The use of Restructuring to preserve value
Dwindling economic activity in Nigeria has reduced the business performance of various entities in the different sectors of the economy. Commercial Banks (“Banks”) are under significant pressure to restore and improve net interest margins, interest earning assets, while ensuring that non-performing loans remain below the threshold set by the Central Bank of Nigeria. Over the last year, lending has become riskier with a noticeable increase in default rates.
The primary focus of Banks now, more than ever, is to preserve value by minimising loan losses and free up capital to create more quality risk assets or improve its liquidity position. In order to ensure the future profitability of Banks are not compromised, the trend where loan facilities are restructured without a good understanding of the Corporates (“Borrowers”) and their business drivers needs to be discouraged.
Many Banks in Nigeria have often restructured facilities just to avoid providing for the loan facilities without understanding the sustainability of such efforts. Incomes and cash flows of many corporates (“borrowers”) have been squeezed by wider market conditions and in some cases lack of appropriate planning and execution.
Currently, several borrowers have cash flows that cannot sustain their current debt profiles. Increasingly, borrowers are asking Banks to restructure their loan facility (“facilities”) and in some cases with the support of Regulatory authorities.
As an early preventive action, Banks can use informal workouts to reduce the required specific provisions for non-performing loans and preserve shareholder value.
It is more important now than ever to ensure that borrowers whose facilities are being restructured have the appropriate underlying business fundamentals to be able to repay their restructured facilities, else the lenders will just be postponing ‘dooms day’ without addressing the fundamental issue.
Banks can leverage on the principles governing informal workouts as highlighted in the “London Approach” below. Informal Workouts Why an informal workout?
Traditional approaches to recovering outstanding and non-performing loans through the legal system may not always be the most efficient and effective way to preserve value in the current economic climate.
During times of financial distress, the number of insolvency cases increase placing additional pressure on an already overburdened Court system.
The turnaround time between when the petition is filed and judgement granted also increases. Further, the value recovered through the forced sale of assets is often not sufficient to offset the outstanding amount due from the borrower because of prevailing market conditions and the time needed to identify interested buyers, particularly in the case of specialised assets.
Given the absence of adequate insolvency laws with provisions to govern business restructuring in Nigeria, any out of Court restructuring is considered an “informal” arrangement. Informal workouts serve as a timely alternative to recovering funds lent to borrowers.
PwC has been involved in arranging and negotiating informal workouts in Nigeria, at the instance of the Borrowers and also as an independent party. We believe this tool is yet to be fully appreciated by Banks and Borrowers alike, as it creates a framework to achieve an informed, sustainable and objective resolution mechanism.
The “London Approach” The key principles governing informal workouts were first conceived by the Bank of England in the 1970s when the United Kingdom was in recession. This approach, commonly known as the “London Approach”, has been adopted in various forms globally and is premised on the assumption that cooperation will prevent greater loss to Banks, Corporates and, in turn, the wider economy. Insolvency legislation at the time did not provide for voluntary restructuring and The Bank of England chose to become actively involved with individual workouts.
The main objectives for this approach include – minimising losses to Banks and other parties through coordinated negotiations; and avoiding the unnecessary liquidations of viable companies. The principles of the “London Approach” are most widely used where there are multiple lenders and significant creditors.
However, they are also applicable when a borrower is renegotiating their facility with one Bank. Various forms of the “London Approach” have been used in jurisdictions where the insolvency laws are not adequate and it remains relevant for the Nigerian market.
Variations of the “London Approach” include – the INSOL International Principles for a Global Approach to Multi-Creditor Workouts, selected sections of the World Bank Principles for effective Insolvency and Creditor/ Debtors Rights System, and selected sections of the UNCITRAL Legislative Guide on Insolvency Law. However, in practice, Lenders and Borrowers have agreed the principles of the variant to be employed and adopted same.
Key Principles Governing the “London Approach” The “London Approach” is based on the principle that Banks work with underperforming or distressed borrowers to resolve financial difficulties that would otherwise have resulted in insolvency (receivership or liquidation).
Prior to agreeing to restructure a facility using this approach, Banks have to assess relevant financial information relating to the borrower, its business prospects, and sustainable debt capacity. From our experience, this review is key in ensuring that Banks support companies that are viable and are not only preventing the inevitable. At this point, the Banks may agree to defer taking punitive actions where the business fundamentals indicate that the interest of the Bank is better served by allowing the borrower to continue to operate as a going concern. Once this has been determined, the starting point for negotiations is agreeing a “Standstill” where the Banks agree not to enforce their security or demand payment for their debts for a period of time with the aim of ensuring that a consensual restructuring agreement is negotiated and agreed. During the standstill period, the borrower will be required to provide the Bank with various information including:
- Details on the viability or the future profitability: Factors to be considered include the industry in which the company operates, product/service demand, company’s positioning in the industry. In our experience this information is crucial in preventing further losses to the Bank.
- Possibility of fund generation through either sale of existing non-core assets or divestment of unprofitable segments of the business;
- Financial projections which confirm the sustainable debt capacity levels of the business;
- Action plans to ensure that factors which contributed to the challenges being faced by the business are being addressed. For any debt restructuring to be successful it should be accompanied by operational restructuring which addresses idiosyncratic issues that borrowers face;
- Steps identified by the borrower as being key for a successful restructuring and how these will be incorporated by Management.
- Plans to ensure that payment terms would be renegotiated with other significant creditors to the business;
- Confirmation from other significant creditors that they are aware that the borrower is going through a restructuring process and would not initiate any insolvency proceeding over an agreed timeline; and • Management’s capacity to drive the turnaround of the business. The Banks would review the above information and use it as a basis to decide sustainable terms of the restructured facility and identify relevant monitoring safeguards to prevent any potential future default by the borrower.
Where has the “London Approach” been used? During the financial crisis in South East Asia, many Banks adopted modified versions of the above approach to resolving the financial difficulties faced by borrowers that were still considered to be viable. There were instances where Regulatory Authorities stepped in on a case by case basis as the Bank of England did in the 1970s to ensure that some form of agreement was reached between Banks and Borrowers. We are aware of a recent situation in West Africa where Regulatory Authorities stepped in to encourage a consurtium of Banks to restructure the facilities of a corporate body through an informal process.
The Regulatory Authorities gave the Banks the option of specific provisions for a significant proportion of the loans or go through an informal work out. The said entity was indigenous and considered to be viable and of strategic importance to a critical economic sector.
This was not the first time the facility to this borrower had been restructured but in the past a review of the company’s business fundamentals was not done and as such cash flow per the restructured term sheet was not sustainable. Eventually, the borrower defaulted and its Bankers had to seek a more sustainable process for supporting the business.
The new terms agreed included an extended moratorium on principal repayment and facility tenor, a reduction in interest rates and pay-off of one of the lenders who had more restrictive terms.
In the last year, we note that a number of indigenous entities in the Energy sector due to factors ranging from delayed project completion to falling oil prices have restructured their facilities in order not to default on their local obligations. However, most of these restructuring have a high chance of failing as the London Approach wasn’t employed. Hence, the participating Banks will need to have a critical look at those transactions. Challenges with using the “London Approach”
As with any approach, there are challenges that arise with an out of Court restructuring, especially where the borrower is exposed to a club/ syndicate of Banks and potentially large/ significant creditors. Once a Bank or creditor “breaks ranks” for instance, it makes it difficult to obtain the collective agreement necessary to consensually restructure the facility. We recently supported a client with exposures to over six local Banks. These facilities were not syndicated and there had been a breakdown of trust and communication between the Banks and the Borrower.
During the early stages of the informal process, one of the Banks instituted insolvency proceedings. It was then agreed that a Coordinating Committee which included PwC, legal advisers to the borrower and the Banks should take over the management of the process.
The Coordinating Committee had representatives from the different Banks and this helped in coordinating the approach to the restructuring for the greater good of all parties involved. During an informal workout, assessing the real financial and economic situation of a borrower can be difficult as the basis of any analysis relies heavily on information provided by the borrower.
This can be mitigated by ensuring that a variety of quantitative and qualitative information are analysed during the initial business review. So in the case mentioned above, we provided the Banks with a Business Review report which answered key questions around the Borrowers- market, people, technology and debt capacity of the business.
This information formed the basis of the restructured loan facility which included an upfront good faith payment, syndication of the restructured facility, and tenor extension.
The newly agreed terms were considered more favourable for the most part to the Banks and the borrower.
Where there are many different classes of debts and non-banking creditors, it may be difficult to structure a transaction binding all the different Banks while ensuring that the large creditors are on board with the process.
In such cases, the needs of the various classes of debt may be better served using formal insolvency procedures as these clearly sets out how different classes of debts are to be treated independent of size or nature.
Conclusion Given our current economic climate and the absence of a formal legal and regulatory framework governing the restructuring process in Nigeria, it is now more important than ever before, to use out-of-Court restructuring processes to ensure the survival of many businesses.
Avoiding Bankruptcies of currently and potentially viable businesses helps to preserve jobs, and can be a driver of economic recovery. Our experience in business turnarounds also lends credence to this, as through the ‘London Approach’ we have assisted businesses remain going-concerns and aided Banks in the turnaround of nonperforming assets, as well as recouping their exposures to such businesses. Most Banks agree that the “London Approach” or any of its variants accomplishes a number of goals including:
• Avoiding adverse publicity likely to cause further reputational damage to the borrower;
• Minimising losses and allowing the borrower to continue operating while providing repayment assurance to its Bankers and other significant creditors;
• Maintaining the borrowers’ going concern, value and goodwill;
• Avoiding liquidation losses and other administrative expenses. Banks need to understand and protect their rights, while still maintaining a cordial relationships with their borrowers. Bankers can seek the support of financial advisers to help with the restructuring process as well as monitor the borrower after a restructuring agreement to minimize the risk of defaults. Borrowers will also have to appreciate the financial, legal and strategic issues associated with any debt renegotiation. Formal insolvency proceeding in the Courts, often delay the turnaround process, can be expensive or can end up being more complex due the adversarial nature of the judicial process. It is therefore in the interest of both the Bank and borrower to utilize and adopt informal out-of-Court restructuring solutions.