(First of four parts)
I. What is debt restructuring?
Debt is defined as “something that is owed or that one is bound to pay to or perform for another”, according to Webster’s dictionary. Restructuring comes from two words, re meaning “again” and structura, Latin for “to put together”. So from the dictionary, restructuring is “to effect a fundamental change in (as on organization of system). But before you begin to think this is an English etymological treatise, DEBT RESTRUCTURING is just what the combination of the two words means, which is to effect a fundamental change in the original structure of the debt. Simple in meaning isn’t it? You’ll be surprised, so read on and indulge the writer.
II. Why do debts need to be restructured anyway?
Debts need to be restructured for two very simple reasons — the borrower has defaulted or is in danger of defaulting on the original terms of payment agreed upon with the lender and both the lender/s and the borrower agree that they have to restructure the debt in order for the borrower to continue payments to his outstanding obligation and eventually settle it in full and of course for the lender to recover his investment. The compelling force here is the deep-seated commercial interest of both the lender/s and the borrower to have the obligation settled in full.
There seems to be many variables here. You might say, doesn’t a debt have to be in default first before you can restructure? Not necessarily. A debt can be restructured in anticipation of an imminent default. An ounce of prevention is worth a pound of cure. Then you will ask, do both the lender and the borrower have to agree for a debt to be restructured? Legally yes, since this is a two party contract. But in the end, assuming there is default already and the borrower is still in denial that there is a problem with the servicing of his debt to the lender, he may have little choice but to agree to a proposed restructuring if he desires to keep his credit rating intact, his integrity unblemished, or his business altogether still his.
III. Why do debts turn sour hence need restructuring?
Debts turn “sour” for a myriad of reasons. (“Sour” is an old banking term for a loan that is in default or been in default. Its origin is unknown, but may be traced to the acidic taste it leaves in the mouth of the bankers or the acerbic way it rubs their composure. Either way, sour loans are never pleasant. The modern and politically correct term is non-performing loan but it sounds too clinical. Just allow me to use sour, not that it’s a better term nor using it means all restructured loans come from banks.) The causes then most attributed to loans turning sour are:
1) Loss of market share and/or competitive position translating to lost revenues and profits
A lost product or the entry of a shining new competitor can wreak havoc on any industry player, and affect his profit and loss and his payment capacity.
2) Deteriorating or poor funds management
A typical example is poor collection of receivables which puts a strain on payables resulting in defaults on some or all payments to suppliers or lenders.
3) Sudden or unanticipated change in technology that caused drop in demand for the company’s product
Although this doesn’t happen too often, this is something that any management should keep a watchful eye on as sometimes new technology comes up so fast and gets introduced in the market before any industry player can come up with his own strategy.
4) Company is overborrowed (alright I will give the modern term this time-overgeared. Rather snooty though)
Any company who borrows more than it should is really inviting trouble. It can be emboldened to invest in projects when it shouldn’t and similarly, it can be tempted to do something unwise with the money.
5) The flip side to #4 — overlending by the lenders
This has happened to some industries in our country when lenders doled out a lot of credits to certain industries which somehow encouraged unwise investments.
6) Ineffective or loose monitoring and control systems
This has many ill effects, like inaccurate cash balances, poor records on revenues or income, etc., that can erode the confidence of management and the lenders on the company.
7) Ineffective governance (the old term is harsher-mismanagement)
There are many examples, some of the more prominent ones being: bad strategy, misreading of the market direction, bad product pricing, poor cost control, etc.
8) In the case of specific projects, poor matching of funds
Concisely translated, the debt was in short term form but the project was long term. Repayment becomes a problem when the loan becomes due or the cash flows from the project do not come in time to pay off the debt.
IV. What are the ways to restructure debt?
There are many ways to restructure debt as there are ways to cut or style a woman’s hair or as there are as many shoes in any woman’s closet. And that means countless. Lenders are forever reinventing the wheel here so to speak, and new creative ways are being implemented regularly. It will be worthwhile to look at the simple, to the rather complex and to the extremely complex.(To be continued)
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(Vicente J. Sarza, is a Principal for Business & Financial Advisory Services of Manabat & Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. This article is for general information only and is not intended to be, nor is it a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. For comments or inquiries, please email manila@kpmg.com.ph or vsarza@kpmg.com).