Restructuring plan should be viable and mutually acceptable. As every restructuring is unique, depending on borrower and the executing team, the notion of the strategy should keep, following things in mind before drafting the plan:
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| • | Restructuring a loan, which is under stress, means introducing changes that will make underlying business viable and profitable once again and to implement changes so that it will generate enough cash flow to cover the service of loan and satisfactorily returns to shareholders. It is important to understand the underlying causes of the problem.
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| • | The restructuring is more than just changing the terms and structure of the facility, as it focuses on sustainable business.
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| • | Economic profitability should be priorities over accounting profitability while restructuring. The objective is to render the company viable and to ensure its continuity.
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A. Better Practices for approaching negotiation in an efficient manner
| i. | Preparation is essential before the negotiation starts: Every negotiation requires preparation and a strategy to implement. During their preparation, the bank can propose and determine how the possible refinancing is going to be distributed, under what conditions, and subject to what limits and guarantees. Negotiating strategy and tactics should include identification of the negotiable points, possible counter-proposals from the banks, and matters kept in reserve (if possible) to be raised during the process.
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| | a. | Be Prepared - It is not possible to draw up a restructuring strategy without a reliable resolvability analysis. The bank should review all available information of the company and current state of business sector, identify the reason and nature of the distress situation.
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| | b. | Evaluate the position - Bank should evaluate its ranking in terms of security among the other creditors and stakeholders. The bank should also assess the number and value of secured claims in relation to other secured and unsecured creditors,
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| ii. | Keep the borrower informed: For a successful negotiation, the bank should inform all the stakeholders and be involved actively in talks about the negotiation progress. Successful restructuring is a team effort. Success requires that borrowers work closely with their investment partners. In a restructuring, investors are not only shareholders but also supporting financial entities. For managers the challenge is always to be a step ahead by preparing the (eventual) next round: to be transparent, and to communicate effectively.
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| iii. | Consistency will deliver results: At this crucial stage in a company's life, inconsistency in communication or strategy can be detrimental. Some ways to be consistent:
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| | a) | Draw up a consistent and credible action plan to improve the company's liquidity. Determine the financial needs in the short, medium and long term.
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| | b) | Be consistent in the plan: try to cover short-term needs with short-term funds, and long-term needs with long-term funds.
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| | c) | Do not equate restructuring with loan renegotiation n. Long-term needs can and must be financed by converting loan to equity, whenever the level of leverage is excessive.
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| | d) | When converting loan to equity, negotiate in detail the value of the stake held by the new shareholders or look for alternative sources of capital.
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| | e) | Finally, the success of the restructuring depends to a large extent on the company surrounding itself by qualified advisors who can offer the benefit of their experience.
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| iv. | A restructuring process consists of reaching a private agreement in order to prevent legal proceedings. It is also possible to base the agreement on corresponding bankruptcy law, although it would have to be under judicial protection and subject to regulations that are often more rigid (creditors agreement).
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B. SWOT (Strengths, weaknesses, opportunities, threats) Analysis
While negotiating the rehabilitation plan, the bank should identify and evaluate the strengths and weaknesses in the account. The strengths and weaknesses in the account should be thoroughly evaluated to assess and draft the strategy. Before initiating the negotiations with the borrower, bank should prepare a strategy to discuss and finalize the meaningful and successful plan.
The cases where the borrower is not sound to understand the restructuring, the banks should make all the efforts to educate and represent the facts in full faith and trust. If necessary, bank should involve external party for explaining the plan and reducing the resistance by the borrower in restructuring.
Bank may adopt SWOT analysis to formulate the plan. In SWOT, all internal and external factors are considered for identification of strengths and weaknesses in the account. On critical assessment of these factors, bank can build the plan into negotiating strategy. The strategy should cover the defined objectives along with needs of the borrower, reason for restructuring, root cause analysis of the problem, proposed solutions, and negotiating parameters. The strategy of the bank should be focused on incentivizing the borrower and must include fees, penalties, and interest. The structure of the new and old facility has to be clearly explained to borrower while negotiating the strategy. A good background check and through homework may reduce the last-minute surprises and enhances the chances of a successful outcome.
Although the borrower should be made aware of deadlines to complete negotiations (i.e., at the specific restructuring plan being offered will expire if not accepted within 30 days), the situation should not end up into a sub-optimal restructuring.
Despite the fact that negotiating with the borrower on restructuring may be heated at times, both parties must understand the need of the situation and work collaboratively in the interest of both the parties and to come to a consensual and mutually acceptable agreement. The negotiation should be drafted as win-win situations for both parties.
C. Use of advisor
After ascertaining the viability of business and ensuring that business plans are sustainable, both parties should come to a negotiable agreement. Depending on the complexity of structure and borrower's financial knowledge and sophistication, an external advisor may be required. Potential areas for advice are: a) drafting the entire restructuring proposal (financial and legal) and b) drafting business plans as a cornerstone for restructuring discussion with the bank.
In order to build trust of borrower in the restructuring plan, especially for less sophisticated borrowers, it is recommended to involve external advisor viz. a lawyer or a financial specialist.
The bank should organize borrower educational unit within the bank that would provide general financial counsel services to borrowers, including NPL resolution.
The bank should also consider providing independent counseling/mediation services to borrowers for finalizing the strategy.
D. Involvement of guarantor (/s)
Depending on the terms of a guarantee, a guarantor is either fully or partially liable for the loan of third party (the borrower). The guarantor, therefore, should be kept fully informed about the status of the loan and the resolution process so that the guarantor is fully prepared to meet his obligations if the bank chooses to call the guarantee. New guarantees or a re-statement of the previous ones should be obtained whenever changes are made to the loan.
This is to ensure that the guarantor cannot use as a defense against payment that changes were made, to which the guarantor would not have agreed, without prior knowledge or consent.
E. Dealing with multi-bank borrowers
The role of the coordinator should be assumed by the bank with the largest loan, but the other banks must also be willing to accept it, should the bank with the largest expose refuse such activities for objective reasons. When appointing the coordinator and setting its powers, the banks shall strive for the following:
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| i. | As a rule, a coordinator should be appointed within 1 month.
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| ii. | The coordinator should be appointed for a certain period (no more than 6 months) with the possibility of renewal (3 months).
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| iii. | During this mandate term, the coordinator may not withdraw without a grounded reason. If the banks do not renew the coordinator's mandate term 1 month prior to expiry, the restructuring process is completed.
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| iv. | The coordinator shall be responsible for the assessment of the need to sign a Standstill Agreement, the assessment of the need to extend the coordinator's mandate, the assessment of the need for external consultant (financial or legal) and the drafting of the proposed solution for borrower restructuring.
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| v. | In the beginning of the process, the coordinator must clearly define the goals, take care of strict compliance of the deadlines, transparent communication and information of all stakeholders and cooperation by agreement
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| vi. | The coordinator takes care of the minutes of creditor meetings which sum up the decisions and the orientations of the process. In case individual creditors or the borrower constantly change their positions without reason, thereby jeopardizing the process, the coordinator transparently informs all creditors and the borrower and is entitled to withdraw as coordinator.
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| vii. | If appointment of an agent is necessary after the completion of the restructuring, this role can be assumed by the coordinator unless agreed otherwise by the creditors. The coordinator takes over all further communication with the borrower, with the purpose of limiting mutual administrative activities.
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It is generally agreed that a negotiated out-of-court debt restructuring is preferable to court proceedings. It tends to be both faster and less costly, hence banks are encouraged to explore the same prior to seeking legal recourse
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To facilitate the process, the primary bank must familiarize themselves with the role of the coordinator and be prepared to assume the responsibilities, if necessary, when a borrower has loans from more than one bank.
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Banks should strive to actively participate and cooperate in these negotiations. While banks may have genuine differences of opinion about the proper course of action to be taken with a borrower, they should state their views openly and be prepared to compromise, when warranted.
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F. Bearing the costs of the workout
Formalizing a workout implies incurring multiple costs that may significantly compromise the financial position of the parties involved in the workout.
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This implies that the borrower does not only assume his own costs, but also the costs and fees of auditors, lawyers and financial advisors that were engaged at creditors' request to complete the restructuring. While this is standard practice, there are certain limits to this general rule that try to prevent that the amount of these external costs become excessive:
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| a) | The borrower is only supposed to assume those costs incurred by the whole body of creditors. This implies that creditors who wish to use their own advisers shall cover their own costs.
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| b) | When engaging the external consultants, throughout the course of the workout process, creditors must strive to help the borrower control and manage such costs, and should not incur any costs that may not be considered reasonable.
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For MSME borrowers, banks are required to streamline workout processes, review existing processes to ensure that any cost levied to the borrower is kept at manageable levels
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G. Checklists for Negotiations
Best practice in the recovery of distressed business loans is based on ensuring that ample effort goes into preparing for negotiations. To prepare for negotiations bank must have a
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| i. | Know loans and security position.
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| ii. | Know the mindset of each negotiating borrower.
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| iii. | Have a realistic assessment of counterparties’ other personal or psychological attributes.
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| iv. | Know the main negotiating points critical to the success of the workout, and how each negotiating point is likely to be perceived by the borrower.
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| v. | Determine the overall posture best to adopt in conducting the negotiations.
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| vi. | Detail the relative merits of your chosen “posture" in terms of flexibility.
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| vii. | Separate the counterparties and their representatives from the problems caused by differences in positions.
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| viii. | Focus on each borrower's needs and interests rather than their stated or presumed position.
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| ix. | Look for solutions with mutual benefits (win-win strategies).
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| x. | Push for objectivity in judging proposals.
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H. Pricing the workout
While considering the price of the workout, the banks should consider cash flow, net present value, involvement of other banks (share, interest rate), and collateral value. The pricing should also factor in the risk in the proposal i.e. the change in risk profile of the borrower and waiver/ sacrifice amount while finalizing the work out strategy.
I. Maintaining fallback strategics
Fall-back strategies are important because of the potential fluidity of any workout. The following are worth keeping in mind as strategy is being developed:
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| a) | Workout strategies can be rendered ineffective suddenly, without warning and often as the result of revisions to what were previously believed to be immutable facts.
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| b) | The importance of comparing options carefully during initial strategy selection - The scope for different views and approaches is ample. While occasionally some solutions will so clearly dominate all others as to not require deep discussion of alternatives, more often the best course of action is not so immediately obvious. In such cases, a thorough analysis and discussion of the strategy options will be an indispensable part of the asset recovery process. Best practice also involves formalizing the process, by holding the type of decision meeting appropriate for removing ambiguity as to what was decided and by recording the decision.
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Comparisons of the various asset recovery options should involve quantification. As a minimum, each strategy option considered should be presented in terms of its internal rate of return (IRR) and/or its net present value (NPV). However, to the extent that certain aspects of risk and uncertainty play an important role yet are not always easily quantified, the framework for analysis and presentation should accommodate important qualitative considerations as well. The SWOT framework may be useful for comparing alternative workout strategies. Regardless of the framework used, it is important to ensure that all main assumptions are set in writing. Over time, assumptions that appear obvious early on are altered and rendered inapplicable. The workout specialist will appreciate having a record of the changing assumptions as the workout plan evolves.
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Clear communication helps keep market participants informed, build confidence in the resolution strategy and maintain public support. Authorities gather a large amount of information in the process of assessing the NPL problem and play a strong coordination role in the resolution strategy. They are therefore best placed to explain to market participants how the NPL crisis is developing, and to propose and implement solutions. Communication is essential to build public support, given that public sector intervention will have fiscal implications, as well as an impact on borrower companies and households. Finally, communication of the resolution strategy creates a basis for a subsequent policy review, thus keeping the authorities accountable.
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J. Documentation of plan
Banks must document each loan workout determination as part of the formal record. This includes documented communication with the borrower demonstrating the borrower has a renewed willingness and ability to repay the loan. Further, sufficient documentation of the ability to repay the loan must be on records for the options evaluated for assessing the borrower's ability to repay.
The bank should establish comprehensive management and internal controls over loan workout activity. This includes establishing authority levels and segregation of duties over the various types of workouts (modification, refinance, adjusting due dates, etc.). In addition, the policy needs to specify volume thresholds tied to financial performance elements such as net worth, delinquency and/or net charge off rates, etc. that trigger enhanced reporting to SAMA.
The contract and documentation should include a well-defined borrower milestone target schedule, detailing all necessary milestones to be achieved by the borrower in order to repay the loan over the course of the contract term. These milestones/targets should be credible, appropriately conservative and take account of any potential deterioration of the borrower's financial situation.
Based on the collective monitoring of the performance of different restructuring options and on the examination of potential causes and instances of re-defaults (inadequate affordability assessment, issue with the characteristics of the restructuring treatment product, change in the borrower's conditions, external macroeconomic effects etc.), banks should regularly review their restructuring policies and products.
For the cases, where the borrower has experienced an identifiable event which has caused temporary liquidity constraints. Evidence of such an event should be demonstrated in a formal manner (and not speculatively) via written documentation with defined evidence showing that the borrower's income will recover in the short-term or on the basis of the bank concluding that a long-term restructuring solution was not possible due to a temporary financial uncertainty of a general or borrower specific nature.
Greater transparency on NPLs can improve the viability of all resolution options, as well as market functioning in normal times. In cases where the ownership of the NPL passes from the originating bank to an external party, information limitations play an important role. To help overcome this problem, some standardization of asset quality data, as well as completeness of legal documentation on the ownership of these loans, would help buyers and sellers agree on pricing. In addition, co-investment strategies in securities originated from a pool of NPLs may reduce information asymmetries between buyers and sellers. This could increase transaction volumes, or facilitate sales at higher prices. A third option is the establishment of databases for realized prices of real estate transactions, given that real estate is the most widely used form of collateral. A transparent and sufficiently large database on real estate sale prices would, therefore, enhance the stability and reliability of NPL valuations, ultimately facilitating the NPL disposal process and leading to smaller price discounts. This would encourage market-based solutions for NPL disposal.
K. Information Access:
One of the key success factors for the successful implementation of any strategy option is adequate technical infrastructure. In this context, it is important that all cases related data is centrally stored in robust and secured IT systems. Data should be complete and up-to-date throughout the workout process. An adequate technical infrastructure should enable units to easily access all relevant data and documentation including:
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| i. | current NPL and early arrears borrower information including automated notifications in the case of updates;
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| ii. | loan and collateral/guarantee information linked to the borrower or connected borrowers;
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| iii. | monitoring/documentation tools with the IT capabilities to track restructuring performance and effectiveness;
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| iv. | status of workout activities and borrower interaction, as well as details on restructuring measures, agreed, etc.;
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| v. | foreclosed assets (where relevant);
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| vi. | tracked cash flows of the loan and collateral;
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| vii. | sources of underlying information and complete underlying documentation;
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| viii. | access to central credit registers, land registers and other relevant external data sources where technically possible.
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L. External Information
As a minimum, the following information should be obtained when restructuring a non-retail loan:
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| i. | latest audited financial statements and/or latest management accounts;
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| ii. | Verification of variable elements of current income; assumptions used for the discounting of variable elements;
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| iii. | overall indebtedness;
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| iv. | business plan and/or cash-flow forecast, depending on the size of the borrower and the maturity of the loan;
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| v. | latest independent valuation report of any mortgaged immovable properties securing the underlying facility;
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| vi. | information on any other collateral securing the underlying loan facilities.
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| vii. | latest valuations of any other collateral securing the underlying loan facilities;
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| viii. | historical financial data;
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| ix. | relevant market indicators (unemployment rate, GDP, inflation, etc.).
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| x. | In case of MSME's access to bank statements of all accounts maintained by the borrower may also be necessary.
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M. Internal Information
Banks should maintain in the credit file of the transactions the documentation needed so that a third party can replicate the individual estimations of accumulated credit losses made over time. This documentation should include, inter alia, information on the scenario used to estimate the cash flows it is expected to collect (going concern vs. gone concern scenario), the method used to determine cash flows (either a detailed cash-flow analysis or other more simplified methods), their amount and timing as well as the effective interest rate used for discounting cash-flows.
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Banks should maintain all internal supporting documentation, which may be made available for review by the supervisory authority upon request. It should include:
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| i. | the criteria used to identify loans subject to an individual assessment;
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| ii. | rules applied when grouping loans with similar credit risk characteristics, whether significant or not, including supporting evidence that the loans have similar characteristics;
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| iii. | detailed information regarding the inputs, calculations, and outputs in support of each of the categories of assumptions made in relation to each group of loans;
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| iv. | rationale applied to determine the considered assumptions in the impairment calculation;
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| v. | results of testing of the assumptions against actual loss experience;
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| vi. | policies and procedures which set out how the bank sets, monitors and assesses the considered assumptions;
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| vii. | findings and outcomes of collective allowances;
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| viii. | supporting documentation for any factors considered that produce an impact on the historical loss data;
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| ix. | detailed information on the experienced judgment applied to adjust observable data for a group of financial assets to reflect current circumstances.
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N. Restructuring documentation
Important documents in any workout will be the term sheet, the loan agreement, and the security documents. Even before the banks have determined that a going concern solution is feasible and indeed preferable and the transaction starts crystallizing, they will want to start preparing documents.
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The documentation will also determine the conditions of effectiveness of the restructuring. Before these have been met, the restructuring is not complete and it is theoretically possible to revert to the default and real bankruptcy.
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The proposal should contain the following elements:
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| i. | Full description of the borrower
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| ii. | Amount(s) of the loan(s) to be restructured
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| iii. | Restructuring fees and expenses, if any
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| iv. | Name(s) of the bank(s)
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| v. | Anticipated date of closing
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| vi. | Representations and warranties
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| vii. | Repayment schedule(s)
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| viii. | Mandatory repayment(s), if any
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| ix. | Cash sweep mechanism, if any
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| x. | Interest rate(s) and applicable margin(s) if floating rate
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| xi. | Default interest
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| xii. | Interest payment dates
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| xiii. | (Revised) events of default
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| xiv. | (Additional) security
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| xv. | List of documentation
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| xvi. | Taxes
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| xvii. | Governing law
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O. Checklist:
| i. | Establish parties to be part of the workout transaction
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| ii. | Establish what minimum terms acceptable to parties other than the borrower
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| iii. | Prepare draft term-sheet
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| iv. | Negotiate draft term-sheet among parties other than borrower and reach tentative agreement
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| v. | Submit draft term-sheet to borrower
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| vi. | Negotiate, agree, and initial term-sheet
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| vii. | Have lawyers prepare draft legal documents for workout, including new or amendatory loan agreement and security documents, based on initialed term-sheet
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| viii. | Negotiate, agree, and sign legal documents for workout
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| ix. | Determine when conditions of effectiveness have been met and workout is complete.
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