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This book is a must-read for wholesale bankers and other professionals dealing with companies in financial distress.

Heavy Weather Banking provides a structured approach to the various lending mistakes and lessons learned from actual banking practice, and a relevant toolbox on restructuring do's and don'ts, both in terms of content and effective behaviour.

Quickly following the dotcom bubble burst of 2000, and the financial-economic crisis that started in 2008, we are currently experiencing the third major credit crisis of this century. The outcome remains uncertain, but it seems likely that many corporates will struggle to survive.

This textbook on distressed corporate debt restructuring is written from the bank's viewpoint, and concentrates on how the bank should best manage problematic loans, causing as little as possible financial and reputation damage to the bank.

Heavy Weather Banking is not an academic finance book, but rather a practical, easily accessible textbook that provides a comprehensive overview of the many topics, from early warning signals and lessons learned, to reaching a successful restructuring. The book includes many real-life examples.

“This is a valuable addition to the literature on distressed debt and one which I shall be recommending to all of my bank clients and trainees in this space.” - Adrian Grant, Consultant and Trainer on loan origination & restructuring

Rob Wijman is one of Europe's leading loan workout and restructuring bankers with a deep and global experience in high profile cases. Wijman provides training, workshops and lectures on corporate crisis situations in addition to advising distressed businesses.

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RECOMMENDATIONS

HEAVY WEATHER BANKING

THE BOOK OUTLINE – ACKNOWLEDGEMENTS & DISCLAIMER

SECOND INTRODUCTION

BOOK I
Lessons Learned

1. Early warning signals and red flags

2. Leverage and debt structural issues

3. EBITDA, liquidity and cash flow

4. Documentation

5. Syndicate and other lenders

6. Ownership and management

7. Industry and Market

8. Collateral / Legal issues or “The insecurity of security”

9. Creative accounting and fraud

10. Other reasons for loan losses

BOOK II
Restructuring and Recovery

11. Causes of misfortune

12. Customer centricity – but who is our client?

13. Stakeholders – trust and liquidity

14. When to transfer to restructuring – the Crisis Timeline

15. Content and Behavior in Restructuring

16. Restructuring in three phases

17. Critical considerations for the bank

18. Critical considerations for the company

19. Sources of conflict and dealing with conflict

20. GCR function and place in the bank organization

Summary

ANNEXES

Annex 1 – ad Ch. 15 Standstill Considerations

Annex 2 – ad Ch. 16 Restructuring in three phases – the first drill

Annex 3 – ad Ch. 16 Restructuring in three phases – digging deeper

Annex 4 – ad Ch. 16 Restructuring in three phases – the second drill

Annex 5 – ad Ch. 16 Restructuring in three phases – the third drill

ABOUT THE AUTHOR

Rob Wijman

Heavy Weather Banking

Corporate Debt Restructuring in Times of Crisis

Digital edition December 2021

Haystack Publishing

www.haystack.nl

needle@haystack.nl

Author: Rob Wijman

Editor: Susan van Ass

Cover illustration: Hein de Kort

Cover design: Jessica Wieberdink (Focus Boekontwerp)

Foto auteur: Freekje Groenemans

Layout: Debbie Brok (Focus Boekontwerp)

E-book: Debbie Brok (Focus Boekontwerp)

For info: wijman.rob@gmail.com

ISBN 9789461264978

NUR 793, 800

BISAC BUS004000, BUS000000

© 2021 Rob Wijman

All rights reserved. No part of this publication may be reproduced, stored in an automated database, or made public in any form or by any means, electronic, mechanical, by photocopying, recording, or otherwise, without the prior written consent of the authors.

RECOMMENDATIONS

'Heavy Weather Banking is a must-read for everyone involved in corporate debt restructuring and workout. Rob is fond of saying that “to be effective in restructuring one first has to be able to structure good credits”. Accordingly, this book should also be read by relationship bankers responsible for originating and monitoring corporate loans. Rob has drawn on his unusually deep experience as a senior banker “at the coalface”, bringing his text to life with a rich array of case studies and his engaging conversational-style. This is a valuable addition to the literature on distressed debt and one which I shall be recommending to all of my bank clients and trainees in this space.'

Adrian Grant, Consultant and Trainer on loan origination & restructuring (founder of loanworkoutbanker.org)

'It is a great gift for practice and management literature when experienced professionals like Rob Wijman share their hands-on experience and practical insights on real-life cases they have been involved in. This book is an informative must-read for anyone interested in the practice of turnaround management, distressed “heavy weather” banking and insolvency related topics. It offers valuable lessons and tips and tricks both for young professionals as well as more senior specialists.'

Jan Adriaanse, PhD, full professor of turnaround management at Leiden University in the Netherlands and partner at corporate finance firm BFI, Amsterdam

'The unique feature of Heavy Weather Banking is that it combines a structured approach and storytelling, which gives it "real' feel. The case studies are insightful and different in their own way, which provides a 360-degrees view on restructuring.'

Alexander Pisaruk, CEO of Raiffeisenbank Ukraine

“Rob has distilled his extensive experience to create a rich resource for professionals involved in corporate turnaround - restructuring and credit bankers, FO relationship bankers as well as advisers to GCR teams.

He draws from his extensive experience to highlight both the “technical” aspects of restructurings and the “soft” skills associated with delivering leadership in these often complex and highly charged situations."

Keith McGregor, Senior Managing Director at FTI Consulting, former EMEIA Restructuring and Capital Transformation Leader at EY

'It is impressive how Rob Wijman shares his enormous wealth of knowledge and expertise with us.

He points out the basic errors in banking starting from real cases, proposes an amalgam of remedial recipes and highlights the new trends in key areas of banking. A must-read for any current or future leader in banking.'

Rudi Deruytter, CEO of CKV Bank Belgium

'Insightful, interesting and informative – a pleasant read packed with lots of valuable insights. A must read for professionals in finance to be prepared for the (hopefully not near) future.'

Jelle Hofland, Restructuring Partner at Clifford Chance (Amsterdam)

HEAVY WEATHER BANKING

“Banks expect a major financial setback due to the corona pandemic.” News headlines in the summer of 2020 said that the top three US banks had set aside some $28bn as loan loss provisions during the first half year of 2020. And although much less than their American counterparts, the main Dutch banks also saw material increases in their buffers for credit losses in the first three quarters.

It is clear that the COVID-19 crisis created heavy weather for everyone - individuals, businesses and governments alike – and on a global scale, also for the banking industry. At the time of finalising this book, it’s the second half of 2021, and the earlier expected avalanche of bankruptcies has not taken place, not yet at least, mainly thanks to the safety nets created by governments. The safety nets have increased government debt in many places, which debts may still be sustainable thanks to current mild interest rates.

The chart below shows the estimated increases in debt-to-GDP ratios, in percentage points, over 2020. Source IIF, BIS, IMF

Image 01 - This chart shows the estimated increase in debt-to-GDP ratios, in percentage points, over 2020.

After the economic benign interlude since the last financial economic crisis, the banks have been re-strengthening their Restructuring and Recovery teams, in anticipation of an avalanche of work with their most troubled credit relationships – both individuals and business clients. As said, early last summer, all economic analysts and other experts predicted a global economic crisis of unknown magnitude. However, so far, the expected avalanche did not materialise. There was hardly any increase in the number of distressed corporates, resulting in a limited workload for the banks’ restructuring officers, and in material releases of provisions for credit losses that were taken last year.

It makes one wonder: is economy a science? The 2008-2009 financial-economic crisis was not foreseen, and the last year widely predicted economic doom period has not materialised – so far. Pushed by banking supervisors and regulators, many bank officers are working hard to make new models, that are more predictive and can better calculate future credit losses than the old ones. Will they succeed?

One thing is certain: there will always be individuals, businesses, banks and even governments that run into financial problems. And many of them will opt for a (financial) restructuring, with the ultimate goal to reach a turn around to a healthy financial situation.

This book explains the “do’s and don’ts” in international restructuring and recovery, based on lessons learned in earlier crisis situations. This book is meant to give some guidance to banks and bankers that are going through heavy weather. And to anyone else who is interested.

You only learn in bad times, not in good times.

Good Times - Bad Times: a big difference. In good times all banks are profitable and every credit relationship manager is a good banker. Your client, the company, makes enough money to pay all repayments, some fees and a decent interest margin on its loans. Apart from the mandatory annual review, the credit file stays in the closet. The client performs on its debt, and the bank will never notice that mistakes may have been made in the credit analysis at origination, in identifying and establishing the optimal collateral package, in the documentation and in subsequent monitoring after closing. The client pays, so there is no need to actively check or correct anything. The credit file can remain in the closet, and nobody is harmed.

Bad times are different. When your client stops making enough money to meet all its obligations, the situation changes. Suddenly it will start to matter what position you’re in, compared with the other creditors, whether you have collateral or other priority rights over other creditors. And the big question will be whether the company can turn around and survive, whether you as bank can or should support the company to survive, and whether you can still correct the earlier mistakes that your bank may have made. Only in bad times you will have to ask yourself whether your bank is still “in-the-money” or “out-of-the-money”.

And my first intention with this book is to support you in making the right choices and doing the right things in any financial restructuring or loan workout.

Relationship, Return and Reputation are the key pillars for sustainable banking.

My second goal is to encourage relationship bankers to keep the interest of their client at heart, and not only because (in the Netherlands, at least) you have signed up to the Bankers’ Oath. Question to answer first: who is your client? You have to realise that every corporate in distress will have many stakeholders, including their management, owners, employees, customers, suppliers and a variety of other creditors. And many of these stakeholders are clients of your bank as well. However, when dealing with a corporate client in crisis, we have to realise that the company is the client. The company and its future are at stake. And in that perspective, other stakeholders are not “the” client. Realise that e.g. management or even owners can be replaced. How to diligently deal with, and (financially) restructure a corporate in distress to help it turn around, is the subject of the second part of this book.

The “Lessons (re)Learned” department is often ignored in good times.

The third important goal is to once more record the many expensive lessons learned in corporate lending. The “Lessons Learned” department in any bank is one that is mostly closed in good times, and only occasionally reopens during bad times. Then, after the next crisis has been survived, the “Lessons Relearned” dept closes again, only to be reopened again as the “Crying Out Loud” dept in the new crisis.

Maybe it’s a bit cynical to say that bankers have memories like goldfish, but it is remarkable that the historical track record of the banking industry shows that the same mistakes have been repeatedly made.

THE BOOK OUTLINE – ACKNOWLEDGEMENTS & DISCLAIMER

The book starts with an introduction to restructuring by highlighting the ins and outs of an actual work out case that I have personally managed. When? In the beginning of this century. Where? In Poland. Which company? I have changed the name, as the company has never reacted to my request whether I could use its actual name.

After the Polish experience, the main body of the book will follow. It consists of two parts: lessons learned and restructuring. The first part of the book is about the inherent credit risks in lending, common mistakes that banks have made, sometimes more than once, and the lessons that should be learned from these mistakes. We will see that mistakes are not exclusive to corporate lending, but that mistakes are also made in consumer lending, and in lending to financial institutions and governments.

For easier reference, the various lending mistakes are classified in ten categories, as follows, in Book I: “Lessons Learned”.

1.Early warning signals / Red Flags

2.Leverage / debt structural issues

3.Liquidity / cash flow issues

4.Documentation issues

5.Syndication / other lenders issues

6.Ownership / Management issues

7.Industry / Market specific issues

8.Collateral / Legal issues

9.Creative Accounting / Fraud

10.Other reasons for loan losses

When looking at the individual cases, we will see that there are many overlaps, that the root cause for a problem loan situation is not a single issue, but that there is often a combination of categories and factors in play.

The second part of the book is about how to deal with problem loan situations once they have arisen. This part is meant to be a Restructuring and Recovery handbook, a manual on work out situations, based on my personal experience. By the way, “Workout” is an often used synonym for both restructuring and recovery situations. And the restructuring and recovery function in ING Bank is called Global Credit Restructuring (GCR). In chapter 20, the last chapter of this book, I will provide my views on the strategy / purpose of the GCR function, and what I personally believe is its proper place and organisation within the bank organisation.

Neither the first, nor the second part of the book is a comprehensive manual. It simply can’t be, given that every case is different, and because we can’t predict how future cases will – literally - work out. However it is meant to give important guidelines on how to deal with work out situations. The second part of the book provides content, tools, techniques and some important restructuring principles, but surely also guidelines on “softer skills”, on more or less efficient behaviour and communication when dealing with problem situations.

The layout of the book’s second part, or Book II: “Restructuring” is as follows.

11.Causes of misfortune

12.Stakeholders – trust and liquidity

13.Customer centricity – but who is our client?

14.When to transfer to restructuring

15.Restructuring in three phases

16.Contents & behavior

17.Critical considerations for the bank

18.Critical considerations for the company

19.Sources of conflict and dealing with conflict

20.GCR function and place in the bank organization

In order to promote accessible reading, you will find important topics phrased in bold italics. The book will conclude with a summary of some main lessons and takeaways.

As stated, I have changed the actual name of the Polish company, just as I changed the names of most other individuals and corporates, especially those relating to lesser-known private companies. Names of publicly listed, some other very well-known companies and their top managers, names that are well-known in the public domain, have not been changed.

All examples are based on my personal observations and experience, and it is possible that not all information is accurate or complete, or that others may have different views on the situation and/or information that I have provided.

In addition, I would like to emphasize that all ideas, statements and conclusions are based on my personal opinion and in no way reflect those of other individuals or institutions, including those of my former employer ING Bank.

At the end of this introduction, I want to express my sincere gratitude to all the people who have supported me in completing this book. A big “thank you” goes to the early reviewers of this book, including Jan Adriaanse, Rudi Deruytter, Jelle Hofland, Alexander Pisaruk and especially Adrian Grant for his enthusiasm and a great editing job - in case you still find language errors, it is because I made changes afterwards - and Keith McGregor for his valuable insights and suggestions. Another big “thank you” goes to my favourite cartoonist Hein de Kort, for his spot-on cover design.

I am also grateful to all GCR team members and other colleagues at ING Bank for their outstanding performance, tireless support and great sense of humour to deliver great results from our many adventures. Working with so many smart and talented men and women, from diverse cultural backgrounds who joined our teams in the early crisis years after 2008, will always be one of my fondest memories.

I also thank the bank’s senior management for their deep support for and trust in our departments – they were always approachable, attended our team meetings on a regular basis, and without doubt helped us reposition the restructuring and recovery job “from the dark side of the bank to the spotlights” – which could have been an alternative subtitle for the book.

Rik Santegoets provided useful support on the initial graphs and illustrations, Jeroen Vos gave welcome legal advice, and Freekje Groenemans took a real good photo. Finally I would like to thank Geerhard and Angels at Haystack for their professional and creative support, which enormously helped bringing this book to market.

SECOND INTRODUCTION

WestConnect

Created in last century’s roaring late eighties and nineties in Central and Eastern Europe, WestConnect succeeded in acquiring some high profile real estate properties and established retail businesses - department stores - in the country’s main central city locations. The acquisition price was not excessive, but the transfer came with some strings attached, including the government withholding part of the shares. Taking over the old communist-style trained staff was part of the deal as well, and the acquired properties were completely outdated and poorly maintained. As an example, the Katowice based department store resembled an old, ill-lighted industrial shed rather than an attractive shopping place.

WestConnect was in the first place a real estate investor, but quickly developed some new department stores specialized in fashion, and added retail chain stores for cosmetics, music, movies, magazines and books. It also created some more or less successful joint ventures with established western brand names in photography, cosmetics and water.

In 1999, ING Bank – through its local subsidiary – put out a prospectus, aiming to provide a $99m investment loan A (for further development and refurbishment of the commercial real estate), tenor 6,5 years, and a $22m working capital facility loan B (mainly for stock financing), on a yearly roll over basis. On a side note, “stock” is meant as “inventory” here (European style), not as “shares”. Both loans A and B were to be syndicated. The total $121m loan was real money, as in those days the $ was still valued above the Euro. ING Bank had a total “final take” participation of $55m, and the other syndicate participants were ABN AMRO, BPH PBK (Bank Austria), Bank Zachodni WBK (Allied Irish), Bank Handlowy (Citi), BRE (Commerz) and the German bank for small – and mid-corporates MHB.

The first observation is that there was a clear mismatch between the loan in foreign currency ($) and the company’s source of income which was in Polish zloty (PLN). That the rents of the various properties were indexed against the US dollar was mentioned as a mitigant. This was not a real mitigant, because the tenants were fully dependent on zloty income as well.

This currency mismatch is one of the classical lending mistakes in banking and has often led to material credit losses

Despite a low initial capitalization, the financials showed a positive equity, thanks to a material revaluation of the commercial real estate properties acquired by WestConnect in the amount of PLN470m – well in excess of $100m.

While sales levels reached between $150-200m in the period 1998-2001, operational cash flows were negative already before financing costs, and came in at minus $10m (1998), minus $18m (1999), minus $12m (2000) and minus $5m (2001).

The usual “hockey stick” type of financial projections and ample collateral package led to a positive credit decision

As often happens, the financial projections were positive, thanks to aggressively forecasted sales increases and better margins. The assumed revenue increase was even more aggressive, taking into account the then negative economic sentiment leading to low consumer spending and increasing competition from many strategic newcomers (hypermarkets like Casino), booming shopping mall development, and the outdated department stores that weren’t really attractive to shopping visitors. At credit origination, little or no attention was paid to the legal / ownership issues for some of the most material properties, or for the generally felt political sentiment that material state assets had been squandered away for a song to some crooked foreign investors…

There were some strong mitigants against those early warning signals. Yes, this was a start-up company with negative results, but it also was a market leader in a Polish economy that was turning around. Obviously, cross selling was an important consideration for house bank ING to finance WestConnect – a future IPO mandate was seen as a realistic proposition. Also, there was ample collateral value in the real estate properties that had an estimated market value of $160m. Another strong point was that the WestConnect CEO and CFO (a highly talented ex-ING banker) made a strong impression and did a convincing presentation to ING’s Credit Committee (“CC”). The CC approval conditioned inter alia that the mortgage security rights would be perfect and legally enforceable.

The historic financials were pretty bad, and the CC approval came in only after two rebounds. And this was not the first, nor the last time, that a positive outlook and financial forecasts, enhanced by an overestimated collateral value, caused the hope factor to get the upper hand over the fear factor. And it wasn’t the first time that a level of false comfort was created by conditioning something to be perfect in an imperfect world. Having a perfect enforceable security right on these - still partly state-owned - commercial properties in Poland was basically impossible, and both the commercial and the credit risk bankers should have been aware.

When WestConnect showed a historic record loss in its 1999 financial report, the local Credit Committee commented in her credit review that: “At present moment the best of evils is to continue the financing, especially in view of the security (key mortgage rights were not yet registered because of ownership issues), and to give them the chance to finally fulfill the forecasts”. Further it was concluded: “The credit documentation remains strong and (so) we are committed”. This was not correct given that most financial covenants - when properly calculated – had been broken and, in addition, the client’s sales revenues didn’t flow through the ING bank accounts as conditioned. No attention was paid to the company’s announcement in the report that: “negative operational cash flows will require repayments to come from other sources – in particular, from the sale and lease back of real estate.” The review was approved, conditional to a second opinion from GCR.

Transfer to the work out department, the first drill and initial talks

GCR immediately took over control of the file, since we felt there were simply too many red flags. During the “first drill” - desk top analysis including loan and security documentation check - we found that the syndicate’s security package (both the 200 mortgage registrations and the pledges on stock) was far from perfect. In addition, a complete security overview was missing, conditions precedent before disbursement had not been met (inter alia there had been no control of uses of funds against the investment plan), basically all financial covenants were broken, the legal opinion about the enforceability of the mortgage rights was not received and also the formal approval from the shareholder to enter into the loan was missing.

After spending a few weeks in Warsaw for these first checks, we started to arrange strategic meetings, first with the client and then with the syndicate and various advisers.

WestConnect main shareholder told us that he was committed to improve the operational results and to reduce debt by sale of real estate properties. Merrill Lynch was retained to attract outside investors and DTZ Zadelhoff was requested to revalue the properties. In preparation of a sale, the real estate properties were split from the retail business. In order to improve efficiency, responsibility, insights and financial results, the retail business was split in various business units (covering the various city centre department stores, children’s toys shops, a few different fashion outlets – media retailer FRS had always been a separate business entity). Further, reorganization measures included staff reductions, limiting the number of suppliers, introducing private labels and promoting the stores in stores concept, where significant parts of the real estate space was to be rented out to third parties including boutiques, Albert supermarkets and H & M fashion.

Meanwhile it was late summer 2000, and the banks agreed to continue financing and not call the loans. Of course, we sent a letter, confirming the defaults, and reserved our rights in that respect. We wrote a Memorandum of Understanding (MoU) setting out the considerations, and all rights, principles and preliminary agreements between the company, loan A banks and loan B banks. No indefinite waivers were given, but rights were reserved, and – anticipating material sale proceeds from (some of) the real estate properties - the loans were extended for one and a half year until FYE01.

Although this MoU was only signed by all parties late 2001, a few months before the revised repayment date, in practice it did serve and would serve as a roadmap for the workout process, both in the beginning and going forward.

Image 02 - WestConnect Initial Restructuring Steps

Starting of the work out including initial hurdles

An out-of-court restructuring (in financial jargon, this is also known as a “workout”) was agreed, which is a going concern solution to maximize both the banks’ recovery outlook and shareholder value. The alternative of a liquidation of the companies and collateral enforcement would cause a big loss to the banks. Real estate appraiser DTZ revalued the various properties to 50 – 80% of book value, depending on location, and disregarding any claims which would be preferential to the secured lenders in the event of an insolvency. Apart from preferential claims, 3.75% ownership of some of the key properties was retained by the government, which in practice gave the government a blocking “golden share” vote. In addition, an eventual sale to non-Polish investors would require approval of the Ministry of Interior, another severe limitation on the eventual proceeds from a forced sale.

In order to start working on a consensual solution, a temporary standstill was agreed. As I mentioned, we drafted an informal MoU which described the process going forward, including a restructuring of the company’s assets and business, defining the individual banks’ rights to the security pool (the loss sharing agreement for both loan A as loan B lenders was based on original limits), setting milestones and deadlines, and arranging for regular information (monthly updates on progress in sale activity, business reorganization plans and financial results) and retaining independent expert advice on the company’s business and strategy going forward. Further collateral was perfected by providing all business assets as security, including all trademarks, patents, shares and joint and several liability of group companies. Interest margin was doubled to 200bp, and the company agreed to pay for all costs, including advisers’ fees and the Agent bank’s expenses.

During the workout, we faced a multitude of problems, of various nature. The more than 1,000 pages loan and security documents were in the Polish language only. The lack of concept of a Security Agent / Umbrella Facility meant that we did not have one syndicate loan, but rather 8 banks x 2 loans x 2 borrowers i.e. 32 individual loans. We had to replace the original lawyers White & Case because we thought they had insufficient legal insight, and were thinking more in problems than in solutions, and brought in Linklaters.

During the workout, many extended deadlines and extensive documentation changes required unanimous consent from the syndicate banks, which led to many comments and proposed adjustments, and in practice meant that we had to work a few days round the clock every time we neared a deadline.

Because of incorrect wording in and understanding of the loan documentation, the principal amounts put in mortgage documents only covered 91% of the principal amount which was due under the A loan. Additional registrations and many corrections needed to be made. Perfecting the mortgage registrations was a time-consuming process.

Approvals for roll over of credit B were often coming in at the latest moment. When the first maturity date was coming up, one Polish bank declined to extend just on the day before, despite the bank’s account manager handling the case having advised us earlier that he personally was positively advising renewal of the loan. This was evidence, and not for the first time, that in Polish banks decisions are taken on the highest level only, that lower-level managers cannot argue against this (“the boss is always right”) and that arm twisting games are still very popular in Poland. The next morning, I had to call the Chief Risk Officer (CRO) of that bank during his breakfast, just before he went to his Credit Committee meeting where the case would come up for decision. And this was not the last time that we had to convince dissenting banks.

Another syndicate banks’ issue was the frequent change of responsible staff, also because, during the process, some of the Polish syndicate banks became owned by western banks. While there was huge pressure from the new foreign shareholder in these banks to clean up the Non-Performing Loan portfolios, the MoU was a big help to keep them on the right track. Many discussions were needed to convince senior foreign management in the Polish banks that the borrowers involved were not the typical “local crooks” but that effectively all parties were working together to preserve full value for everybody.

Initially, the government with its small shareholder stake successfully opposed the envisaged business restructuring – through court they were able to block decisions taken in shareholders meetings. The stalemate was only solved when an agreement was reached for the price to be paid to hand over the last portion of shares. Essentially co-operation had to be bought.

Getting the auditors PwC to sign off with an unqualified opinion and providing a going concern statement, while the bank loans were due and not yet formally extended, was a constant struggle during the workout. By the way, this was not typical for PwC or WestConnect, struggles over going concern statements are quite common in most financial restructurings, where default covenants are triggered and long term financing is not always guaranteed.

Further developments - and more hurdles - in the work out

The continued economic distress in Poland in 2001/2002 didn’t help investor appetite. American investor interest faded after 9/11. Strong support came from the majority shareholder, who remained committed to preserve value in his companies. He injected approx. $100m over the years 1999-2002, both to cover losses and to make incidental repayments to the bank syndicate. During the workout, the syndicate loan was brought back from $121m to reach $93m by FYE02. Despite this positive development, the Polish banks continued their “power play” restructuring attitude. As an example, when we had negotiated an interim repayment of $10m, they would say “Where there’s 10, there’s also 15…” As experienced poker players, they had little recognition of or respect for a win-win situation, which was another lesson learned. Of course, these tactics led to delays in envisaged deal deadlines, but also to frustration and an increased mistrust between the lenders group and the shareholder.

From the beginning of the workout, we had always maintained that no individual bank would get out of this loan syndicate without accepting a considerable haircut. Nevertheless, some syndicate participants had been trying to leverage on ING having by far the biggest stake, and in reality, we did enter into negotiations to take over other banks’ exposures. And although our bank never really favored buying into distressed debt, except when we had strong defensive reasons to do so, internal approval was given to take over other bank exposure at a discount of minimum 20%. Negotiations however stopped at a gap of 12.5% offer versus 30% ask.

In the course of 2002, the shareholder and the banks agreed to follow two parallel strategies, both aiming to repay the syndicate loan, either through a sale of commercial real estate or through a mortgage-backed bond issue arranged by Morgan Stanley. WestConnect was committed to take either solution, and would take the first route that would come along.

New management was retained, including a tough playing American investment banker as CEO of the holding company. The new CEO decided to answer the poker play initiated by the banks, and knew perfectly well how to play on the banks’ “greed and fear buttons”. We had quite a few tough “bend or break” negotiations with the guy and occasionally had to call on the shareholder asking him to either force him back in line or fire him. Of course, the shareholder backed his new CEO, but we always reached agreement on the next steps.

I mentioned “greed and fear buttons”. It is long ago, but I will always remember an old banker saying to me that, “Banking is balancing between greed and fear”. Now you may think this is quite cynical – it is - but surely there is some truth in it. One of the instruments that we used to convince the banks to stay on board, was the pricing tool. In the last year, and after we increased the original margin from 100bps to 200bps and in the second instance to 300bps, we conditioned a monthly 25bps step up in margin. When we finally reached a margin of 450bps, the shareholder definitely had a strong incentive to refinance as well.

The turnaround and closing of the financial restructuring

Meanwhile, the retail business restructuring in separate business units started to pay off, assisted by the Polish economy slowly picking up in 2002. Towards the end of 2002 we were still considering two exit routes – a sale or refinancing of the real estate. Morgan Stanley was retained to work on a mortgage-backed bond issue, a securitization containing WC’s prestigious real estate properties. This was a first time ever in Poland. Those bonds needed to be dressed up nicely in order to obtain investment grades by three agencies: Moody’s, Fitch and S&P. The preparations and the rating process took many months – and we really doubted whether it would ever fly. But then, in 2003, a favorable deal was reached on the partial sale of FRS cosmetics business to LVMH subsidiary Sephora. Sephora and FRS created a joint venture and ING arranged financing, secured by a put option to LVMH on the remaining FRS cosmetics shares.

Towards the end of 2003, a complete financial restructuring was closed. Thanks to repayments – the sale proceeds of FRS cosmetics business helped - and a favorable $/EUR development the total loan exposure had reduced to €83m, which was refinanced by a €63m mortgage-backed bond and a €20m refinancing package, for which the shareholder provided first class security. All syndicate banks were repaid in full. We made a restructuring fee of €1.1m on the refinancing package, and the release of €15m loan loss provision meant that ING’s Polish subsidiary ended 2003 with a profitable result.

The main lessons learned from this restructuring tick most boxes in this book.

1.Many red flags were already visible at the time of credit origination

2.Leverage was too high – surely when related to earnings.

3.Currency mismatch: debt in $ while the income was in PLN

4.Negative operational cash flows made it impossible to service debt

5.Various serious shortcomings in loan and security documentation

6.Incoherent syndicate with “power play” attitude by Polish banks

7.Committed shareholder was key to reach a consensual outcome

8.Industry / Market issues: low consumer spending and new competitors in adverse Polish economy, low (US) investor appetite

9.Security was insecure: ownership issues, limited sale potential for the real estate properties, untested / difficult court system

10.Equity / solvency buffer was “artificial” as it was mostly created through asset revaluation

11.No check on use of funds against actual investment plans.

And a few lessons may be added.

12.Multi-creditor workouts require a pro-active lead

13.All communication should be clear and transparent

14.Co-ordinated efforts work better than divide and rule tactics

15.The MoU initially served as an informal standstill, later as an effective roadmap during the workout

16.Seniority and direct contact with decision makers in banks is required to get things done

17.The willingness to co-operate in a multi-creditor workout will in principle exist as long as there is something to be gained – or negatively – something (more) to be lost.

18.In this case the shareholder was convinced that there was longer term upside potential in both the retail and the real estate business. And he was right

19.In quite a few instances, we have seen businesses in Poland, that in principle were viable businesses – at least, after an operational and financial restructuring - but which could not be saved or continued in Poland because of a lack of concerted efforts (examples include automotive, chicken breeding, shipyards, and various steel companies). The Polish banks and their restructuring officers didn’t have a vested tradition in win-win situations. On the contrary, there was an obvious natural mutual distrust. Power play was the order of the day and traditionally, the biggest mouth gets the best result. Hopefully, this has meanwhile improved.

20.FX development in this case worked in our favor. Taking into account that at disbursement of the loans the $ was around €1.10 and that at refinancing the $ was closer to €0.90, we can conclude that a close to 20% capital gain was made in an environment that was slowly turning to “Eurozone”. In case this development had been adverse, the refinancing would not have been achieved as it was

21.The “greed and fear” or rather hope and fear factors worked hand in hand to keep the banking group together. Despite a “deal fatigue”, which was growing in the more than three years this restructuring took, the shareholder’s financial support and strong margin step-ups were good incentives for the banks to stay on board. Of course, the banks always realised that the proceeds from a forced “fire sale” of the real estate properties would lead to a credit loss

22.All steps had to be prepared and explained in bank meetings as idiot-proof as possible. We sent around memorandums outlining the strategy, which memorandums were suitable for direct use to present the case to the other banks’ internal Credit Committees.

23.A disciplined approach was needed to keep the syndicate together: “No one gets out before the others, i.e., not unharmed”

24.This principle had to be confirmed and reconfirmed, that the best possible outcome was only achieved as long as the lenders and the company kept working towards the same goal: a turnaround and deleveraging of the company, and benefit from the upside potential in the company’s real estate value. A win-win for all.

BOOK I
Lessons Learned

1. Early warning signals and red flags

There have always been numerous, more or less famous economists predicting the next financial economic crisis – the one that will be bigger than any crisis before. Supranational institutions like the OECD, IMF and World Bank have continuously expressed their growing concerns, about uncertainty and tensions in global trade, about the perceived low quality of many corporate loans in the banking industry. And often these concerns were taken over and repeated by the local supervisor watchdogs (DNB and AFM in the Netherlands). What history has taught us, is that good times are invariably followed by bad times, however the timing is uncertain. At the time of writing this, more than a year after the COVID-19 pandemic struck, surely certain sectors have been and still are suffering, but so far we seem to have escaped a deep global economic crisis.

Some years after the 2008 financial-economic crisis, a shaky balance was reached

What happened in the European market in the last decade? Since the financial crisis hit in the fourth quarter of 2008, soon to be followed by a global economic crisis and a European sovereign debt crisis in 2011 – 2012, the ECB has been giving out unlimited amounts of money - basically for free. Initially this was important, as the traditional banks’ distrust in each other reached a historic peak after the fall of Lehman. Hardly any bank held sufficient liquidity to lend material funds to their traditional counterparties. Therefore, following the Fed’s example of providing inexpensive and almost unlimited amounts of dollars to the US banks and other banks in need of dollars, the ECB had to start acting as “lender of last resort” for Europe. The ECB gave out loans to financial institutions against minimal interest rates – the so-called LTRO (Long Term Refinancing Operations), to be followed later by an unprecedented buying spree of government and corporate bonds.

Especially the weaker South European banks took full advantage of the basically interest free LTRO funding. With positive results, because only by investing in their own government bonds, that did pay a few percent interest, these banks were able to show positive interest results and profits. The positive consequence of giving out “free money” was that the ECB effectively prevented an immediate domino style collapse of many (inter)national banks and the European bank system. The negative consequence was that European politics embarked on a long “kicking the can down the road” course that lasts until today, and the end is not in sight. Cheap financing given to the banks meant that they could offload bad assets, shore up capital ratios and make returns on the free money provided by the ECB. The financial system has not been really cured, and many of the crippled banks are still able to continue their zombie lifestyle.

A fine example of a “living dead” zombie bank was the world’s oldest bank, Monte die Paschi di Siena, whose unsustainable Non-Performing Loan portfolios only came to light in 2017, i.e. nine years after the financial crisis broke. And saving the German shipping bank Nord Lb in the beginning of 2019, required €3.6bn of taxpayers’ money. This is even more shocking, when we realise that all major European banks have been subject of repeated stress testing of their loan assets in the past ten years.

Of course, the sovereign debt crisis revealed an already known inconvenient truth: it made clear that lending to governments is not without risks. Despite this reality, which was maybe most visible in the unsustainable debt levels of Greece, the Solvency II regulations were introduced at the same time – right during the governmental debt crisis. Solvency II is an EU directive, aiming to harmonise capital levels for European Insurance companies. In short, Solvency II introduced a number of new guidelines, including a zero (0 %) risk weight for government bonds. This implies that those bonds essentially are risk free! This is totally insane, given the agreed 50% haircut on Greek debt in late October 2011, and the many other examples on government debt that have gone before. It only shows that political considerations often come before practical ones.

A welcome side effect of the strongly reduced interest rates for European governments was the material reduction of interest payments on sovereign debt. According to German central bank calculations of some years ago, the Netherlands had a lower interest cost advantage of many billions, and the total combined EU advantage exceeded a trillion euros. Negative interest levels reached the level of -0,5% in September 2019. The ECB continued its ample and free money program by injecting somewhere close to €2.6 trillion – roughly the annual GDP of France - in its quantitative easing (QE) program in the European economy and by purchasing basically all sovereign and corporate bonds on offer in the process.

All these measures would eventually lead to an unprecedented high level of debts (on all levels, sovereign, corporate and individual), which, combined with largely inflated asset prices (real estate, bonds and stocks) has in the course of the last three years led to a record high, and most likely unsustainable, financial bubble situation. Another side effect of interest rate levels reaching zero is that credit markets move to lessening of credit protection, which often has led to more covenant lite deals and lending to higher risk corporates.

Initiating workouts at an early critical stage becomes harder and may only happen when liquidity becomes the issue, reducing time to recover and narrowing options.

What will happen if these record high debt levels will ever need to be refinanced against higher interest rates? The good thing is that hardly any political and/or financial economic decision maker has any incentive to try and increase interest levels, so common opinion is that we will remain in an effective zero interest rate environment for quite a few years to come.

Anyway, this book isn’t supposed to deal with macro-economics so let’s go more micro and look at some individual names and situations. We will look at some early signs of possible distress in this first chapter. The list is not limited, but includes the following:

1.Losses and profit warnings

2.Market behaviour: falling stocks and bond prices, hedge funds shortening stock, critical analyst reports

3.Cyclical business in downturn

4.Outdated business model

5.Fraud incidents and litigation

6.Lack of clear or inconsistent strategy

7.Lack of control over foreign subsidiaries

8.“Flight forward” e.g., growth by many acquisitions, taking on big projects

9.Sudden departures of key executives, and

10.Delays in financial reporting (which could be caused by discussions on valuations, impairments, going concern statement, management letter)

Winning a prestigious award is not always good news

In October 2017 the Dutch financial newspapers reported that SBM Offshore and Fugro, both listed on the Amsterdam AEX resp. Midkap stock exchanges, had won the FD Henri Sijthoff award for the best annual report. SBM builds FPSO’s (Floating Production Storage and Offloading installations that produce crude oil from sub-sea wells), while Fugro has built a reputation in geotechnical services both on- and offshore. Both companies are predominant oil and gas service providers. The SBM annual report was complimented and described as a very clear report, transparent on its market position, risks and strategy. The same was said about Fugro, and its transparent reporting on its various challenges and problems in recent years was applauded.

Is it a good sign to win prestigious prizes, like the award for the best annual report, the CEO of the year, the CFO of the year, or the European prize for public private partnership that in 2015 went to the Sea Lock IJmuiden project?

Of course, both the Dutch Rijkswaterstaat and construction companies BAM and VolkerWessels were very proud on creating the Sea Lock IJmuiden joint venture – that is, until the project led to material uncalculated losses exceeding €200m in the second half of 2017 and the first half of 2018 which caused profit warnings and stock price hammerings for both builders. Again, it became clear how difficult it is to properly calculate large infrastructure projects.

Ahold’s Michiel Meurs won the 2002 CFO of the year award. This was just before the US Food scandal broke in February 2003, when it became clear that this Ahold subsidiary had overstated its revenues with $500m over the two years before. In addition, sales and results from Swedish and Argentinean subsidiaries were falsely included in consolidated financials. The same scandal caused the downfall of Cees van der Hoeven, the much-celebrated CEO of Ahold.

Renewable energy visionary Ad van Wijk, CEO of Econcern, won the CEO of the year award in 2008. This was just before Econcern went bankrupt in June 2009, as a result from overstated and fraudulent financials.

Is it a good thing for a company or a CEO to win a prestigious award? It has been claimed that a CEO looking for the spotlight to win prices, may have less focus on his business. Dutch travel company OAD won the Koning Willem I award not long before it went bankrupt. The Dutch technical construction company Imtech became “Royal Imtech” in 2011, and in the same year its CFO Boudewijn Gerner won the prestigious CFO award. This was one year before the company had to disclose substantial fraud and losses in its organisation.

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ABOUT THE AUTHOR

Rob Wijman has a lifetime of practical experience in commercial banking and risk management. After various (management) roles as retail banker, corporate relationship banker and risk manager, he joined the international restructuring department of ING Bank in 1996 – right before the start of the Asian and Russian crisis.

That was the start of many adventurous international restructuring and recovery activities, including personally setting up and leading high profile creditor steering committees, and doing the actual work out management of many corporate distress situations, mostly in Western and Eastern Europe, and occasionally in Asia and the USA.

From 2008 to 2015, he was the global head of Global Credit Restructuring (GCR) at ING Bank. In this function, he was responsible for the management of all problematic exposures worldwide and for setting sufficient provision levels for eventual loan losses. In addition, he was a core member of the bank’s highest Global Credit Committee.

His last eight years at ING Bank were the most intensive and challenging years, but also the most adventurous and instructive period in his professional banking career. By the end of 2015, Rob happily left ING in order to lead a more “quiet life” and started his own training and consultancy business.

Now looking back, he is still grateful that he was allowed to do the global restructuring job for ING during the crisis years. In the past six years, he has been giving many workshops on restructuring, mostly to banking institutions and the Big Four firms. Looking ahead, it is obvious that there will be much more challenging work coming to the banks’ restructuring teams – is it not this crisis, then the next.

With this book, he is rather excited to share some of his experience, adventures and lessons learned with you.