Q: How do you view the current middle market restructuring environment?
A: Across the middle market, we have seen an uptick in restructuring activity since the beginning of the year, particularly among consumer-facing and healthcare businesses. COVID-related demand inflated some consumer companies’ earnings during the pandemic. Now, many of those businesses are experiencing a “hangover” or delayed effects from volatility in earnings. Economic headwinds, lingering supply chain constraints, increased costs, and inflation have only compounded and extended the challenges at the consumer level. Even though the pandemic began more than four years ago, we are still waiting to see consumer demand and earnings completely stabilize.
Q: What are the dynamics in the healthcare sector?
A: In healthcare, we’ve seen physician practice roll-ups and skilled nursing facilities (SNFs) struggle with increasing costs in the face of capped reimbursements. While labor costs and availability seem to be stabilizing, these factors were impactful, especially in the SNF space. The lack of staff prevented many facilities from growing censuses to pre-COVID levels. Other drivers include integrating acquired businesses, consolidating costs, and the difficulty of perfecting the formula of the doctors’ and nurses’ salaries. Often, older and more seasoned doctors are not incentivized to keep the same pace of work that they had earlier in their careers. SNFs rely on Medicaid and Medicare reimbursements, which haven’t kept pace with the increase in operational costs, causing significant distress. Additionally, severe labor shortages have prevented many facilities from reaching full resident occupancy.
Q: What trends do you notice across middle-market private equity portfolios?
A: We have seen an increase in poorly managed or underperforming businesses across the middle market running out of gas in the face of mounting leverage and liquidity challenges. Many equity holders meaningfully supported underperforming businesses through 2023, anticipating moderated borrowing costs in 2024. As the prospect of lower interest rates and equity returns has decreased, many equity holders are declining to fund additional liquidity needs and are handing these businesses over to lenders.
Q: What do middle market lenders need to consider before deciding to “take the keys” of a business?
A: Lenders must determine whether the business can be stabilized and generate additional value. Often, equity holders have declined to fund additional liquidity needs of a business in the months leading up to restructuring, worsening the company’s state. Alternative lenders must consider whether they really want to restructure existing debt in the hope that the business rebounds under current ownership, weighing the company’s current value against potential value and factoring in additional capital investment and appropriate risk.
Q: If we see more alternative lenders “taking the keys,” how do they plan to turn these businesses around? What resources do they have?
A: Few lenders have the resources or skillsets to “take the keys” and unlock value in distressed businesses through operational turnarounds. Most lenders will need to recruit and retain third-party assistance to 1) evaluate a company and its prospects and options, 2) assist in formulating a path forward, 3) execute the plan, and 4) transact when necessary. Generally, unregulated lenders have more options than regulated lenders. Regulated lenders generally do not have the appetite or the bandwidth to take control of operations or manage business turnarounds.
