The UK economy: are we out of the woods yet?
6 June 2014
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A period of low UK interest rates, recent improved stability in the eurozone and £12bn in consumers’ pockets as compensation for the misselling of payment protection insurance are just some of the factors that are generating improved confidence in the market.
So does this mean a reduction in the number of restructurings and insolvencies?
Maybe in due course, but we are not out of the woods yet.
There have been many casualties of the financial crisis, starting with the collapse of banks such as Northern Rock, Bradford & Bingley and Lehman Brothers and continuing onto the high street as HMV, Comet and Blockbuster all entered into administration.
But the same circumstances that have tipped some companies into insolvency have benefited others. Companies that can afford to pay only the interest on their debts, known as zombie companies, have been able to continue in business due to the low interest rates and lenders’ general preference for ‘amending and extending’ loans rather than implementing a restructuring, which would involve recognising a loss on those loans.
In some cases, such amend and extend restructurings can be achieved by consensus between the company and all the lenders.
The amend and extend restructuring typically pushes back the repayment date for the main debt in return for benefits such as a higher interest rate, additional fees and more stringent undertakings from the borrower.
Where unanimous agreement on the terms cannot be reached, a scheme of arrangement may be the answer. A scheme of arrangement is a statutory procedure that enables a company to make an arrangement with its creditors which, if approved by the requisite majority of creditors and sanctioned by the court, will be binding on all of them, whether or not they voted in favour of it. It is often referred to as a cram-down procedure, which recognises its value in imposing a majority-approved solution on a dissenting minority.
It is worth noting that lenders have become increasingly keen to use schemes in the restructuring of foreign companies.
The English courts have recently found sufficient connection with England to accept jurisdiction for English law schemes of arrangement for German roofing supplier Monier, Vietnam Ship Building, and the Hungarian telecoms group Magyar Telekom, which involved a Dutch debtor.
In response to this, other European jurisdictions including France and Spain are in the process of making amendments to their respective insolvency regimes which incorporate some of the flexibility that has made the English law scheme so popular.
Turning back to zombie companies, despite the recent trend to amend and extend, zombie companies may yet end up being restructured or entering insolvency as a result of factors including a potential rise in interest rates and banks’ efforts to strengthen their balance sheets in reaction to continuing pressure from their regulators.
In light of this, certain UK and European banks are currently looking to dispose of their riskier assets. Irish Bank Resolution Corporation is in the process of conducting a series of loan portfolio sales with a face value of €22bn (£17.8bn), consisting of corporate loans and commercial and residential mortgages. RBS has announced the establishment of a ‘bad bank’ company within its group, created to speed up the sale of £29bn of high risk assets.
Where loans are sold at a price below their face value to reflect the risk that the borrowers may not be able to repay the loans in full, as is likely to be the case with many of these loan sales, it may be that the purchasers will want a more radical restructuring of these loans, going beyond the amend and extend model.
For example, we may see more lenders exchanging their debt for an equity stake in the business. This can be done via a scheme of arrangement, as with the recent Co-op Bank restructuring, or through a sale of the viable parts of the company’s business, usually out of administration, to a lender-controlled purchaser.
Such a swap relieves the business from the burden of the repayments and gives the lenders a greater element of control to restructure the operational aspects of the business in order to return it to financial viability.
So, despite signs of economic improvement, we could see a new wave of lenders implementing more radical restructurings of companies before we can truly say we are out of the woods.
Clare Merrifield is a banking managing associate at Linklaters