What is debt restructuring?
Debt restructuring refers to the process that enables a private or public company or a sovereign entity with cash flow issues and financial problems to adjust and restructure falling debts to help improve or restore liquidity so that it may continue its operations.
Investment banks help firms take on debt structure through negotiations with creditors to allow for cash flow, hence relieving financial burdens. The debt’s maturity may be reduced, interest levels lowered, and even the principal.
A restructuring investment bank is one of the advisors brought on as part of any restructuring. For any restructuring, there are two sides:
1) The debtors side
2) The creditors side
For restructuring, the investment bank will work with either the debtors or the creditors but not both at the same time (due to potential conflicts of interest).
Essentially, restructuring is ultimately a compromise between the debtor and creditors. The compromise allows the debtor to continue operating, this time with an improved capital structure and ensures creditors are reasonably happy with their expected returns.
Advising Debtors
Debtors would be advised by restructured investment banks that would analyze the debtor’s situation and advise the company to put it on the right track.
Of course, prior to filing, the debtor is motivated to draw as much as possible under any revolving credit facility it may have. The rationale being that a company will need to do everything possible to conserve liquidity access to the credit facility would be frozen upon the bankruptcy filing and fully drawing on the revolver will enhance cash and give the debtor a little bit more leverage when dealing with this creditor.
In counseling the debtor, restructuring bankers might counsel sale of some of its assets to raise cash proceeds, if possible, without violating existing credit agreements.
While conducting sales of such assets, bankers often conduct an auction and might engage a stalking horse bidder.
Some jurisdictions even treat such asset sales as “free and clear” of obligations of the selling debtor. This will allow the investment bank to make more fees in this respect.
Where a bank gets a mandate to advice a debtor, there’s one major mistake that people come to make when they hear the term restructuring investment banking, that the bank advises a company that is really going down.
While a few firms simply will liquidate, restructuring predates on the assumption that the debtor will remain in business while seeking to reduce an oppressive debt burden. The creditors typically also want the firm to survive because this, quite naturally, tends to maximize the recovery amount that may be available to the creditors.
Advising Creditors
Speaking generally, the restructuring banker has less work to do advising creditors. This is because the parties are, by nature, different: creditors are concerned only with maximum recovery rates and will, nearly always, be sophisticated investors who understand the restructuring process.
In that case, the creditors will have been exposed to all different types of restructurings, and they need only consider the proposed plan of reorganization and to decide how they should vote.
Not like debtors, creditors do not need to prepare the extent of restructuring materials disclosure statement, plan of reorganization, monthly operating reports, 13-week cash flow models.
As a restructuring investment banker advising a creditor, the sole objective is to help the creditor to obtain the best possible recovery. In this respect, restructuring investment bankers will look at the debtor and attempt to identify problems with the plan of reorganization. The presence of any issues might better position a creditor and may yield a higher recovery.
Another advantage to bank restructuring that focuses on creditor-side mandates: there are typically classes of creditors (from secured creditors to unsecured creditors, and so on).
This, in turn, means there are multiple opportunities to land a mandate to advise a class of creditors when compared with advising the debtor, which typically hires just one restructuring investment bank.
Finally, creditors (in particular, bondholders) might hire an investment bank such that this class of creditors can avoid material, non-public information and also be unrestricted with respect to their ability to trade the bonds.
When there is a feasible reorganization plan, then the creditor’s investment bankers can then communicate this to the creditors and at this point, the bondholders are no longer allowed to trade on the information until the plan is made public.
An out-of-court restructuring is a negotiation between the company and its creditors. As an out-of-court restructuring is initiated either by the company or enforced by its creditors, there could be debt modification, debt exchange, voluntary haircut, and debt repurchases in possible outcomes.
Creditors may agree to change terms, such as interest rates or maturity dates, but the better enticement is usually required. Creditors may be threatened with a reduction in outstanding debt for equity or the issuance of a new debt instrument, but this also leads to a “holdout” problem.
One way to redeem part of the debtor’s debt is also available, but is unlikely without some concession by the debtor or the creditor believes it would be better than in-court restructuring.