Beleaguered banks and borrowers look to debt restructuring

In fear of not seeing a cent from their multi-million euro debtors, banks and their borrowers are turning towards corporate loan restructuring, which has soared to billions of euro in Romania. But banks remain keen to claw back every available cent. Specialists say this year could see private equity funds step in to suck up the businesses they consider worth saving.

Dana Verdes

“We started to restructure a loan back in 2008 and it is currently our longest ongoing restructuring case. The loan – in the region of EUR 100 million – which involves several borrowers, is expected to have a positive outcome next month. And it is not the largest restructure we have handled. That one was slightly below EUR 200 million,” Andrei Burz-Pinzaru, partner at Reff & Associates, tells Business Review, adding that the volume of restructured corporate loans which his firm manages reaches half a billion euro.

It is no secret that when confronted with a national recession combined with a credit crunch, many firms have faced difficulties in coping with debt over the past two years. This resulted in a dramatic shift of focus in banking practices, from new money deals to restructuring, specialists say.

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And the figures support this. “We provided assistance in notable restructuring deals in excess of EUR 1 billion last year, an increase of some 40 percent in value compared with the previous year, when this trend had just begun,” Iuliana Craiciu, partner at Musat & Asociatii, tells Business Review.

Mirela Iovu, CEC Bank vice-president, adds, “Last year the bank’s percentage of restructured company loans reached 10 percent, similar to 2009’s results.”

Although there are no market statistics on the total value of restructured loans – as the parties involved in these processes are reluctant, for obvious reasons, to make public the information – lawyers say that the total volume could reach roughly EUR 10 billion.

Large corporate restructurings are expected this year as well, specialists say. “Currently, there is a more positive outlook for the credit market, especially in sectors such as energy or infrastructure projects. Nonetheless, we do not expect 2011 to be the end of the restructuring trend, but we would rather see new restructuring mechanisms, rarely tested so far, like the sale of toxic assets or even debt-to-equity swaps,” said Craiciu.

Experts say that there are discussions in the market of potential interaction between private equity funds, banks and borrowers regarding restructuring.

When is loan restructuring used?

Lawyers describe several situations. According to Burz-Pinzaru, loan restructuring may be on the table when the borrower defaults on some of the essential provisions in the contract.

“Any loan agreement has certain key performance indicators, which reveal how healthy the borrower is and how able to repay the debt. When the crisis hit, these financial indicators were compromised and in the vast majority of cases no longer met by firms. This raises a red flag for lenders, which find themselves in the situation of analyzing if this is a temporary situation or a systemic deterioration of the borrower’s financial situation. This is one standard case in which the lender and the borrower must sit down and consider the restructuring of the loan,” says the Reff & Associates partner.

Another case, he adds, is when the loan maturity is reached. “For example, we have seen cases of real estate refinancing projects where the maturity was quite short and there was no way the borrower could have repaid the loan from its own funds but only through subsequently financing. Now, because of the crisis, financing with another bank is very difficult and all the parties will consider restructuring the loan,” says Burz-Pinzaru.

Lawyers also cite dramatic cases such those that involve other creditors – aside from the bank – that become aggressive because they do not get their payments and so sue the borrower or, even worse, apply for its bankruptcy.

“We have a big problem in Romania in my view, as bankruptcy is used as a blackmailing tool. The law and the courts should be much tougher on abusive insolvency claims. This is an additional pressure point in restructurings,” says the Reff & Associates partner.

Which areas are worst hit?

All businesses are in the process of restructuring loans in one way or another, say specialists. Real estate finance continues to be a real problem for banks, because it is very difficult to foresee the future and the market’s trajectory.

In real estate financing, developers have suffered due to the credit crunch: the lack of financial resources as well as the resulting decreased appetite for new investments have generated chain reactions. It has affected investors, contractors, designers, tenants, lenders and ultimately consumers.

“Generally, borrowers are having a hard time making the required payments to lenders and their counterparties. Also, they are encountering difficulties in collecting amounts owed to them, which leads to negotiations with various parties and sometimes – more frequently lately – to disputes. The lenders have a difficult job in assessing all such events of non-payment or disputes, in order to decide if the restructuring process is worth giving a try,” Madgalena Raducanu, managing counsel with Salans, tells BR.

After real estate, lawyers say that SMEs have been in big trouble as they have been severely hit by the crisis.

Haircuts, the final frontier

Haircuts, or debt forgiveness, are not a very common practice on the Romanian market, specialists say.

“Yes, there are exceptional situations when we have agreed to reduce the debts of certain clients, by no more than 50 percent,” said Gianina Lazanu, manager of the large debts recovery department at BRD, speaking at an event about insolvencies. Turning to the size of the loans, she added, “EUR 10 million is too much. Compromises are made along with another three-four banks and up until now there have been fewer than 10 cases.”

Why would a bank agree to such a measure? It’s all about the numbers, as . in the event of bankruptcy, lenders recover just 30 percent of the loan, and as such a haircut can be a way out.

“It is used when they realize they cannot recover the full loan from the borrower. Then they say: ‘why reschedule and pretend that we are going to get the full amount?’ They agree to write off a certain amount from the loan which will give the company a push towards recovery,” explains Burz-Pinzaru.

The A-Z of restructuring

Lawyers say that borrowers looking to implement a loan restructuring process need to be prepared to find additional funding to comply with creditors’ and banks` requirements in this respect, reach a consensus among multiple creditors, draft a viable restructuring plan from a business perspective and provide a new or improved security package.

“From a legal perspective, the scope of work in a restructuring process usually involves several steps. First is the diagnosis phase, the performance of a thorough review of all the financial documents and ancillary documentation, including the borrower’s constitutional documents and legal status,” Mihai Dudoiu, partner at Tuca Zbarcea & Asociatii and co-head of the firm’s banking and finance practice group, tells BR.

He adds: “Another phase regards restructuring strategy – establishing this by taking into account the options available depending on the profile of the borrower’s financial indebtedness, as well as the drafting of all related documents and assisting in subsequent negotiations with the other parties involved. Afterwards comes the implementation phase – conducting the restructuring process and, finally, disposal of non-performing loans, if need be.”

The borrower’s eye view

The process has both advantages and disadvantages.

“Restructuring will give a very good understanding of the company’s capacity to generate cash flow. And, obviously, at the end of a successful restructuring a company will have a financially viable operation and the creditors will have a well performing client,” outlines Marius Zidaru, director, business recovery services leader at PwC Romania.

Alexandru Ambrozie, partner at Popovici Nitu & Asociatii, adds, “The substantial advantage of the mechanism is that the company will not only escape the insolvency procedure, but be able to avoid the distressed sale of its assets.”

On the same theme, the Musat & Asociatii representative points out that restructuring where the debtor is not insolvent may provide benefits such as a short-term grace period, rescheduling, the refinancing of one or several loans via a new credit facility, short-term bridge loans and a stand still period.

But all this comes at a cost. “Aside from the immediate benefits which are new financial terms, the restructuring will often involve additional obligations on the debtor, such as new financial covenants, operational restructuring such as the sale of non-core assets or disposal of obsolete merchandise, corporate restructuring – considered with a larger group of companies, due to the need to simplify and centralize the decision-making process e.g. via merger, and, last but not least, new or additional security created to cover for the shortage resulting from business devaluation,” says Craiciu.

According to the PwC Romania director, the most significant drawback is that the shareholders and management might lose control in the decision-making process, as creditors will generally impose certain covenants that the company must comply with as part of the restructuring agreement.

Central Bank contemplates debt-to-equity swap

The National Bank of Romania (NBR) has resumed discussions on a draft regulation concerning the temporary holding of shares within financial assistance or restructuring of a non-financial entity. According to market specialists, the main benefit of this draft regulation is that it will equalize the position of banks in comparison with other creditors.

“Essentially, it allows the bank to hold shares in a non-financial debtor, when the shares are issued in exchange for debt, which is thus cancelled. Such holdings will be temporary up to 36  months,” says Craiciu.

Experts point out that the exit mechanism is not regulated and therefore may be flexible. The lender’s exit may involve, for example, assignment for a pre-agreed value to the sponsor or to a third party by way of a put/call option.

“In the hypothesis that a lender will assume such a mechanism, it is presumed that it will be obliged to apply all diligences in order to make profitable the debtor whose shareholder it will become through the mechanism, because the investment return and its recovery will begin with the distribution of earned profits, but banks are not built to provide management,” says Iovu.

Musat & Asociatii lawyers tell BR that restrictions are applicable, such as the requirement to draft a viable restructuring plan to be endorsed by the central bank and producing evidence that the debt-to-equity swap is the only measure available to ensure debt recovery.

Yet, banks are not keen  the bank’s exposure to the debtor has to be in excess of 60 percent of the debt.

A potential pitfall for banks, say lawyers, is that by the debt-to-equity swap, the bank loses its secured creditor’s rights. In the event of insolvency, the bank’s involvement in the management of the business may trigger directors’ liability issues if it can be proven that measures approved by directors nominated by the bank lead to insolvency.

The draft regulation detailing the conditions of the banks’ debt-to-equity swap was formally endorsed by the Central European Bank in December 2010.