Thursday, 20 September 2018

Pop it in the fridge

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Despite some high profile deals, the flood of restructuring activity has yet to break in Germany. But those deals that have happened have been innovative and surprising, creating a dynamic and unpredictable market environment, often despite the best efforts of cautious creditors. Donal O’Donovan reports.

In the wake of the buyout boom most observers had predicated carnage in the big European LBO markets. Germany was poised to be among the biggest arenas for restructuring, simply because so many top of the market deals targeted German assets. While advisers have been busy, many of the deals expected to falter have instead soldiered on or found equity investors to keep debt investors afloat.

Equity investors and well timed accessing of the bond market took Heidelberg Cement off the critical list. It vindicated senior lenders, who had shied away from taking control of the business. Despite speculation that its debt would drag it down, ProsiebenSat1 has managed to trade through the recession, again seemingly proving lenders right.

In December 2009 the pliability of lenders in a potentially distressed situation was borne out further. Incumbent lenders supported the acquisition of academic publisher Springer Science & Media (SSBM) by a consortium comprising Swedish private equity firm EQT and GIC, the private equity arm of the Singaporean government.

The deal had an enterprise value of €2.3bn but included a new loan of only €150m, thanks to a debt syndicate that was happy to stay in place rather than risk a sale falling through. CLOs even picked up the slack created by the banks opting to exit the deal.

The same mentality translated into refinancings. Kion and Pfleiderer were essentially structured to allow the companies to shrug off covenant breaches, with banks preferring to wait and see if an improvement in economic conditions would allow the businesses to recover. They calculated it made more sense to make covenant changes to nurse deals through.

Such deals do more than prevent the suffering associated with taking write downs – or worse. They have allowed lenders to pick up consent fees, tighten covenants and drive up margins on existing debt – either with increased cash or PIK margins.  

The trend has made hard restructurings relatively rare, but explains the tendency to put deals on ice or ’in the fridge’. It is frustrating for investors waiting in the wings, but is understandable from a lender perspective, at least in the short term. The absence of a UK style bank guarantee scheme to compensate for losses on write downs means that German banks are especially disinclined to push for restructurings, according to London-based bankers.

There are other regional differences. “We have seen German banks position themselves so that they remain primarily a lender while in the same deal UK banks, for example, have become primarily equity holders,” said Frank Grell, Hamburg-based finance partner at law firm Latham & Watkins. “That is an attitudinal issue rather than a result of a particular banking regulation or any particular bank’s own constitutional requirement.”

The trend holds up across the debt markets, according to Holger Iversen, a real estate focused partner at Latham & Watkins. “The practice of wait and see, of ’putting deals on ice’ is even truer of real estate loans. Banks are aware of the issues so, for example, when a loan to value covenant is breached banks and servicers involved are careful to observe all of the correct formalities without actually taking any tough decisions. Banks are very carefully, but that does not translate into action.”

It means deals remain in the pipeline that in other jurisdictions might start to break out, even when there is a bid for the assets involved. In real estate, “banks are actually swamped with offers from potential investors who want to come into deals, but the banks themselves are not ready to engage unless the decision is forced on them, by owners handing back the keys for instance,” Iversen said.

COMI shift, shifted back

There may be fewer hard restructuring deals than anticipated but those deals that have completed have surprised observers. In 2006 when Schefenacker shifted the country of main interest (COMI) to the creditor friendly UK to execute a restructuring, many had expected that to mark the start of a trend. It never did. “Jurisdiction shopping has not been as great as people had anticipated,” said Grell.

Despite received wisdom that Germany is an awkward jurisdiction in which to swap debt for equity, last May autoparts supplier Honsel agreed a comprehensive restructuring built around a debt for equity swap and radical writedown of debt from €510m to €140m. “Honsel showed you that can achieve results under the German system that are as effective as you would achieve under a UK scheme of arrangement,” Grell said.

Under the deal agreed, incumbent sponsor RHJ International invested €50m into the business in exchange for retaining a 51% equity stake. Goldman Sachs advised the company and Latham & Watkins advised a steering committee of senior lenders, who took a 49% stake in exchange for writing down their more than €300m of senior debt to the new €140m total. Existing mezzanine and PIK lenders received nothing under the restructuring.

Strikingly the deal was agreed consensually, outside the German courts system and under the existing loan documentation. This was possible because of a priority agreement which allowed the deal to go ahead with majority rather than unanimous consent from lenders in each tranche of debt.

Out-of-the-money subordinated debt holders had limited hold-out potential, given the obvious distress of the credit. Perhaps more significantly, a significant portion of junior debt was held by investors with cross-holdings in the senior facilities who supported the restructuring and voted with the majority across tranches.

The deal was quickly followed by the restructurings of Monier. This was a contested loan to own deal where senior lenders including distressed debt investors considered a COMI shift to the UK but ultimately executed a deal in Germany. They correctly determined that a deal could be executed without taking that expensive step because it had the overwhelming support of creditors.

Monier, with bank debt of more than €2bn, was among the stand out deals of the year.

Lenders to the German roof supplies maker took control of the business after seeing off a major effort from sponsor PAI to retain control of the company. A successful outcome for distressed debt investors came in large part because of their better appreciation of the mood among CLO managers and other senior lenders. They were prepared to countenance a restructuring but wanted to see as much debt as possible kept whole. 

Lenders to Monier rejected PAI’s offer to inject €135m of new cash into the business and swap one-third of debt for up to 50% of equity. Instead they backed an alternative plan initiated by distressed debt investors Apollo, TowerBrook and York, who collectively held in the region of 20% of debt. The lender-initiated proposal at Monier cut debt by 50% to €700m of senior debt and €300m of PIK, that debt paying an interest slashed to just 25bp, or €30m annually.

PAI’s proposal had featured a more aggressive deleveraging of Monier. The plan was sensible in terms of the long-term viability of the business but offered less equity, with less debt remaining in place. Lenders ultimately favoured the deal that was worse for management but better for keeping debt managers’ portfolios stocked.

Houlihan Lokey and Lazard advised Monier creditors, while Goldman Sachs advised PAI and the company.

Re-born in the USA

COMI shifts to the UK have largely proven unnecessary but creditors, and company managers, have gone abroad to get deals done. When companies have attempted to shift jurisdiction to execute restructurings, the US and its Chapter 11 regime has been the favoured destination.

Global Safety Textiles took that approach last summer – the fist move of its kind. Senior lenders to the company, which makes textiles for the global automotive industry, became owners of all the shares in a newly formed German holding company of the reorganised GST Group. Several companies in the GST Group had filed for US Chapter 11 bankruptcy protection, including the US holding company and two German entities that moved their centres of main interest to the United States. In order to maintain the business of GST Group during the Chapter 11 proceedings, all non-US entities in Europe, including Germany, remained outside local insolvency despite the US proceedings.

Under the restructuring plan Global Safety’s senior lenders took 100% of the equity interest and long-term debt in a reorganised GST Group. The deal is now set to be followed by chemicals business Almatis, headquartered in Germany but incorporated in the Netherlands.

The threshold to access Chapter 11 is low: a company must simply be able to demonstrate a reasonable connection to the US, which is fairly straight forward for most large scale industrials. Applying for Chapter 11 coverage appeals to managers, who remain in place and have considerable control under the system. It is often considered, at least initially, as a defensive move. That is in contrast to the UK, where managers are peripheral and in-the-money- lenders dominate proceedings.  

What probably ought to be a consideration for companies opting for the US system is whether a reorganisation executed under Chapter 11 will be recognised by a German court. That is unlikely to be tested because creditors who themselves have a US connection will feel bound by a ruling, even if a German court might be likely to upset it.

Use of Chapter 11 remains rare and probably has limited application. A domestic solution may well be in train anyway: the German government is preparing new insolvency legislation could change the restructuring landscape, by making the threat of insolvency less dire for creditors. 

At the moment the lack of use of insolvency procedures hinges on the lack of control creditors can exercise once a company files – in particular over the appointment of administrators. But there is support for an initiative to move towards something more like Chapter 11 or to enable UK style scheme of arrangements.

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