Are We Headed for a Recession? Ask an Economist…

dadIf your work touches the restructuring world (or if you’re married to one of us), you know that one of our favorite topics of cocktail and conference small talk is to speculate about when a recession will hit.  And when work will pick up. Now, many of you have lawyers and accountants in your families. It just so happens that I have a family economist, Dr. Michael M. Kurth, Ph.D.

So this week, let’s ask dad: “Are we headed for a recession?”  (And yes, the following dialog really is representative of family dinner conversation at my house.)

Trump Claims That We Are in the Midst of a Tremendous Economic Expansion That Makes This the Greatest Economy in the HISTORY of America…. Is that True?

Well, Daughter.  (There are six of us.  He can’t keep track.  So I am “Daughter.”  Or as I prefer, “First Daughter.”)  There is no question that investment has soared after Congress cut the corporate tax rate from 21% to 35%. And we currently have record low unemployment.

Is This Economic Performance Sustainable or Is a Recession Coming?

The president’s economic team claims that gross domestic product (GDP) will be growing at a rate of 5% or more by year end.  But there are growing indications the economy may be headed in the opposite direction.  The most recent sign of an impending recession is the flattening of the yield curve that measures the difference between short-term and long-term interest rates.

How Reliable Is the Yield Curve in Predicting a Recession?

Its a very reliable indicator.  It has predicted every recession for the last 60 years.  Here’s how it works.  (In case you were going to ask...)

The yield curve is normally upward sloping, indicating that long-term interest rates are higher than short-term rates. This is because lenders and investors generally consider long-term loans to be riskier than short-term loans and they require higher interest to compensate them for the additional risk.  (That makes sense.)

When the yield curve turns negative – referred to as an “inverted” yield curve – it means that short-term interest rates are higher than long term rates.  That, in turn, suggests that lenders and investors consider the short-term riskier than the long-term. This has happened 10 times since 1955 and 9 of those times it was followed by a recession within about a year.  (If we were at my house, he would graph this for you on a napkin.  Paper or cloth.  Seriously.  For this blog, however, you get a proper graph, below.)

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The one time it wasn’t followed by a recession was 1966, when it was followed by weak growth… But technically not a recession. (Seriously, dad?  I wasn’t even born in 1966.)

So, I Understand How It Works.  Is the Yield Curve Flat Today?

Well, Daughter. Currently the yield curve is still positive and upward sloping.  But it has been steadily getting flatter. The differential between short and long-term rates are now just .32% compared to a normal spread of around 2 to 2.5%.  (Ahhhhh…!)

What Are  Some Possible Explanations for This Flattening Yield Curve?

Funny you should ask. (He was going to explain anyway.) You know about the “Trump Bump.” The stock market had a significant surge after Donald Trump was elected president.  During his first year in office, the Dow Jones Index went from 18,259 to 26,392, an increase of nearly 50%. But… in January it shed 2,500 points in two weeks.  And it has been bouncing around the 24,000 point level ever since. (Visualize my dad bouncing salt shakers across the edge of the table to illustrate here.)

  • One explanation is that investors are getting spooked by uncertainty over trade wars and other Trump policies.  Just take a look at the Cboe stock market volatility index. It averaged 11.85 in 2017. But so far this year it is averaging 16.94.
  • Also, many investors are “baby boomers” who either retired or are nearing retirement age.  After the big market rally, they seem more interested in preserving their stock market gains than taking additional risks.
  • And from a broader perspective, the Obama Administration kept interest rates near zero for eight years to stimulate investment. At the same time, the federal government borrowed massive amounts of money from abroad in an effort to spend our way out of the recession. But the artificially low cost of capital distorted the capital structure of our economy.  That means significant over-investment in the most capital-intensive sectors.  (Ah… so Republicans can blame this all on Obama administration policy failures?)
  • Not so fast, Daughter. The Federal Reserve Bank knew its policy of “quantitative easing” was unsustainable and was poised to raise interest rates as soon as the economy improved. But with unemployment at historic lows, the Trump administration decided to pour even more money into the capital markets.

(Do you have questions about how quantitative easing works? Here is my favorite explanation ever: Quantitative Easing Explained.)

So You’re Describing a Boom and Bust Cycle… Is This Cycle Inevitable?

Well, we’ve seen this before.  In the Austrian school of economics, it is known as the over-investment theory of the business cycle. According to this theory, there is a natural structure to investment in the economy based on people saving and investing. Boom-and-bust business cycles are created by temporary injections of funds into the capital markets that lead to low interest rates and investment levels that cannot be sustained. Sustainable growth comes from people saving to finance investment, not temporary injections of capital that create the illusion of prosperity.

Okay, Wait… What I Really Wanted to Know Is Whether the Yield Curve Is Signaling That the Big Boom is About to Turn Into a Big Bust?

Right, Daughter! Some financial analysts argue that the yield curve doesn’t apply to our new, technology-driven economy and that there are still many unexploited profit opportunities out there. They are urging the Federal Reserve Bank not to raise short-term interest rates. And they will likely blame the Fed if they do raise rates and a recession ensues. (Wait… I’m a bankruptcy attorney.  Isn’t a recession good news for me and my colleagues?)

Well, yes, Daughter.  Some people may be rooting for a recession for perverse incentives. (Paternal stink eye.) Or for political reasons. An economic downturn, for example, could be bad news at the polls for Trump and the Republicans. (The big tax cut was more a Republican idea than Trump’s idea).  I am not among them. We need economic growth to pay just the interest on the $20 trillion debt our government has amassed.  And it’s not just the US. The world is awash in $164 trillion of debt, which will make it harder for countries to respond to the next recession and pay off debts if financing conditions tighten.

So What Does Your Economist’s Magic 8 Ball Predict for the Upcoming Year?

The big economic stories will be inflation, higher interest rates, and a declining stock market. This is very much at odds with the picture the Trump administration has painting as it poured “rocket fuel” onto the economy. And I am not rooting for a recession. (Stink eye again.) As an economist, I’m just informing you of the situation as I see it so you can take precautionary measures.  (Like taking vacation now, before the recession wave hits….?)


If you would like to know more about this, google “an inverted yield curve” and decide for yourself.  Or I can give you my dad’s email.

Mette K.

 

 

BCBG Creditors’ Committee Organizational Meeting: March 9, 2017

Shortly before midnight on February 28, 2017, BCBG Max Azria Global Holdings, LLC and affiliates filed for Chapter 11 bankruptcy protection in the Southern District of New York. The United States Trustee has scheduled a meeting to form an unsecured creditors’ committee on March 9, 2017 in New York.

Store Closings and “Right Sizing”

The Bankruptcy Court has entered an interim order authorizing store closing sales at 120 BCBG locations, predominantly retail and factory stores. Each of the stores to be closed has historically operated at a loss. Collectively, the stores generated $10.3 million in losses in 2016, representing 63% of BCBG’s total losses from stores with a negative contribution margin. BCBG estimates the store closings will generate $20.1 million.  The liquidation sales commenced before the bankruptcy filing and are expected to continue through the end of April. It appears that, at least in the short term, about 50 of BCBG’s stores will remain open, together with a significant number of its partner shops located inside major department stores.

A Bankruptcy Sale…. Maybe?

BCBG has also filed a draft plan with a “toggle” feature, allowing for either (a) the sale of BCBG’s assets to a third party; or (b) a debt for equity conversion on terms to be negotiated.

BCBG says that it has begun marketing its assets, and it has filed a motion to approve bidding procedures. The motion includes a request to allow BCBG to provide a stalking horse bidder-if one is found-with break-up fees and expense reimbursements.  The proposed procedures, if approved, would require potential bidders to submit preliminary bid documents to BCBG and its investment banker, Jeffries, in order to receive due diligence information. They would also require interested bidders to provide non-binding indications of interest by March 30, 2017, with an auction tentatively to follow by May 22, 2017.  But the procedures proposed by BCBG and its lenders also grant them wide latitude to move forward, instead, with a debt for equity conversion… the terms of which have yet to be negotiated.

More Information

Additional information about the case, including a list of stores scheduled to be closed and the company’s proposed sale procedures and plan, can be found on the website maintained by BCBG’s claim agent, Donlin Recano.

 

On the Auction Block: Essential Living Foods, Inc.

Essential Living Foods, Inc. is on the auction block a mere three weeks after seeking bankruptcy protection on December 1, 2016. Don’t blink, or you could miss it.

The Proposed Bid Procedures

Yesterday, Essential Living filed a motion asking the court to approve bidding procedures; the hearing is scheduled for December 27th.

  • Terraholdings, LLC has made the initial “stalking horse” offer to purchase the company for $1.5 million, subject to overbidding with a proposed opening bid of $1.57 million.
  • Essential Living has asked that the Court set a hearing to approve a sale to the successful bidder on or before a lender-imposed closing deadline of January 10, 2017.
  • The sale process is being overseen by the financial advisory and investment banking firm Mirus Securities, Inc.
  • The debtor has proposed that all bid documents must be received by the company and its bankruptcy counsel, Weintraub & Selth, no later than two business days before the sale hearing.

The Company’s Operations

According to its court filings, Essential Living, a subsidiary of Beon Holdings, Inc., was incorporated in 2004 as a benefit corporation that sells sustainably sourced organic superfoods sourced from small farms around the world in locations such as Ecuador, Peru, and Indonesia. Its primary products include gogi berries, golden berries, maca, raw cocoa, smoothie blends, trail mixes, supplements and other organic superfoods and snacks. (Yum!) Customers include Costco, Whole Foods Market, and health food stores and grocery stores across the country.

56680825 - goji berry drink

Essential Living has a co-manufacturing facility in Commerce, CA, a third-party logistics warehouse in Los Angeles, and several warehouses. It has eight full-time employees handing accounting and administration, sales, warehousing and logistics, and food safety. Substantially all of the company’s assets are to be sold, including product formulas and blends, contracts and significant purchase orders, know-how, trade names, trademarks, inventory, accounts receivable, and fixed assets. In its emergency motion seeking authority to use cash collateral, the debtor valued its primary assets at roughly $1.9 million (consisting of approximately $700,000 in accounts receivable, $1.2 million in inventory, and $50,000 in cash on hand). It has projected gross sales of $700,000 and collections of $500,000 for December 2016.

Additional Information

Additional information can be obtained from Mirus Securities, Weintraub & Selth, or the Bankruptcy Court. The case is pending in the U.S. Bankruptcy Court for the Central District of California, Los Angeles Division, under Case #2:16-bk-25844-RK.

Mette H. Kurth

Tequila Shots, Default Interest, and the 9th Circuit’s Reversal of In re Entz-White

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Friday night I hosted a Día de los Muertos party.  Naturally, I invited other bankruptcy attorneys. And when you mix lawyers and tequila, things can get pretty crazy.  It wasn’t long before someone was well into an animated story about his Absolutely Worst Day Ever as a Lawyer. Now that its Monday morning and we’ve all sobered up, here’s a recap of his Very Bad Day and the surprise reversal of In re Entz-White that caused it.

Last Week, Debtors Could Avoid Accrued Post-Default Interest in the 9th Circuit by Curing an Underlying Default…

My friend (let’s call him “Roberto”) was representing a debtor that had fallen behind on its loan and was facing insurmountable default interest.  If it could avoid the default interest and other late penalties, it could otherwise cure its defaults, restore its loan to its original terms, and successfully reorganize. “No problem!” Roberto had said. And he took the case on a contingency.

Roberto was right. In re Entz-White Lumber & Supply, Inc., decided back in 1988, held that when a debtor cures a default it may avoid all consequences of the default, including higher post-default interest rates. In other words, it may both repay arrearages at the lower, pre-default interest rate and return to pre-default conditions, including pre-default interest rates, for the remainder of the loan obligation.

Mechanically, it works like this. Section 1123(a)(5)(G) of the Bankruptcy Code requires that a debtor’s plan of reorganization adequately provide for its implementation, including by “curing” any default.  The Bankruptcy Code contains a long list of definitions. Oddly, “cure,” used throughout the Bankruptcy Code, is not one of them. To fill in that gap, the Ninth Circuit adopted the Second Circuit’s definition of cure, e.g., curing a default means taking care of the triggering event, thereby nullifying all of its consequences, including default penalties such as higher interest.

Roberto had relied on Entz-White in charting a path forward for his client. The case was on the verge of confirmation, and he was on the verge of earning his contingency fee.

…. But on Friday, the 9th Circuit Issued a New Opinion Overturning Its Prior Ruling

On Friday, instead of celebrating, Roberto was shooting tequila in my living room and crying into his cerveza.

In In re New Investments, decided earlier that day, the Ninth Circuit overturned its opinion in Entz-White, holding that Bankruptcy Code Section 1123(d) voided Entz-White’s rule that a debtor who proposes to cure a default may avoid a higher, post-default interest rate in the loan agreement.  The Ninth Circuit reversed the bankruptcy court’s underlying order, which had confirmed a Chapter 11 plan based on Entz-White… and simultaneously upended my friend’s pending case as well.

Section 1123(d), which was enacted in 1994, well after Entz-White was decided, states that:

Notwithstanding subsection (a) of this section and sections 506(b), 1129(a)(7), and 1129(b) of this title, if it is proposed in a plan to cure a default the amount necessary to cure the default shall be determined in accordance with the underlying agreement and applicable nonbankruptcy law.

Following is a brief summary of the case and the court’s rationale.

1. Evaluating Applicable (Washington State) Nonbankruptcy Law

In New Investments, the debtor had defaulted on a real estate loan, thereby triggering a default-interest provision. It then filed for bankruptcy protection to avoid foreclosure.  Its plan was to sell its property and then use the sale proceeds to payoff the loan – thus curing the default – at  the pre-default interest rate. The lender objected, pointing to its contractual rights under a promissory note that called for payment of a higher interest rate (equating to approx. $670,000) upon default. The loan agreement was governed by Washington state law. The Ninth Circuit concluded that Washington allows for a higher interest rate upon default when provided for in the loan agreement. See Wash. Rev. Code Ann. Section 61.24.090(1)(a). Thus, it held that cure, as determined under the parties’ contract and applicable state law, required payment of accrued default interest.

2. The Plain Language of Section 1123(d) Drives the Ninth Circuit’s Decision

The Ninth Circuit stated that the plain language of Section 1123(d) compelled its decision. As with all plain-language arguments, there is nothing to analyze here. You can read Section 1123(d) and decide for yourself whether you agree.

3. Surprise! The Legislative History Indicates This Result May Be Unexpected

In case you disagree with the Court’s plain reading of the statute, the Ninth Circuit also looked to the statute’s legislative history and stated it would not help New Investments. Essentially, the Ninth Circuit concluded that Congress had a very particular, and different, purpose in mind when it enacted Section 1123(d) and that it may not have anticipated all of the statute’s consequences. But that, it said, is not a good enough reason to ignore the statute’s plain meaning.

What was Congress trying to do when it enacted Section 1123(d)? The legislative history indicates Congress was primarily concerned with overruling the Supreme Court’s decision in Rake v. Wade, which had stated that, in order to cure a default, a Chapter 13 debtor would have to pay interest on his arrearages even if the underlying loan agreement did not provide for it. Congress was concerned that Rake v. Wade provided an unbargained-for windfall for creditors and enacted Section 1123(d) to “limit the secured creditor to the benefit of the initial bargain.” Congress, the Ninth Circuit acknowledged, may not have anticipated how Section 1123(d) would be interpreted in other contexts.

But the Ninth Circuit felt that its holding, if unanticipated, would not be inconsistent with Congressional intent. In holding the secured creditor to the benefit of its bargain, Congress had said that a cure pursuant to a plan should “put the debtor in the same position as if the default had never occurred.” That, it said, is consistent with holding both parties to the benefit of their bargain and with the concept of cure generally (which it conceeded Section 1123(d) did not alter or attempt to define).

The Ninth Circuit tacitly recognized that its holding will make it more difficult for some debtors to reorganize, undermining the Bankruptcy Code’s goals of offering a fresh start to honest debtors. But it felt that its decision strikes an appropriate balance between the interest of debtors and creditors.

4. The Interpretation of Cure in Section 1123 is Consistent With the Concept of Unimpairment

The Ninth Circuit also stated that its ruling in New Investments would be consistent with the concept of unimpairment under the Bankruptcy Code.  To render a creditor “unimpaired” such that it cannot object to a debtor’s plan, the debtor must cure defaults and may not “otherwise alter the legal, equitable, or contractual rights” of the creditor. One of these rights is post-default interest.

Future Default Interest Differentiated

It is worth noting that the New Investments decision focuses on the treatment of accrued, default interest when a debtor is calculating required cure amounts.  But once default interest or other penalties are paid and a default is therefore cured, the debtor can still return to pre-default conditions as to the remainder of the loan obligation.

Judge Berzon’s Dissenting Opinion

In a dissenting opinion, Judge Marsha S. Berzon wrote that neither Section 1123(d) nor any other provision of the Bankruptcy Code provides a definition of “cure” contrary to the one announced in Entz-White.

As for the majority’s conclusion that Congress displaced Entz-White when it passed Section 1123(d)? Judge Berzon argues at length that this conclusion is not supported by either the plain language of the statute or its legislative history. Instead, Judge Berzon argues that the Court should not read the Bankruptcy Code to erode past bankruptcy practice absent a clear indication that Congress intended such a departure.

My friend Roberto would certainly agree.

Download the Case Here

Pacifica L 51, LC v. New Investments Inc. (In re New Investments, Inc.) No. 13 -36194 (9th Cir.) 2016.

 

 

 

Sold! Court Approves Lender’s Credit Bid for The Picture People

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Another retailer comes off the bankruptcy auction block….

Following a hotly contested sale process, yesterday the bankruptcy court entered its order approving The Picture People’s sale to its prepetition lender through a designee, TPP OPCO, Inc.

The sale did not generate cash for creditors but instead was completed through a $12 million credit bid.  (English translation: The lender was allowed to bid for the company by crediting its outstanding debt against the purchase price.)

The company has indicated that the sale will enable it to continue as a going concern, preserving roughly 1,200 jobs for its employees.

The credit bid, meanwhile, remains subject to attack by the Creditors’ Committee on a post-sale basis through December 9, 2016.

The Order Authorizing the Sale of Assets is available for download here, and the entire docket is available on KCC’s website.