Posted in Finance Articles, Total Reads: 4234
, Published on 25 June 2011
Corporate debt restructuring is the reorganization of companies’ outstanding liabilities. It generally a mechanism used by companies which are facing difficulties in repaying their debts. In the process of restructuring, the credit obligations are spread out over longer duration with smaller payments. This allows company’s ability to meet debt obligations. Also, as part of process, some creditors may agree to exchange debt for some portion of equity. It is based on the principle that restructuring facilities available to companies in a timely and transparent matter goes a long way in ensuring their viability which is sometimes threatened by internal and external factors. This process tries to resolve the difficulties faced by the corporate sector and enables them to become viable again.
Other alternatives available to restructuring are refinancing or bankruptcy. If the company cannot be revived then companies go for bankruptcy. Sometimes, companies go through phases when it becomes very difficult for them to repay their debts. For example airline industry went through such phase of high aviation turbine fuel (ATF) prices, increasing labor costs, dearth of skilled labor, rapid fleet expansion, and intense price competition among the players. Similarly, retail companies like Vishal Retail faced lot of difficulties in repaying their debts during the crisis of 2008-2009.
Assume that there is a Company A-B-C which has an outstanding debt which it cannot meet. Company A-B-C owes this debt to three lenders – X, Y and Z.
From point of view of A-B-C
At this point A-B-C can consider few courses of action. It can consider re-financing, i.e. take on further debt in the hope of turning profitable and to pay off its original debts. However, this may not be possible if Company A-B-C is not in a position to sustain such levels of debt. Another way out could be for Company A-B-C to cease its operations and to undergo winding up. This has the obvious defect of afflicting an unnatural death on the company’s existence. At this point, Company A-B-C could also consider a structured plan to re-negotiate the terms of its current debt with the lenders. This is where restructuring gains prominence.
From point of view of X-Y-Z
CDR gives lenders an opportunity to convert their NPAs arising out of debt stricken corporate accounts into productive assets. The lenders interest lies in recovering the principle amount lent to Company A-B-C along with returns on that investment. They may also force A-B-C into liquidation but it may lead to low returns. If the company is facing financial difficulties for factors beyond its control, lenders may agree for restructuring to facilitate revival. The decision should be based on a thorough examination on a case to case basis. Wherever the demand for restructuring is legitimate, and there is a good reason to believe that the corporation may be revived, it must be considered for restructuring.
Impact of DTC on CDR
When the Direct Tax Code becomes applicable from April 1, 2012, it will have a significant impact on the companies that choose to undergo Corporate Debt Restructuring. The new tax code will make the business houses more averse towards altering their debt structures. This is because the DTC states that loans waived by lenders will be treated as income in the hands of the borrowers and taxed accordingly. This will increase the taxable income of the victim companies and hence their tax payable, another blow to their already crumbling financial backbone. Though CDR packages do not always involve waiver of loan repayments for the loanee, but there are plenty of cases where a partial waiver is agreed when loans are rescheduled. This happens when the creditor is opting for an equity position in the company by letting go a portion of the debt.
From point of debtor CDR benefits in the short run, but in the longer run it hurts their credit ratings. This makes it harder for them to raise fresh debt or dilute their equity share. From point of creditors like banks it will affect cash flow, performance measures and key balance sheet accounts. It may also lead to asset liability mismatch. Management need to understand the impact of debt restructuring on their company’s key financial indicators before taking decision of CDR.
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