Amend and Pretend: Private Credit's Hidden Defaults (w/ Tuck Hardie, Houlihan Lokey)

0:00Think of all the chaos we just discussed and the headlines we're seeing that there'd be a lot more defaults. But defaults have generally been low. And so if you find out about it, odds are I didn't do my job. So people kind of hold their nose, close their eyes and kick the can down the road. What's on your mind for 27? What happens with all this debt that's coming due in 28? I think, I mean, we're moving balance sheets now that are due in 2028 to 20, 2030. You know, there's a lot of people who want to get past the next presidential election in the U.S. Claude has replaced a lot of what we used to hire Junior Resources to do because I can now put credit docs into Claude and it'll tell me in five minutes what the borrower has in the way of flexibility.

0:42Does it get moved? Does the people actually start enforcing the documents? Or is everybody going to behave here? And because things are so uncertain and nobody wants to take the L officially. It's not venture capital. It's private equity. It's the private equity funcast. Pour yourself a drink and have a seat. They say that every day your business is late to AI, you fall two days behind. But how do you keep up? The competition is only moving faster. Fortunately, there's NetSuite Next. You probably know NetSuite, the AI-powered business management suite that securely connects all of your data. trusted by over 44 ,000 customers?

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1:54Go to netsuite.ai slash funcast. Built for every industry, ready for every boardroom. netsuite.ai slash funcast. All right, three years ago, this guest and I did an episode called It's Restructuring Time. That was November of 2023, and boy, did we have a lot to say back then. It's been three years. I think one of our most downloaded episodes, certainly in the last five years. Tuck Hardy is the managing director and Houlihan Loki's financial restructurings group. He's a longtime friend of the firm and a return champion to the podcast. So, Tuck, what's happened in the last three years? Not much since 2023.

2:35Oh, come on, Devin. That's crazy. It's been an interesting three years, probably some of the most volatile really since the GFC. occasioned by the lack of a reduction in interest rates, which I think everybody was counting on, the chaos coming out of Washington, D.C., whether it's Liberation Day tariffs and then the elimination of the tariffs, the consequences of the various military conflicts around the globe on commodity prices, in particular oil and natural gas, and the spillover effect of that on the consumer. And really everything that you and I or anybody else buys has gotten more expensive because it's got to move around through some diesel-powered truck or diesel-powered train or similar.

3:34And the implications of that on the income statements of literally every business in the economy. And then you've got the overarching concerns that, you know, AI is going to put us all out of business, or it's going to put a whole bunch of software companies out of business. Although they're, you know, and then the, you know, the potential AI bubble from financing all these data centers that nobody wants in their backyard. So it's been a lot of fun out there. Like I said, three of the most interesting of my 26 years here at Houlihan. I was going to say, the hits keep coming. And just a reminder for everybody, so you were a client 26 years ago.

4:23You worked at Marvel. Stan Lee and Spider-Man were your bosses. You were in a tough situation and I think called Houlihan for some help and then joined the team. and you guys have the biggest restructuring team on the planet. I believe you're on all continents other than Antarctica. So sorry for, what is Antarctica? The penguins are safe. The penguins are safe. Yeah, penguins, no polar bears. Is that the Antarctica thing? That's right. So you see a lot. You just get a lot of reps, which is why we've had you back now for the second time. You're seeing a lot. Your team sees a lot. When it was November of 2023, right, We still had a president who was apparently running for office and then decided not to.

5:07We had a very tight and fraught election. We had Liberation Day. We have a war, all the things you listed. Like, are these cycles in your 26 years, are the cycles getting faster of distress, or we're just more attuned to it because we're so plugged into the matrix all the time? Well, I think the frequency of policy changes, drastic policy changes, has accelerated with this most recent administration. And because of the absence of stability, chaos, it's hard for people to plan. And balance sheets that are put in place under a certain set of circumstances don't work when those circumstances change, you know, kind of outside that second or third standard deviation from the mean.

6:00You know, people understand modest inflation. People understand changes in technology. People understand volatility in base commodity prices occasioned by economic forces. But when you invade Venezuela and you find yourself in a war that essentially shuts off a big chunk of the supply of petrochemicals to the rest of the world, you know those are not things that people banked on when they were thinking about you know what what risk factors do we need to put in in the investment memo when we look to to make this loan or make this equity investment and you know as a result you're dealing with things that people hadn't really thought about COVID is the perfect example nobody thought about a pandemic and that was in nobody's investment memos.

6:54It is now and will forever be. But, you know, and I guess the one that I would analogize to today is, you know, is AI going to eat, you know, every part of the economy and make it redundant and put it out of business? You know, I was talking to somebody the other day about sending their kid to become a diesel mechanic because it's one of those jobs that Claude can't do. But, you know, these are the same parents that told their kids to be accountants. And then after that, what didn't work? A computer program. Exactly. Parents get out of the business of predicting future job security. I think that's probably my advice for everybody diesel diesel mechanics and uh and and chefs i suppose any philosophy majors i think to deal with all the uh moral challenges in the world and and and uh quite big uh questions we have so we need another renaissance here um so let's do this let's take a quick little uh like reframe uh for everybody because there's this is now headline news since we talked right you were saying your phone was starting to ring more in 23, you're getting more calls as kind of rates, you know, or we're hoping rates were going to come down.

8:13And then we've had, let's call it chaos in the last three years, certainly business chaos of people trying to address these rapid swings in policy and then international events. But there's a lot of language. Every industry has its own language. And that's confusing for people. So how about we just do like a quick fire, define some of these terms for me, Tuck, as you know them. And if I have them wrong, fix them for me. So like, what's an LME? Well, so LMEs have evolved, you know, it was originally thought that sponsors could use holes in the covenant packages of the credit documents that they had in place to raise capital in a way that was detrimental to the existing lenders.

9:08And they would then turn around and use the threat of doing that to get those same lenders, the existing lenders, to do something favorable for the sponsor. What's happened since the LME balloon blew up is a couple things. One is creditors have all figured out that it was a zero-sum game and there were winners and losers, and they've kind of banded together. The evolution of the co-op agreement, which nobody had ever heard of three years ago, is now prevalent in most, if not every multi-lender syndicated loan that is, you know, headed for trouble or in trouble so that the creditors know that at least the folks at the table aren't going to be the ones taking drastic actions that would be detrimental to their recoveries.

10:02There's still obviously the opportunity for somebody who's not at the table to take advantage of the covenant flexibility that a borrower might have. And in fact, there are folks whose business models are, I'm not going to sign the co-op agreement and I'm going to, you know, know, play the game the way it's supposed to be played, which is for my own benefit as opposed to, you know, signing the co-op and, you know, pledging allegiance to the group. So that's, so the LM phenomena has kind of evolved over the course of the three years from being the wild, wild west, which has now since been tamed by a lot of folks saying this is a bad idea for our industry, the creditor industry.

10:46And then out of that sprang the co-op agreement. So all it takes is a good restructuring advisor and an attorney from Simpson Thatcher to find the hole, exploit it, and then the hole gets filled by the next round of good lawyers from Kirkland and Ellis. Well, except that the market determines whether those holes will exist or not. And, you know, the number of folks in the credit world who are looking to put money to work, as that number goes up, the flexibility in the documents comes back. I mean, I can remember, you know, post Enron, everybody was, you know, looking at ways to tighten down documents and, you know, make sure that something like that never happened again.

11:32And as the market evolved and as people needed to put money to work on the creditor side, they gave a lot of that flexibility back to the borrower and the sponsor. So I don't think you'll ever be able to kind of legislate away all of that flexibility because the market will continue to find a market equilibrium. But that equilibrium changes based on whether or not it's a borrower's market or a lender's market. And then you layer on top of that the fact that there's so much of this money that's now mark-to-market reported, and people don't want to show negative marks on the creditor side, and so they're doing things like the amend and pretend or the amend and extend because they don't want to.

12:27So that was next on my definition list was that. So but real quick for the audience, LME stands for what? Liability Management Exercise. Yeah. Things that none of us knew about a few years ago that all of us see. Or let my maturity extend. There we go. Good. All right. So what's amend and extend? And this is later talking about the debt wall. But when somebody says amend and extend or amend and pretend or, you know, usually used in the pejorative, what does that mean? And what does it look like? It's really an exercise where a borrower realizes that they're going to be unable to refinance a particular balance.

13:08A sponsor is unable to refinance a particular portfolio company's balance sheet by the existing maturity date. The existing credit documents almost certainly have some quantum of flexibility in them that would allow for new capital to come into the balance sheet. and it would be damaging to the existing creditors' recoveries. And so the borrower approaches the creditors and says, look, I'll give up this flexibility that I have in the balance sheet to raise additional capital that would negatively affect your recoveries, but I have to have something in return for that. And what I want in return for that is time.

13:50And I want the time to allow for the borrower to hopefully grow into its balance sheet And the necessary growth is really a function today of the fact that a lot of these balance sheets were put in place with extremely high leverage levels, but at historically low rates. You know, people used to fight about LIBOR or SOFR floors. Nobody talks about floors anymore. Now they're talking about, you know, caps. and so if your balance sheet is of a certain size but it was set at a particular price and that price is now 500 600 basis points higher you might have been able to afford it all things being equal at you know s plus 100 but at s plus when s was uh one now that s is five you know you simply can't afford the balance sheet anymore and so you need more time to hopefully grow into that balance sheet.

14:49And that's what the amend and extend phenomena is all about. And there are reasons why, both on the borrower side as well as the creditor side, that it might make sense to do it. There are also instances where it's being abused and people are doing it knowing that it's really a kick the can over the cliff. Because when the balance sheet does finally come due at some point, the quantum of debt will have grown and the business won't have grown into it. And all you will have done is really reduce the returns or recoveries for folks. All right. So the last one here, LME, amend and extend, and then PIC.

15:40I think those go hand in hand on the amend and extend and PIC. So what does PIC stand for, and when is it used, and is that the issue when you amend and extend as you're just now raising the bar for recovery? Yeah, payment in kind is the actual, what the acronym stands for. And really, it was designed to address temporal issues that a particular borrower or industry might be having in order to prevent the balance sheet from forcing something that it wasn't time for. And again, like everything, there are instances where it makes sense. And so I'll give you a great Liberation Day example. I had a borrower that had most of its offshore goods produced in China but was busily moving it to another jurisdiction.

16:45And as a consequence of the cost of that move, which had been layered in and was all in progress, but they needed to spend some money to do that. And so they went to the creditors and said, gee, we'd like to pick or not pay or accrue this quarter's interest and half of the next quarter's interest. But here's where we're spending the money on. We're moving our manufacturing out of China into another jurisdiction. It'll have the same margin structure in terms of the product. And then once we get this move accomplished, we'll be kind of back where we thought we were before Liberation Day occurred.

17:24and the creditors all said that makes sense to us. And so as a consequence, the borrower was allowed to pick the interest for a quarter and then half of the next quarter's interest. And once the business kind of got back on its feet post that change in jurisdiction for the manufacturing operations, they were able to pay their interest in full, including the interest that had been picked during this temporal problem of moving the manufacturing. That's not what happens most of the time. Most of the time, it's a business that was bought at too high a multiple with too much debt, that the cost of that debt is too high as a result of the current interest rate environment.

18:07And people don't want to realize a permanent capital loss by putting the business up for sale and realizing that it's not going to sell for 100 % of the debt and or any of the equity that was invested in it. And so they're, you know, kicking the can down the road with an amend and extend or amend and pretend. And they're agreeing that some portion of the interest that would otherwise be due can be picked so as to allow the business to continue to operate with adequate operating cash flow. But, you know, the loser in that situation is the creditor because they're not getting 100 percent of their interest obligations paid.

18:52The sponsor or the owner of the business benefits because the option on a turnaround has been extended by whatever period of time the amend portion of the or the extension portion of the A &E is granted. and the creditor benefits, I suppose, because they don't yet have to admit to their investors, the LPs and whether it's a BDC or a CLO or some private credit fund, you know, that their loan is impaired. And if they're in the middle, in the midst of fundraising, they're probably going to give the borrower the flexibility that the borrower is asking for with some limitations. And that also allows the sponsor to continue their fundraising efforts for their next fund because they don't have to tell their LPs or future LPs, hey, we bought this business for too high a price in the current environment and its balance sheet is too over levered and we can't afford it and we've probably lost our equity dollars.

19:56And so the dynamics of the fundraising cycle, both on the creditor side and the borrower side, the sponsor side, are incentives to kind of unnatural flexibility being provided to borrowers that really don't deserve it. So the A &E and the PIC solution work in some instances, and they should be employed in others. But they also can be abused. And there's a difference between PIC. There's PIC from inception, like, hey, we made this loan, and the interest is going to PIC. And then there's PIC at some point along the way where you have to PIC the interest because you can't afford it. or there's some event that you and the lender have decided, hey, can we give me some relief here?

20:47So let's jump into, so when you read about PIC, just understand the difference. Listeners, PIC doesn't mean this is a bad loan. It may be PICing from inception sometimes for some period of time. It doesn't always mean there's danger ahead, but it's not a good thing if you can't afford your interest. Yeah, those tend to be loans against, you know, hold co equity in the opcos. And they're essentially loans against equity value where they're picked from inception. And they are risky bets because you're basically, you know, wearing the creditor hat but taking equity risk. But there are people out there who do that.

21:29But yes, what I've been describing is the situation where the borrower and the lender make a deal on picking all or some portion of the interest that was previously paid in cash. All right, Liz, this leads great into my next question, which was you'd think of all the chaos we just discussed and the headlines we're seeing that there'd be a lot more defaults. But defaults have generally been low, I think, like, you know, actual defaults. So how should people understand the gap, the chaos and the lack of default? As I said earlier, I think we should redefine what default means. Default is in the eye of the beholder of the debt.

22:15Default is in the eye of Altman, I guess, since he's the guy who tracks defaults. defaults. But what is a non-performing loan, which is now what a lot of people are focused on as opposed to a capital D default or event of default, what is a non-performing loan is also something that people are revisiting the definition of. As more and more borrowers are paying less than 100 % of their cash interest burden, you know, should that be defined as a non-performing loan or not? The reason for the relatively small percentage of capital E, capital D events of default and thus bankruptcies is really the dynamic that we've been talking about, which is that, you know, the credit funds are fundraising, the equity funds are fundraising, and nobody wants to find out how bad a deal they have on their books.

23:21And so people kind of hold their nose, close their eyes and kick the can down the road. The end of that dynamic will come in whole or in part, you know, because the limited partners, the investors in these vehicles are asking for capital back. And they're not committing to the next fund until they get a certain quantum of their existing capital returned on account of their existing fund investments. And that's actually slowing down the amend and pretend or amend and extend phenomena. And I had a situation recently for a sponsor-owned business that wanted to do an amend and extend with its existing creditors.

24:14And we could get, you know, nine out of the 10 of them to agree. But one of them just simply said, I can't do it. My investors will, you know, string me up by my thumbs if I agree to, you know, to an extension on this credit. And frankly, I don't want to lose my job. So I'm going to say no. And you guys have to find a solution that doesn't result in me having to extend the loan. And we found a solution, essentially a replacement lender, who came in at an advantageous price. But the existing creditor, who simply was unwilling under any circumstances to do it, got out. And I think you'll start to see more and more of that as folks realize that there are some of these balance sheets out there that don't deserve to be extended.

25:05And the GPs or the managers of these funds realize that their ability to continue to raise capital for new funds is being impaired by the fact that they're not returning a sufficient quantity of existing investments. And one major development since you got in the business 26 years ago, and certainly accelerated in the last handful of years, and since the last time we talked, is the rise of private credit and private credit's role here. So how much of this dynamic around lack of defaults, extensions, other kinds of things, how much does private credit play into that? And let's take a lesson from the GFC and maybe even COVID a little bit and then apply it to what's going on now.

25:49So I think you have to take COVID, again, as kind of a temporal event that nobody anticipated and that everybody assumed would pass. And it generally has. You know, you occasionally see somebody wearing a mask, but not very frequently anymore. And most of the businesses, like the movie theaters and restaurants that were really hurt by COVID, have by and large recovered. I'm sure there's an exception out there that I can't think of right now. But anyway, so that really was temporal. Now, the problem with COVID was that everybody took on more debt. Nobody sold equity as a way to get through COVID.

26:33And so if you had a portfolio of 100 companies and 10 of them were under levered at the beginning of COVID and 10 of them were already over levered, the 80 in the middle went from being appropriately levered to now they're over levered because they all took on debt to get through. And a lot of those have worked their way through, but some didn't. And that was, you know, a lot of what we were doing when you and I talked last is working to those who didn't, who weren't able to work through the incremental debt that they took on. And now the abundance of private credit investment vehicles that are providing capital to sponsors to create these portfolio companies is part of the reason why you are seeing these, I'll call them unnatural acts being taken by creditors because of the fundraising dynamic I mentioned earlier.

27:30When I got into this business, you had unsecured bondholders and banks. And unsecured bondholders wanted their money back, and banks wanted their money back, and the banks had to deal with their regulators. You and I all age ourselves here like First Union didn't need to fundraise. They were a voracious middle market lender, and they didn't have to worry about fundraising. How about Irving Trust? There's one for you. Nobody remembers Irving Trust. Anyway, the point of the comment, though, was that the dynamics that exist today for – or the incentives that exist today didn't exist back then because bondholders bought bonds.

28:08And if you didn't give them their money back, they declared defaults because the trustee on the bond indenture said, that's what I'm supposed to do. And you ended up in bankruptcy. Or the bank who lent the money said, well, I'm not going to go explain to the regulator who I have to answer to, you know, why it is I'm giving you pick interest or more time or, you know, whatever. You know, you can't pay me, you know, file bankruptcy and we'll see where the value shakes out. And you kind of had these very simple structures. Now you have very complicated structures. You tend to find a lot of the same investors in a whole portfolio of credits.

28:46in industries. And the fundraising dynamic and the mark-to-market dynamic really have changed people's behavior. And as a result, it changes what I do for a living because instead of now of managing bankruptcies, I'm trying to mediate between borrowers and creditors what a fair allocation of future risk on a turnaround is as part of an amend and extend or a liability management exercise. You know, how much flexibility, you know, do I as a representative of a borrower have to give away to get people to give me more time? And, you know, how much money should the sponsor put in versus how much money should the creditors put in?

29:35Kind of that, maybe I mentioned this on the last one of these podcasts, but, you know, the burden sharing concept. Everybody's made an investment in a borrower. Things have changed from what was originally anticipated. How are we going to share the burden of that change in dynamic? You know, should it all fall on the sponsor or should the creditor bear some of that risk? And, you know, what's the ratio of risk sharing or burden sharing? And so that's kind of what what my business has turned into now is really trying to mediate those kinds of issues because so few people really want to go through, you know, the real pain and cost of a bankruptcy.

30:19And it's not just the professional fees, it's the cost on the organizations that have to, you know, run these companies. And as a result of all that, people have really tried to avoid it unless there's just really no way to avoid it, whether it's a litigation judgment that you've lost and you have to deal with it through a bankruptcy or a bunch of leases that you have to get rid of that there's no other way to do it than a bankruptcy or something like that. But if it's just a borrower and a syndicate of lenders, I would think that today 85%, 90 % of those get worked out. I talked to a reporter from one of the business publications that covers my industry, and she said, well, how come I'm not reading about more of what you're working on?

31:10I said, well, most of the time my job is to make sure you never find out about it, to do it behind the scenes, avoid the consequence to the borrowers, customers, and suppliers, and employees of the publicity. And so if you find out about it, odds are I didn't do my job. It may be surprising to some listeners that in a situation where the debt is impaired, right, even by a penny, if the debt was impaired, that would mean the equity is worth zero, right? Why is the equity holder even at the table if the lenders are saying we believe our debt is impaired? Why do they have a seat at the table? Why aren't the lenders working it out themselves?

31:53There are two reasons for that. One is the cost of pushing the sponsor away from the table through a litigated process is very high. And two, by and large, the participants in the private credit lending community really aren't, they're not set up organizationally in terms of the type of people that work there or the number of people that work there to manage companies on a day-to-day basis. It's a skill that a lot of them just simply don't have. A lot of them will actually admit that they don't have it. They can rent it from various firms, and they'll come in on behalf of lender groups and manage an asset, typically through a sale process.

32:47But there are some of them who do have that skill, And so, you know, they have an advantage over those who don't because they can say, look, Mr. Sponsor, your portfolio company is way over levered. You're out of the money. You know, I'm prepared to pick up the keys and run the business for my benefit and the benefit of whatever other lenders are in my syndicate. So your threat of, you know, stop me or I'll shoot, kind of the blazing saddles analogy, is, you know, doesn't scare me. A lot of times, though, you know, that lending community doesn't have that skill set. And as a result, they don't want the keys thrown at them because, you know, they don't know what to do.

33:32And they don't want to sell it right now for whatever reason, you know, unique to the business or a particular industry. And so they keep the sponsor around managing the asset. They typically put in as much in the way as they can of guardrails on actions that the borrower or sponsor can take. They implement director changes to make sure that there are people that are keeping an eye on the business with a different mindset, not an equity mindset, but a creditor mindset. And they typically make sure that the value attributable to their stake in the business versus the sponsor stake in the business is shifted so that they get more of the potential upside that they're allowing to potentially create.

34:26Yeah, on the positive side, you've got a sponsor who knows the business, knows the industry, knows the management team, has a relationship there and is built to manage a company, at least from a board and operating team and things. On the downside, you have a sponsor who's incentivized to swing for the fences to get back to where the equity is worth something. And they also get to continue to charge fees, pretending it's invested capital in the fund because they haven't written it off or taken a zero, officially taken a zero on it. So it still counts as dollars in and they get 2 % of that invested capital after year five.

35:00So huge financial incentive for the sponsor to play ball there, though it does. I mean, I've been in Workout 25 years ago during the dot-com bust, some telecom deals and things, having the guy from PwC fly down every month and scream and yell at me. Like officially in Workout where they hired a consultant to come in and things, not this kind of somewhere purgatory we have these days. So it feels like the lenders are using the sponsor as the old Workout consultant. It's like, hey, you know the business. You've got incentives here. We're going to put structures in place that you don't swing for the fences and blow out the debt value.

35:36And you can pretend it's still an investment in your portfolio and charge 2 % on the invested capital. Well, they might charge the LPs or they might accrue 2 % on the LPs value. But I can promise you the lenders aren't letting anybody pay those sponsor fees in cash. Oh, yeah. That could be turned off on day one. No, the monitoring fees are gone, but I get to charge my LP 2%. That's right. as this as vested capital. That's right. All right. Let's jump into like when you get called and what it looks like around the table before we get into some predictions here. And I know you've got, um, you're a busy guy these days, you got other stuff to do, so we can't hold you for an hour and a half here.

36:14So how do you, when you get the phone call, um, we talked a little bit about this on the episode from, uh, November 23, like you wish you got the phone call sooner. You often are getting it in a, in a, you know, Hey, we got to move here. But like, how do you quickly assess the difference between a good business with a bad balance sheet versus a business that's broken? You know, what are the things you're getting to right away? We follow a lot of industries through our corporate finance colleagues. And so we know, you know, industries that are going through macro distress or trouble. we obviously you know are because we have such a large group of people that are in our group and and we have the experience that we do have it doesn't take very long to assess okay this is a this is a bad balance sheet and a good company or this is a company that's you know seen better days and then you know you want to find out you know how quickly you're going to have to address the the creditor stakeholders in the balance sheet.

37:23You know, what's the liquidity? Covenants is one thing, but liquidity is the primary thing. You know, when is this company going to run out of money, not be able to make payroll, stop servicing, you know, its critical trade creditor obligations, and thus, you know, the business grinds to a halt.

37:45And once you've assessed the liquidity of the situation, you know, you then have the ability to figure out, all right, you know, what's the triage? I need to go talk to the creditors about making payroll, or do I need to go talk to the creditors about just simply giving me a covenant waiver so I don't have to tell the world that I'm in default and thus, you know, bring the whole house of cards down because everybody gets afraid because I'm in workout. And then, you know, you assess the business from its fundamentals? Is it a software business that's going to be eaten by AI or is it a manufacturing business that just simply needs to move its operations from China to Vietnam or somewhere else?

38:31And what does that mean? And what is that going to cost? You know, that's the other thing. And how much of your team is player versus coach or player-coach? And I know we talked last time about being like a grief counselor most of the time in your job. But are you coming in and saying, here are some things you could do right away and directing some things to do? Or are you just there to negotiate and referee between the lenders amongst themselves and maybe the lender and the sponsor between those groups? We don't. Yeah. We don't typically provide operating advice. We're providing financial advice.

39:12Now, some of that advice may, though, spill over into the operations. You know, if I can make payroll by deferring a tax payment, even though I'm going to pay a penalty on not making my tax payment on time, but I can make payroll, you know, our advice to the CFO is, look, pal, we've got to make payroll because otherwise, you know, nobody's going to make the donuts next week. So we're going to pay the penalty to the IRS when we eventually pay the IRS. Or, you know, you end up having a conversation with the landlord on some facility that is no longer of significant value to the operations. And, you know, gee, Mr.

39:55Landlord, we're not going to be able to make your rent payment this month because I don't have any more operations in your facility. And I've got to make the payments to the guy who's got the facility where I do have all my operations. So it's not us making operating calls, but us evaluating what the financial demands are, what the financial resources are, and helping management figure out which ones are alternatives versus aren't. What are the flavors of phone calls you get? Well, nobody calls us until they have to. Some people realize that they have to sooner rather than others. and that's a function of really the firm.

40:38I'm thinking in particular about sponsors now. That's really a function of the firm's experience. If they've never had a defaulted credit before or they've never had a business that was over levered and been unable to service their debt, they're going to call you last because they don't realize that they have a problem until it's very late in their own realization. Have they already gone through a few rounds with the lenders themselves before they're calling you? Probably, and the lender community loves it when the sponsor guy calls up and says, I need some help with my balance sheet because the first thing the lender is going to say is, well, just put some more equity in there and I'll give you the time.

41:22And the sponsor thinks, okay, well, I guess that's what I'm supposed to do, not realizing that sponsors putting in dollars to a distress situation is of tremendous value to the creditor, and they should get something in return for that. And one of the things that we educate sponsors on is kind of what the market is when the sponsor is willing to write a check into a distress situation. And it is a market that is somewhat bespoke, but there are guidelines that we can give sponsors when it comes to what they should be getting in return for equity dollars or what they should be getting in return for simply continuing to manage the asset for the benefit of a bunch of creditors.

42:06And we try and educate the sponsors on what we're seeing in that regard so that they can, you know, get better value for their effort and their capital. how many times is the call hey i can see something into q2 next year let's get ahead of this start planning and you guy you advise me as a sponsor on how do i handle this lender group i have versus hey talk i got a fun payroll on wednesday for next monday and it's not going to happen so what do we do yeah i would say that as the sponsor community has watched other sponsors, they've come to the realization that acting sooner is in their interest.

42:55It does require them to be intellectually honest with themselves about a particular situation and also with their LPs, but it ends in better outcomes. And kind of going back to the LME conversation we were having earlier, in a lot of instances, sponsors have this tremendous amount of flexibility in their documents. And they could use it aggressively against their existing creditors. But that's going to have at least two direct results. One is all of the lenders in that particular borrower's balance sheet are going to remember what the sponsor did. And if they're in other portfolio companies of that sponsor, they're going to find a way to get even.

43:43And the other thing that it will do is it will say to the new money market, oh, we've got a sponsor who's prepared to use LME against their existing creditors. We're going to need to tighten up the docks next time around or tighten up the or increase the cost to this particular sponsor. And so a lot of times my advice to sponsors is, hey, you have all this flexibility in the docks and you don't want to look like a schmuck to your LPs by just giving it away for nothing. Let's go get something for it. So you say, all right, Mr. Creditors, I have the ability to put in another$100 million ahead of you and really jam you.

44:23I'll get more liquidity for the company and I'll get more runway. but your recoveries, if this doesn't turn out well, are going to be diluted by this$100 million worth of senior financing. Of course, the creditors say, well, we hate that idea. And you say, all right, well, how about I don't do it? You give me X and some more time, and I'll give you back the flexibility in the document. It's kind of that, it's a trade, but it's a non-financial trade. It's trading away flexibility for something in return from the creditors. And the speech that I often find myself giving to private equity sponsors is, your competitors in the sponsor community are doing this.

45:05And so therefore, your investors are going to ask you, what are you doing to take advantage of the balance sheets that you have? You know, you're great at running the businesses, but are you also great at managing your balance sheets? And a lot of sponsors have really embraced that because the LP community has said, hey, hey, you know, I see what, you know, sponsor X is doing with their creditors when things get tight. Why aren't you doing the same thing? And so they call us and say, all right, you know, we're kind of getting on the bandwagon here. Help us figure out what we can and can't do when things get tight.

45:41You got one quick question and then we'll pull out the crystal ball before. I don't want you to be late to your next meeting, given how busy you are these days. So one, in first sign of stress as a sponsor, do I call my lender or do I call you? Well, of course they should call me. But I think if it's really a very minor issue, they'll typically call their lender first. And the lender, you know, again, if it's a relationship lender, they can probably work it out. But my advice has always been, look, you can call me. I may or may not charge you anything. I'm in the business of creating relationships and longstanding business with sponsors or creditors for that matter.

46:29And just, you know, I'll give away advice for free. It's the way you build a business and the way you build a reputation and a career. But the first move isn't to punch your lenders in the face. No. That's not the move. No. I would never advise that. Yeah, yeah. It was just to be like, yeah, first call, here we go. I've got Tuck Hardy on the line. He's going to speak for me and tell you what we're going to take. I want to get to predictions because we could talk about this all day. Sure. All right, so look into your notes. Look into the conversations you're having in all the continents except Antarctica internally.

47:03You know, your group meetings, as you look out into 27, what's on your mind for 27? What do people need to be paying attention to? What are some of the triggers? or like, hey, I know things are getting better if, or I know things are going to get tougher if. Like, what are you guys talking about internally? Look, I mean, it's the continuation of the impact on the global economy from the increase in gas and diesel. The implications of the war in Ukraine on a bunch of metals that affected, I mean, I think the market has kind of digested the fact that the metals that we used to depend on Ukraine for, we're now looking for alternative sources.

47:48And that's benefited some economies. You know, I think the interest rate environment obviously is going to be critical. A lot of these balance sheets could make sense with a meaningful reduction in market rates. But I don't know that that's going to happen, you know, in 2027.

48:13And then the continuing impact of the ever increasing changes in technology. You know, and it's hard to predict where the impact is going to be, frankly. um you know i laugh you know we were laughing about the kid going to uh diesel mechanic school and you know maybe being a chef but you know claude has replaced a lot of what we used to hire junior resources to do because i can now put credit docs into claude and it'll tell me in five minutes you know what what the borrower has in the way of flexibility whereas we take you know either one of my associates or some law firm's associates, you know, a day or day and a half to do it.

49:06And now it gets done very quickly. And, you know, Claude's getting smarter, too. I mean, yeah, 100 percent. If we talked a year ago versus today of what we're capable of doing with those things, yes, I think that just means you can take on more business without hiring fewer people, probably not removing fewer people. But let's get to this, because I think we've got literally one minute before I'm going to lose you. Like the debt wall. Everybody talks about the debt wall, like from Game of Thrones. Does it get moved? Do people actually start enforcing the documents? Or is everybody going to behave here because things are so uncertain and nobody wants to take the L officially?

49:45What happens with all this debt that's coming due in 28? I think, I mean, we're moving balance sheets now that are due in 2028 to 2020-30. There's a lot of people who want to get past the next presidential election in the U.S. They don't want to know what happens. They want time for whatever happens to kind of work its way through the macro environment. I think you're going to see more of those balance sheets come due than you did in 23, 24, but certainly not all of them. I think a big chunk of them, you know, is it 50-50, 60-40, 30-70, 70-30? I couldn't possibly tell you, but a big chunk of them will continue to get kicked.

50:33But I think a growing portion of them will eventually have to come due and people will say enough's enough. Great. Tuck, let's not do this every three years. We'll get you back before the election. And so for people listening. Yikes. Yeah, I would think the 2028 people don't want to be renegotiating their debt in the middle of whatever this next election is coming. So I had I had just kick the can. I had a client who hired us not too long ago and said, I want this done before the midterms. And we got it done. And they were happy with the outcome. But, you know, things like that are definitely impacting behavior, for sure.

51:14Certainly as a consequence of the chaos that's coming out of Washington these days. Yeah, my wife is smart. She booked a trip out of the country during the midterm. So I'll have been gone for that. But anyway, we have Tuck Hardy, his managing director in the financial restructurings team at Hulan Loki, the largest restructuring team on the street, or as Tuck would say, all the streets on the planet, every continent except Antarctica. All right. That's great. Thanks so much again. Thanks for bringing clarity to the chaos, and I'll see you next time we're in New York. Tuck, thanks so much for coming back, and we'll see you again soon.

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52:54Thank you.