Debt Restructuring

Debt restructuring is a refinancing process whereby the company facing cash flow issues enters into an arrangement with lenders to renegotiate favorable or flexible terms, thereby saving themselves from bankruptcy. For example, the lenders may choose to lower the interest rate for the business or increase the time limit for paying the interest and principal amount.

A debt restructuring strategy can significantly deteriorate the brand image and result in a morale drop among employees. However, to save the organization from bankruptcy, such a provision might be an option that cannot be ignored. Moreover, once the restructuring happens, securing additional credit from other organizations might also get more challenging.

• Debt restructuring refers to the refinancing process where the company having cash flow issues comes into an arrangement with lenders to renegotiate favorable or flexible terms to save themselves from bankruptcy. 
• The debt restructuring methods are debt for equity swap, bondholder haircut, and negotiating payment terms.
• It may save the company from bankruptcy in the short term, but there is no guarantee that it will work smoothly after debt restructuring.

Debt restructuring is a process of restructuring the company’s obligation facing financial difficulties.

It may include debt for equity swaps, haircuts, an extended period of non-payments, and reducing interest rates.

Although it may save the company from bankruptcy in the short term, there is no assurance that it will run smoothly after debt restructuring.

Even though a debt restructuring plan adversely affects the credit score of the organization or individual, it is an important function that gives them a fighting chance to rebuild their image or give them the ability to even remain afloat.

Moreover, the organization secures cash flow to meet the immediate demands of the business to remain in operation. It also provides them with legal protection from creditors and protects their assets from being liquidated.

Let us discuss a few methods through which corporate debt restructuring is done through the points below:

#1 - Debt for Equity Swap

In debt to equity swap, the lenders may choose to forgo the outstanding debt for a stake in the company. It is usually done in cases where the company has a large asset base and a large balance sheet, and bankruptcy will create little value for the lenders.

Thus, the lenders take the company's management and run it as a going concern. The lenders take a major equity stake and thus dilute the original shareholders, who may own a diminished stake in the company.

For example, the debt for equity swaps is one of the best ways to deal with subprime mortgages. A householder who cannot service his debt of $200,000 may agree with the bank to reduce the mortgage to 75%, i.e., $150,000, and the bank will receive 60% of the amount of the house's resale greater than the percentage of 150,000.

#2 - Bondholder Haircut

A defaulting company with outstanding bonds may negotiate with the bond investors and offer payments at a discounted price, omitting or reducing the interest payments or principal payments.

For example, Wells Fargo owed $267 billion to the bondholders in its annual report of 2008. A 20% haircut may reduce its debt by $54 billion, creating an equivalent amount of equity that was good enough to recapitalize the bank.

#3 - Negotiating Repayment Terms

A company may negotiate repayment terms, including reducing the interest rate, writing off some outstanding loans, and increasing the time to repayment. That is a more affordable method and can be achieved by an agreement between the lenders and the company.

Let us understand the concept better with the help of a couple of examples as discussed below:

Example #1

XYZ Enterprises manufactures electronic products such as earphones, Bluetooth headsets, and charging cables. The production of the new state-of-the-art headphones was covered by a loan taken from their bank and a local creditor.

The product upon being launched did not do too well in the market and as a result, XYZ Enterprises were facing a huge cash flow issue. After struggling to find ways to tackle the issue, they decided to adopt the debt restructuring strategy.

Therefore, their interest rates were slashed and the repayment period was elongated to ensure they had more time to repay their debt and could manage their current liabilities such as salaries and rent.

Example #2

Bed Bath & Beyond, is a home décor and kitchenware brand founded in 1971. They specialized in affordable products that made them a household name in the United States.

However, they struggled to make the transition into the online space and were soon overtaken by e-commerce giants such as Amazon and Walmart. The company lost over 30% of its sales in 2020 and 2021 as a result of the pandemic.

In January 2023, they received a notice of default from their creditor, JP Morgan. The company’s spokesperson informed the SEC that they do not have the funds to repay and would like to opt for corporate debt restructuring.

A debt restructuring plan can have significant effects on the morale, image, and prospects of the company. However, there are a few factors that make restructuring debt an advantage and a few that qualify the other way around. Let us discuss the advantages and disadvantages through the points below:

Advantages

• Legal protection to the business from the lenders
• Protection of the company's assets
• Protection of the company from closing down will run as a going concern
• Jobs of the employees are saved
• Better recovery for creditors than bankruptcy

Disadvantages

• Lower recovery by lowering interest payments and increasing schedule
• Write-offs may hit the balance sheet of the creditors.
• No assurance that the business will run smoothly and will make timely payments even after debt restructuring

This article is a guide to Debt Restructuring and its meaning. Here, we discuss its examples, methods, advantages, and disadvantages. You can learn more from the following articles: -

• Restructuring
• Restructuring Cost
• What is Asset Restructuring?
• Debt Schedule