In order to fight against inflation, the Federal Reserve (Fed) increases its interest rates. Inflation is a decrease in the purchasing power of our money which causes the prices of goods and services to rise over time. The pandemic has presented additional challenges such as labor shortages, outbreaks of COVID variants and changing consumer habits, which has increased pressure to provide high-demand goods and services . As expected, the Fed recently hiked interest rates by a quarter of a percentage point in March and another half a percentage point in May. Rates are expected to climb to 3% by the end of 2023. This is the biggest increase in over 20 years.
The logic behind this decision by the central bank is that higher interest rates will lower demand, allowing prices of goods and services to stabilize and come back down. Many economists say the Fed’s recent action to curb inflation may be too late and that raising interest rates for corporate borrowing could trigger a recession, while others believe our economy is strong enough to dampen inflation without collapsing. Either way, rising rates will likely lead to higher restructuring agreements.
The state of capital and labor markets
Over the past two years, the amount of funds made available to businesses facing challenges has been unprecedented. Federal stimulus 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, more lasting ramifications of our “easy money” environment may be upon us. We could be heading into a more turbulent economic period that could ultimately look like an economic recession. Some companies may need to restructure their balance sheet or their operations or both. To better understand why some companies may be forced to consider restructuring options, let’s look at some key dynamics: the current position of capital markets, supply chain issues, and the status of our workforce. Below is a brief analysis of where the United States stands in these areas just over two years into the pandemic:
- Capital markets: Economy refers to the wealth and resources of a particular territory in terms of the 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 in an organization’s stock price. With anticipation of the Fed’s interest rate hike, stock prices and cryptocurrencies have already fallen. It is safe to say that these markets will experience volatility for some time. Since risk is always priced into the stock market, most analysts expect a quick recovery once inflation is brought under control, especially if the economy remains strong.
- Labor markets: The labor market may seem to be rebounding, but it remains fragile and on the move. Although the number of unemployed has steadily declined and many organizations are recovering, this is not indicative of the overall strength of the market. Other variables contribute to slowing the recovery, such as the appearance of Covid variants, unknown future peaks and labor shortages. To retain talent and stay competitive, many organizations are raising salaries, which can also make inflation problems worse.
- Supply Chain: The pandemic has disrupted every aspect of our global supply chain, from raw materials to finished consumer products. We are now very aware of the risks and vulnerabilities of our supplies as the Covid has highlighted over the past two years. Businesses are looking to build resilience and replenish, but some won’t be well suited to switch models to meet demand. Forecasts indicate that these challenges will continue until 2022 and possibly beyond.
Corporate Restructuring Predictions
Even if capital markets rebound and the labor force rebounds completely, restructuring will be necessary for the survival of some organizations. Interest rate hikes, continued inflation, supply chain issues and labor market instability will all likely contribute to more restructuring activity in general. Trends likely to emerge during the second half of 2022 and 2023:
- Many struggling organizations have managed to push back bankruptcy filings by borrowing funds at attractive interest rates over the past few years. Some have also received federal stimulus relief. As interest rates rise, access to capital markets will tighten, making future borrowing or modification of debt difficult. The interest rate on loans and the fees associated with obtaining loans could be an insurmountable challenge. To remain viable, organizations in this position that have not resumed pre-pandemic operations may need to restructure their assets out of court or seek bankruptcy protection.
- Lenders will work with corporate borrowers to find reasonable solutions, but many will seek to exercise their contractual rights, including foreclosures and seizures of assets. Overall, lenders will be more aggressive than they have been for the past two years. There is no doubt that the task forces of banks and alternative lenders will become more active in assessing the value of businesses in the post-pandemic environment. Any inability to repay the secured bonds would likely lead companies to seek out-of-court restructuring or chapter 11 formal proceed.
While many organizations will remain stable during this time, others will fall into the categories listed above. For those who have recently experienced financial headwinds, it is crucial to assess their financial situation to determine the best path forward to thrive.
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