Mind the gap

17 August 2021

Reading the roundtable discussion on “Debt in the post-Covid world” (contained in the latest edition of Real Deals and linked at the bottom of this article), I was struck by the contrast between the very high levels of M&A-related financing activity reported by the panel versus the currently low levels of transactional activity involving the many restructuring professionals that I’ve been speaking to amongst advisory firms, the portfolio management teams of banks and credit funds and, of course, fellow lawyers.

Aside from those who are involved in some of the bigger, long-standing cases such as the collapse of Greensill and Wirecard, many have spent the long hot summer enjoying the freedom to socialise and recharge after a very busy 2020.

Distressed opportunities

The questions on many minds are: When will signs of distress return to the market, together with the investment opportunities that this should give rise to and, when that happens, how can that distress be dealt with?

In the UK, government intervention has been very effective at giving breathing space to many businesses, particularly those which have had to be mothballed for much of the past 18 months in the consumer-facing sectors. It has prevented creditors from taking action for unpaid debts, helped businesses to put employees who may (or may not) be needed back in the future on furlough, they’ve enabled the deferral of tax payments, and government guarantee schemes have supported the provision of finance to many businesses by banks. The record lows seen in insolvency statistics from The Insolvency Service also bear out the effects of that package of measures. Similar trends are being seen in the U.S. and across Europe.

The implication is that many businesses which would ordinarily become insolvent in “normal” times are still trading when arguably they shouldn’t be. Many others who have been able to “get by” with all that support will at some point need to face up to the problem of the liabilities which have mounted during the pandemic.

As reported by the lending panel, if a business is in a favoured sector and/or backed by a strong sponsor, then there is a huge amount of liquidity in the market to enable liabilities to be refinanced and thereby stretch out the problem so that it can be more easily managed over time. I’ve seen this in the hotel sector, for instance, where certain lenders appear to be confident of a strong bounce-back and have been willing to refinance defaulting loans, albeit for a high price. 

However, what could happen to those businesses who fall into consumer sectors which are “unloved” by lenders and who don’t have sponsor support, as reported by the lending panel?

The indications from the UK government are that their intervention will wind down over the next six months, and so the expectation is that distressed investment opportunities will begin to be seen after that. The furlough scheme is gradually being unwound, payments on government guaranteed loans are starting to be required and deferred taxes are becoming payable. At the same time, businesses are opening up and spending precious financial resources to meet their related working capital requirements. Not every business will recover quickly enough to manage all of those demands on their cashflow. There is also the risk of a return to further lockdowns should health services be unable to cope with further waves of Covid, which would be disastrous for many if that were to occur.

New solutions

If debt from a lender isn’t available and a business lacks the liquidity to cover its debts, what might the solution be?

As you have probably read elsewhere, many businesses in the UK have turned to formal restructuring processes such as a scheme of arrangement, CVA or restructuring plan to resolve their unmanageable liabilities. However, although many are giving thought to ways to make them more efficient, the professional costs presently associated with these restructuring tools are high and they are not an obvious choice for SMEs or businesses in the lower-mid market, or where those costs simply can’t be borne.

Perhaps different sources of capital could be found? Where the main challenge faced by a business is the amount of rent owed to its landlords, this may be the time for bigger institutional landlords to be more creative in their approach to their tenants. They could seek to convert the debt owed to them into equity. They could offer debt financing of their own. They could, if a business is regarded as viable and important to the value of a wider property scheme such as a shopping centre, look to take ownership as well as providing additional capital.

In many cases at this end of the market, however, it seems probable that we will see a return to old-fashioned pre-packaged administrations in order to deliver a business into a new structure, free of its historic liabilities. The recent changes to regulations around pre-packs will, however, make it more difficult to do ‘connected party’ transactions involving incumbent directors and sponsors, which could provide opportunities for new investors. This may, therefore, be a good time for readers to catch up with, and stay close to those insolvency practitioners who are currently a bit less busy!

Read the full roundtable discussion published on the Real Deals website.

This article was first published by Real Deals.