“COVID-19” and “Coronavirus” are now everyday talking points. Many corporations have implemented remote working arrangements and have either significantly scaled back or completely halted operations. Layoffs have been widespread, and the economy is under tremendous pressure. With revenues declining or eliminated, corporations with substantial debt obligations are faced with the challenge of meeting debt payments—and are exploring options for restructuring debt. But stresses in credit markets may create a wave of defaults and liquidity issues that ripple across investment markets.
While a sharp recession appears to be unavoidable, policymakers can take steps to cushion the blow. Congress has authorized relief payments to both businesses and individuals while the Federal Reserve (Fed) has promised to provide financial support with trillions of dollars in emergency lending. In a bold move, the Fed has cut its benchmark interest rate to zero in order to bolster the economy. In addition to cutting interest rates, the Fed announced in mid-April that it would buy at least $700 billion in government and mortgage-related bonds as part of a wide-ranging emergency action to protect the economy from the impact of the Coronavirus outbreak outbreak.
These strategies aim to prompt lenders to extend financing, while investors pile into government bonds, which results in lower yields. Now, more than ever, it is cheaper to borrow money or refinance existing debt obligations. This eases the financial burden many companies now face by freeing up cash through debt restructuring techniques. These techniques can lower interest repayments on refinanced current debt and access to new low-interest funding, so that they may retain their core workforce and stay afloat through the peak of the pandemic.
In times of severe economic downturn, creditors are often in support of debt restructuring because they understand they would receive less should the company be forced into bankruptcy and/or liquidation.
Six Alternatives to Restructuring Debt
1. Refinance Existing Borrowings at These Lower Market Rates
Lower interest payments free up cash for alternative essential uses.
2. Extending the Maturity of Existing Debt, Thereby Lowering the Future Recurring Payment Amount
This option can be combined with an interest rate refinance (point 1 above).
3. Debt/Equity Exchange
This occurs when creditors agree to cancel a portion or all of their outstanding debts in exchange for equity in the company. The swap is usually a preferred option when the debt and assets in the company are very significant, so forcing it into bankruptcy would not be ideal.
The creditors would rather take control of the distressed company as a going concern. Again, a company considering this option will have to consider the impact of ownership dilution and gaining support of current shareholders.
4. New Borrowings at Low Interest Rates
Companies may need to assess their current leverage ratios (debt/equity and debt/assets), as well as restrictions on borrowings, to determine their capacity for new borrowings and the trade-off between taking on new debt and the benefit of being able to pay unavoidable expenses.
5. Issue Callable Bonds
A company will often issue callable bonds to protect itself from a situation in which interest payments cannot be made. A bond with a callable feature can be redeemed early by the issuer in times of decreasing interest rates. Callable bonds have a higher interest rate than non-cancelable bonds, but callable bonds allow the issuer to readily restructure debt in the future because the existing debt can be replaced with new debt at a lower interest rate.
6. Issuing Equity Instead of Taking on New Borrowings
Equity may be a cheaper option in the short term (no mandatory payments, depending on the type of equity issued), and proceeds from equity issuance may be utilized in paying down high interest debt. However, potential ownership dilution is an important consideration and may not pass shareholder approval. Secondly, the current aversion of investors to companies threatened by coronavirus make equity a less favorable option. One of the safest investor strategies, and the most extreme, is for investors to sell all of their investments and either hold cash or invest the proceeds into much more stable financial instruments, such as short-term government bonds and treasury bills (as opposed to corporate stocks). By doing this, an investor can reduce their exposure to the stock market and minimize the effects of the raging bear.
While several alternatives have been outlined above, at the very least, refinancing of their current interest rates should be considered. This extends beyond refinancing long term debt obligations and includes leases and credit card rates.
Debt restructuring provides a less expensive alternative to bankruptcy when a company or country is in financial turmoil. It’s a process through which an entity can receive debt forgiveness and debt rescheduling to avoid foreclosure or liquidation of assets.
8020 Consulting can help with the process if you need support. You can learn more by contacting us, or you can download this helpful guide to business stabilization and contingency planning:
About the Author
Tennille is a qualified Chartered Accountant with 14 years of combined Big 4 public accounting and industry experience. Prior to joining 8020 Consulting, she spent 7 years as a Management Consultant serving various clients within industries such as Entertainment, Banking, Healthcare Services and others. She held various Controllership, Finance Manager and Technical Accounting lead roles. Her experience covers operational accounting, financial reporting (full set financials and MD&A), technical accounting (revenue recognition, debt accounting, business combinations, asset impairment) as well as compliance reporting (debt covenant calculations and reporting). Tennille has serviced clients in the United States and South Africa (which applies International Accounting Standards).
Categorized in: Financial Planning & Analysis, Business Stabilization