The State of the Industry: Informal restructuring could add significant value

Last week, we published the first article focusing on a report by Deloitte on the state of the business rescue and restricting industry.

Some of the key highlights from the article include:

• Protecting the business and preservation of employment are still ranked as the top priorities of a restructuring process;
• On the back of increased activity experienced by respondents in the past 12 months, 88% of respondents are expecting;
• increased activity levels in the restructuring industry over the next 12 months;
• Availability of post-commencement finance (PCF) is still considered an important requirement for a successful BR process;
• Informal restructuring solutions are preferred over formal solutions, largely due to greater success rates and cost effectiveness;
• The unfavourable stigma attached to companies in BR is a challenge to the success of a formal restructuring process;
• Early identification of financial distress is still ranked as the most important element to be improved in local restructuring;
• The appointment of a chief restructuring officer (CRO) is not common in South Africa, with CROs deemed to be difficult to find;
• Nonetheless, 77% of respondents believe that the CRO role will be more important in the future;
• Respondents anticipate increased demand for distressed funding as one of the key financing trends over the next 12 months; and
• Customer relationship management (CRM) tools, big data, cloud as well as AI and machine learning are some of the technologies expected to have transformational impact on the restructuring process in the coming years.

The article was taken from the executive summery of the report. There are important, very specific, issues that were discussed in the report. Today, we will focus on the role of informal restructuring as well as the rise of the Chief Restructuring Officer.

Informal restructuring to take centre stage
The report points out that, as the COVID-19 vaccination programme rolls out and debt relief measures are unwound, financial institutions will start to take stock of their exposures and restructuring activity will increase.

The expectation is that restructuring activity will become increasingly informal. In part, this is due to recent high-profile cases, particularly those involving state-owned enterprises (SOEs), that have proven that formal business rescue is not a ‘silver bullet’.

The report adds that, as a result, it is anticipated that restructuring activity will increasingly take place consensually, outside a formal process, and in line with the trend observed in advanced economies. Some of the restructuring options expected to be employed in the next 12 months include the sale of non-performing or noncore assets, exits via sale of business, business rescue, and amending and extending debt. Respondents see corporate action – distressed or accelerated mergers and acquisitions (M&A), and managed exits of non-core or non-performing assets – as the most popular means for solving distress in the next 12 months. Restructuring options such as ‘amend and extend’ and ‘covenant resets’ have increased in popularity since the 2017 Deloitte Restructuring Survey.8 While these are attractive in the short term as lenders avoid write-offs and corporates continue to trade as going concerns, the ability to further amend and extend debt facilities remains to be seen; especially given the more stringent capital requirements for distressed positions. Therefore, it is unsurprising that business rescue features as a mechanism to facilitate restructuring over the next 12 months.

The report points out that, to increase the chances of success of an informal restructuring process, the early identification of warning signs and engagement with stakeholders maximise options available to solve financial distress. In fact, 94% of respondents believe the probability of a company being turned around is 50% or greater if restructuring advice is sought when red flags first become evident.

In support of this, 91% of respondents ranked the early identification of financial distress as the most important element to be improved in local restructuring. Notwithstanding the importance of early identification of financial distress, all options provided in figure 10 are regarded as very important for improvement. These include the role of education and professional bodies, consultation with experts or advisors, and the introduction of distressed debt funds. If early identification of warning signs is such an important aspect of a successful restructuring process, what is hindering companies from flagging potential underperformance and distress and engaging in restructuring activity more readily?

The report adds that, unfortunately restructuring remains a relatively dirty word in the boardroom, and avoiding a restructuring process and the consequent negotiations is a point of pride for many. More than half (55%) of survey respondents believe management avoid intervention and back themselves to trade out of the problem. Where distress indicators are ignored and stakeholder intervention is too late, a formal restructuring process or insolvency becomes inevitable.

The rise of the chief restructuring officer (CRO)
The report points out that informal restructuring can be an all-consuming process that stretches existing management to beyond breaking point. A CRO takes the pressure off management and focuses solely on the achievement of the turnaround plan and success of the restructuring. It is therefore not surprising that 77% of survey respondents believe that the CRO role will be recognised as being of greater importance in the near future.

The CRO is responsible for leading the development of the turnaround plan, negotiating the terms of the restructuring on behalf of the company, and delivering the plan. These are time-consuming tasks that require specialist expertise.

The report adds that, however, in the South African context, the appointment of CROs is infrequent and unconventional despite favourable feedback where they have been deployed. This could be due to a combination of factors, including resistance from management, the lack of suitable candidates, and the lack of awareness of the value a CRO could bring to the process.

It is unusual to appoint a CRO: 72% of respondents have dealt with only 15% or fewer cases where a CRO was appointed. Even though this is the case, 68% of respondents believe that appointing a CRO is more cost-effective than a BR process. This further supports the notion that the significance of a CRO could soon be recognised. This needs to be seen in the context of the need for intervention at the first signs of operational and financial distress, as well as the preference for informal restructuring among stakeholders.

The report points out that, not only is the CRO appointment seen as more cost-effective, survey respondents also reported a 51% satisfaction with the performance of the CRO, which compares to 35% for business rescue practitioners (BRPs). For CROs to be effective in a restructuring or turnaround process, they should be brought in to assist prior to the preparation of a turnaround plan.

The report adds that tasks predominantly assigned to CROs include identification of a new/own turnaround plan, implementation of the new turnaround plan, and reporting on and coordination of the turnaround plan implementation. This suggests that value is not only seen in the execution of the plan, but also in the crafting and development of the turnaround plan.

According to responses received, the top three critical skills and characteristics of a CRO are turnaround and crisis management, strategic thinking, and reliability. Skills which most businesses can choose to hire externally, such as sector knowledge and legal knowledge, are rated least important.

The report points out that, as the market for CROs is still in its infancy, survey respondents have indicated that it is difficult to find a suitably qualified CRO. Most respondents (84%) believe that the creation of a CRO panel would aid selection of the most appropriate candidate.