(Second of four parts)
Simple or no-brainer
• Rescheduling of amortizations
Simple company problems like maybe a temporary liquidity crunch can be solved by simple restructuring ways like changing the tenor of the promissory note, where in all cases lengthening is done. (Tenor is not the higher voice than alto but the length of time within which the debt must be repaid, e.g., one-year loan, or five-year loan.) Another is to change the amount of the amortization to temporarily suit the cash flow of the borrower. These can allow the borrower some needed breathing space to source the cash to pay off the debt.
• Change in pricing
In a few cases, the problem was solved by a simple lowering of the interest rate. In times when the interest rates were very prohibitive, or the times when the rates rose to about 45 percent many years back, some loans turned sour because the companies who borrowed could not churn out enough profits to offset these exorbitant rates. When the rates decreased after some time, these sour loans became healthy again. This could be termed as economy-driven restructuring but there were a few lenders who initiated the lowering of rates just to drive the process.
Rather complex or headache-type restructuring
• Sale of some of borrower’s assets to pay off part of debt, then reschedule the remaining debt
Alright, we are off to the difficult ones! This method has been employed many times in many restructurings and with the best results. It is straightforward and somehow easy to implement. The only key here is the quick marketability of the asset being sold since time is of the essence in any restructuring.
• Dacion en pago
Latin for “payment in kind”. Not the kind most men think of but the surrender or the voluntary ceding of property, such as land, buildings, cars, corporate shares, country club shares, etc. to partially or fully pay off an outstanding debt to any, some or all of the lenders just to ease up on the pressure to regularly pay the interest and principal. This is a little more complex than the method above since the buyer is the lender and the critical issue is always the price at which the property is being ceded for. Price determination is where the bottleneck most always resides. Assuming the property is “clean”, meaning not encumbered or mortgaged, then the lender and the borrower will most often battle it out over the price. Lenders often want a lower valuation, and borrowers will always want a higher one both for obvious reasons. Nevertheless, this has been and is a successful way of restructuring.
Extremely complex or the brain-damage type restructuring
• Debt to equity conversions
These are definitely Alzheimer’s or brain tumor type material! This is when an existing creditor converts his debt into equity of the borrower, or when a third party buys the debt and converts that debt into equity of the borrower. There are more counter parties here and more transactions or steps to follow than the normal or simple type of restructuring hence this becomes more intricate and so requires deft handling. There are many critical issues here; e.g., in almost all cases the debt is “bought” at a discount or what finance people call a “haircut”, then translated at face value to the equity side, so there generally is a tedious and sometimes lengthy deliberation on the haircut before the deal is inked. There is also the issue of who the new equity partner is, and how much he will be allowed to own in the company, the covenants by which he will come in, etc. In other deals, the debt is converted into preferred shares, so there are other variables that come into play like what interest rate the shares would earn, if these would be voting or non voting, etc. These types of transactions are better handled by experienced officials or dealmakers since they require specific skills. There have been quite a number of successful deals fashioned out in this way.
• Creation of a new company then only the debt and some assets are transferred to this new company.
There are a few cases where the new strategic investor would not want to carry on all the baggage of the existing company and would specify that he gets to assume only the debt and buys some of the assets in exchange for such assumption. It can get more complex as he can choose to either just assume the repayment of the debt or again, convert this into equity. Again there are many permutations in cases like this. Almost endless actually if the one doing the deal is creative enough. But this is a very useful restructuring device to use in cases where the existing company possesses a lot of baggage and that baggage, whether in the form of financial, contractual or operational is not at all acceptable to the purchasing entity.
• A combination of some of the above or for that ultimate thrill, all of the above
There have actually been cases where, for the restructuring to succeed, the lenders did employ many of the schemes available and even came up with novel ways. I have worked on a restructuring where some assets of the borrower were sold, then a new company was formed to carry on the business, the franchise was sold to this new company, then majority of the debt was converted into equity of the new company, then the remaining debts of the lenders who did not want to convert were rescheduled. And this took more than 2 years to bring to a close. This just shows that the possibilities in restructuring are almost infinite. (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).