Early engagement with lenders over debt a priority
INNOVATION PARTNER PROFILE PwC:IF THERE is a hot media topic at the moment it is debt. Debt in its various forms – sovereign, corporate and personal – seems to have been dominating news coverage over the past year and more. “In many cases corporate debt is at unsustainable levels,” says Declan McDonald, director of restructuring and insolvency with PwC. “And it needs to be addressed in one way or another.”
Among the solutions he favours for companies is an informal debt restructuring arrangement with lenders. “There is some evidence out there that the banks are starting to consider different forms of debt restructuring,” he says. “However, you have to look at things from the banks’ point of view. Simply writing off debt is not an option. The impact that could have on balance sheets would be enormous. Also, in the supported banks any widescale debt writeoff would effectively be borne by all taxpayers and that’s not really an option.”
This means coming to an arrangement that meets the needs of both parties. The companies at issue in this instance tend to be trading concerns which have amassed large volumes of historic debt, typically as a result of acquisitions or property purchases during the boom years. While the companies are generating profits at the operational level these are insufficient to service the debt.
According to McDonald one approach to this problem being taken at present involves “rightsizing” the debt.
“It’s a question of looking at what level of debt the business can sustain on a capital and interest basis and potentially splitting this off from the piece that can’t be serviced,” he explains. “The piece that can’t be serviced is ‘parked’ in some way such as interest-only or perhaps a zero coupon loan note which doesn’t have to be repaid for several years with certain conditions attached should circumstances change. That is the sort of solution we are starting to see being applied in some circumstances.”
This solution meets the needs of the lender in that no debt writeoff is involved while bringing debt-servicing cost to manageable levels for the company. The bank will naturally put strict conditions on the parked debt, including provision for its repayment should the company be sold or other circumstances being fulfilled.
However, such arrangements are by no means automatically on offer to any company which finds itself in such a situation.
“Companies seeking such solutions have to be run in accordance with industry norms and metrics and have a viable future offering prospects of repayment of debt to the secured creditor and long-term value for the shareholders.”
In this regard he recommends that companies take advice and prepare well before even approaching the bank.
“Companies in these situations should take advice first and put a plan together,” says McDonald.
“If you are going to the bank with a solution rather than a problem you have a much better chance of getting a hearing. We are seeing that the restructuring areas in the banks are maturing and there is a willingness to explore realistic solutions.”
One thing a borrower should not do is ignore upcoming repayment dates, loan review dates and so on. “This really is not an option. If a company finds itself in difficulties with its debt levels and does nothing about it, this can lead to a breakdown of the relationship with the bank and a loss of trust. This type of solution is not just based on the numbers on a page. If trust breaks down there will be no deal and the bank will then be looking at enforcement. It should be remembered that enforcement isn’t a preferred option but may be the only option ultimately available to a lender to protect their position. Where a business is generating cash it should get into some sort of dialogue with its lenders regarding restructuring its debts.”
Where, despite the endeavours of the lender and borrower, a solution cannot be reached with the lender examinership may be an option for a business to restructure its balance sheet. But in many cases it may not be appropriate and in others it is seen as overly technical, legalistic and costly.
This is the first major recession in Ireland where the examinership legislation has been available to restructure companies’ balance sheets.
Up until a few years ago the market value of the assets securing a bank’s debt had generally not fallen below its book value and there was little need for banks to agree to write off any portion of their debt and hence they were unaffected by a scheme of arrangement.
However, given the collapse of property values in Ireland and a recent High Court decision on McInerney Homes that secured debt can be written down in a scheme of arrangement, it is possible in future that we will see bank debt being written down through the examinership process. Of course, the written down sum must still reflect what the court considers to be the market value of the security held but this may be cold comfort for the secured creditor involved.
McDonald is quick to point out that the McInerney judgment should not be seen as a definite route to getting bank debt written down. “Examinership can be a difficult process with no guarantees of success. In addition, in most instances new investment is required which may lead to existing shareholders losing control of the business,” he warns.
The requirement for a new investor may also prove a sticking point. “Equity investors with the required level of investment to refinance bank debt through a scheme of arrangement even at current depressed asset values are in short supply and given the fact that they are investing in a distressed entity tend to be looking for high returns. That means that examinership may not be an option for some.”
In the absence of new investment there is the possibility that the company’s bankers may be agreeable to some form of debt for equity swap. This was relatively rare in Ireland up until recently, but there is evidence that some lenders are now taking a medium to long-term approach with cash-generating indebted businesses and are engaging in such swaps as a way of dealing with non-performing loans, rather than getting involved in a forced sale of business assets.
Pursuing these arrangements can offer a lifeline to struggling businesses, free up cash flow, protect employment and allow them to grow. From a company’s perspective, such balance sheet restructurings can have a positive impact by enabling it to continue to trade and compete more effectively with a reduced debt burden. They also have the potential to create long-term appreciation in value for all stakeholders.
McDonald returns to the point of early engagement with banks being an absolute necessity.
“There is limited evidence of debt for equity swaps in the Irish market to date. But for the banks to become involved in any form of creative debt-restructuring deal with a company there has to be a relationship of trust there.
“The company itself has to ensure that it is in good shape to look for a deal by making sure that it is performing at or close to its potential with strong management; after that it’s a question of taking advice and coming up with a proposal which works for both sides.”