapter 11.
So where do we go from here? I guess that we have to watch while exercising caution and prepare ourselves for what may be a tough period ahead of us. Retailers and suppliers to retailers in particular should proceed with caution, although, I suspect that distribution and manufacturing will not escape the impending downturn. Now that I have put my prognostications on the table, let’s see who turns back and throws this in my face a year or two from now.
Jeffrey A. Wurst, Esq. is a partner at Ruskin Moscou Faltischek, P.C., where he chairs the law firm’s Financial Services, Banking and Bankruptcy Department. He is also the Vice President for Chapter Relations of the Turnaround Management Association and is the President of the New York Institute of Credit. Jeff can be reached at (516) 663-6535 or firstname.lastname@example.org.