John Houghton, Howard Lam and Mitchell Seider of Latham & Watkins introduce the Insolvency and Corporate Reorganisation Survey, highlighting several trends in restructuring markets around the world
Opportunities to test the international laws and procedures used to implement going-concern reorganisations are of course linked to the number of opportunities within the global restructuring and workout market. To set the scene, we will offer an overview of the trends in the global restructuring market, starting with the macro-economic backdrop.
Frenetic issuance
In 2013, the US and UK saw a high demand for loans and bonds in an issuer-friendly leveraged finance market. Global leveraged finance totalled $2.25 trillion in 2013, up 32% on the $1.7 trillion raised in 2012, and the highest volume on record. Borrowers have been turning in particular to the high yield market to refinance and repay their debt, with high-yield (HY) issuance running at a crazy pace. For example European HY volume reached a record $123 billion, up 55% on 2012 ($79.2 billion). In the US, September 2013 was the biggest month in history for the HY bond markets, at $49 billion, although overall, HY volume by US issuers decreased 5% year-on-year to $259.9 billion from the annual record high of $274.8 billion in 2012. In other words, less fullsome restructuring and more balance sheet re-jigging. In Asia ex-Japan, HY volume also hit a record high of $33.3 billion in 2013.
Kicking the can down the road
In both the US and UK, the equity cure trend has been also been kicking matters further down the road. Both in sponsor deals and in leveraged loans, and with liquidity flooding the loan markets, equity cures are becoming more prevalent again, albeit often in limited forms. We also see the re-emergence of (quasi) covenant-lite deals, which ultimately means fewer triggers for restructurings, thereby depriving creditors of control, arguably when they need it the most. Moreover, in the UK, companies are continuing to avail themselves of schemes of arrangement (intended more to be used to implement debt-to-equity type restructurings) to effect simple amend-and-extends, and recently even a pseudo-standstill to continue restructuring negotiations.
What is the result of demand outstripping supply, ongoing improvement in terms, and therefore a relentless trend of re-financing, re-pricing and amending? You end up with a plethora of so-called zombie companies, those which solely service debt, have no spare cash to grow, and which are not properly restructured to right-size their balance sheets. According to research commissioned by Reuters, in 2013 in the UK, there were an estimated 227,000 zombie companies with a combined negative equity of £70 billion ($118 billion).
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“European insolvency laws have undergone and are still undergoing potentially game-changing amendments” |
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Companies in the Asia-Pacific region did not suffer from the same gluttony of debt pre-crisis. However, as a response to the global financial crisis, stimulus policies in the region have flooded the regional bond and loan markets with liquidity. Over-capacity in certain sectors and the slowdown of GDP growth across the region, meant that companies are operating in a more challenging environment. In the last two years, some companies have been very active in tapping into the liquidity while they can, which drove increases in both loan and bond volumes. More recently, the flood of liquidity has somewhat receded, and it is becoming more apparent that weaker companies are already experiencing liquidity issues. The exceptionally low default rates in the past few years is unlikely to continue, Asian businesses have also become more global in their operations, and there are many more cases where Asian restructurings are implemented through a combination of procedures in different jurisdictions, including the use of UK schemes, US chapter 11 and 15, along with local insolvency and rescue procedures.
Turning to China, the largest economy in the region, robust GDP growth was critical to solving China's bad debt problems in the 1990s. However, now that we see China's GDP growth rate at its lowest since the early 2000s and China's biggest banks more than doubling the level of bad loans they wrote off last year, it is questionable whether high-speed economic growth propelled by credit growth is sustainable. Indeed, following China's first bond default of Shanghai Chaori Solar this March, it has been suggested that the Chinese policy-makers may be willing to tolerate default by some Chinese companies, which had been reliant on the implicit government support to access loan and bond markets.
Then there is the question of the infamous Wall of Maturity, with around $3.2 trillion of European corporate debt maturing from now until the end of 2017, US speculative grade companies having approximately $645 billion of debt scheduled to mature in the next five years and China's aggregate debt levels having risen in the past decade to a total of 270% of GDP in 2013. In Europe and in the US, the peak year for maturing debt is in 2017; some question whether that is another false dawn as in 2012/13, when the top of the wall was consistently taken off by the high yield market the closer the wave got to the peak.
The opportunities
So where does this leave us in terms of restructuring opportunities? Without a doubt, Europe is offering more opportunities than the US, and we are faced with an increasing number of alternative investors (including from the US) looking to deploy their loan-to-own strategies or seeking simple re-fi lending opportunities in Europe. For example, the inevitable shrinking of the Eurozone banking system will open up opportunities for distressed investors, with more than 350% of Europe's GDP represented by banking assets (compared to about 100% in the US). We also see a continuing trend of non-performing loan portfolio acquisitions from banks, particularly in Germany, Spain and Italy. Although you will continue to see companies availing themselves of more creditor-friendly UK and US restructuring proceedings, continental European insolvency laws have undergone and are still undergoing potentially game-changing amendments, mostly in support of moving away from value-destructive liquidation procedures towards a fundamentally more effective rescue culture. However, even in Europe there is too much money chasing too few opportunities and prices remain high.
In the US, the improving economy, decreasing debt levels and a positive financing environment are keeping the amount of distressed assets low. Investors believe that interest rates will have the most influence on distressed asset valuations, low interest rates having helped distressed companies and forced potential buyers to raise offers. Balance-sheet restructurings are among the top targets for those purchasing distressed companies and opportunities will increase as companies seek to divest non-core assets.
In Asia-Pacific, and China in particular, the restructuring market is undoubtedly picking up, particularly in certain sectors where there is overcapacity (such as the solar and shipping industries). A growing trend is the engagement of turnaround professionals. Hurdles around structural subordination and heavy government intervention, however, will always colour the picture and impact investors' risk appetites.
The search for predictability and transparency
What is undoubtedly clear is that investors worldwide seek predictability and transparency in the jurisdictions that they wish to invest in, particularly in the scenario we are focusing on: the reorganisation of a surviving, going concern. This is especially true in light of the increase in capital market activity and in the complexity and sophistication of cross-border financial documentation, along with prevailing high-entry barriers: precisely the backdrop for the difficult questions asked at a European level on whether there is scope to harmonise. For now, we turn to shedding some light on the key tools and procedures which can be used to implement a going-concern reorganisation.
The guide examines several crucial factors. It will consider reorganisation techniques, and what thresholds and voting requirements will be required in each jurisdiction in order to use those tools.
The guide will consider the importance of protection for the company and its directors. Laws should ideally support directors whilst in the zone of insolvency, not force them to file prematurely for fear of personal or criminal liability. From the debtor company's perspective, this guide compares and contrasts jurisdictions with debtor-in-possession protections versus regimes where third parties run the company with the protection of a moratorium against creditor action (such as UK administrators).
Integral to any developed restructuring process is the ability to cram down junior creditors (or, to look at it from the perspective of some investors, what is the risk of being crammed down in this jurisdiction?) and the crucial issue of who controls the plan. These issues are examined on a comparative basis in this guide.
Finally, the guide will examine the opportunities in each of the jurisdictions for new money to be injected post-petition and upon exiting the restructuring process. It will ask whether new money will be available and if so, what priority it will enjoy. Further, who can provide such new money in practice?
About the author |
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Mitchell Seider Latham & Watkins T: +1 212 906 1200 W: www.lw.com |
About the author |
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John Houghton Latham & Watkins T: +44 20 7710 1847 W: www.lw.com |
About the author |
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Howard Lam Latham & Watkins T: +852 2912 2570 W: www.lw.com |