Restructurings and administrations in Australia
June 2011 | TALKINGPOINT | BANKRUPTCY & RESTRUCTURING
FW moderates a discussion on restructuring and administration in Australia between Clint Hinchen at Allens Arthur Robinson and Damien Hodgkinson at KPMG.
FW: What trends have you witnessed in corporate distress and insolvency in Australia over the last 12 months?
Hodgkinson: A number of trends have surfaced as a result of changes in the corporate distress and insolvency market in Australia over the past 18 months. The big four banks are beginning to consider sale of their debt as a viable alternative to manage impaired exposures. Volumes are still relatively low but the market is more active than it has been historically. The majority of activity is being driven by the larger international funds, and the big four banks have been putting their debt on the market at discounts ranging from around 15% to much larger amounts depending on the level of impairment. Consequently Australia is a target for distressed debt investors, who can be divided in to three groups: the traders, the loan-to-own investors, and take & hold players. The traders are buying large blocks of debt and breaking it down into smaller investment pieces. The loan-to-own investors effectively use debt as a fast track way of potentially acquiring a distressed business -TPG Capital and their acquisition of Alinta’s assets is an example of this scenario whereas the Centro example reflects a number of funds taking a longer term work-out approach.
Hinchen: Entities experiencing any form of corporate distress in Australia across the last 12 months have generally fallen into one of two baskets. The first basket contains those entities that have been excessively geared entering into the global financial crisis or exposed to a down-turning industry or sector, but with fundamentally sound and supportable businesses. The entities in this basket have, in the majority of instances, been supported by lenders through an asset divestment programme or other form of restructuring. The second basket contains those entities whose businesses are not as sound or supportable. These entities have typically been put through a traditional insolvency process – be it receivership or liquidation. Having said this, where it has been a ‘borderline’ query as to which basket a borrower will sit in, lenders have typically continued to provide their support, given the lack of a market for distressed businesses or assets, particularly in the early part of the global financial crisis.
FW: How would you describe the health of the domestic banking industry following the global financial crisis?
Hinchen: The Australian banking industry has weathered the global financial crisis better than the vast majority of its counterparts worldwide. There are a variety of reasons for this – the lack of exposure to subprime assets, the booming mining industry, and the regulatory regime that has governed the Australian banking industry across this period. The industry is very healthy.
Hodgkinson: The domestic banking industry in Australia is strong relative to the situation in many other countries – this reflects our generally strong economy and outlook. However, there is some concern in the banking industry around lack of financing activity in the corporate sector given a relatively slow M&A market and the re-emergence of funding alternatives including corporate bond programs. This is driving increased competition and margin pressure in some areas of the banking market which creates challenges given wholesale funding costs for banks remain high. Residential lending has equally been subdued and there is some risk around an increase in default rates in some markets particularly in the event that interest rates increase.
FW: Has there been an uptick in non-performing loans? What strategies are banks and other creditors adopting to deal with defaults?
Hinchen: The level of new non-performing loan situations over the last six months has decreased overall. That said, there are some notable exceptions, particularly in the retail sector. Banks are continuing to take a conservative approach to default situations, but they are more willing to consider a traditional insolvency procedure now than they were 12-18 months ago, where a receivership would have resulted in a fire sale of assets at low prices given the lack of market activity.
Hodgkinson: In terms of an uptick in non-performing loans, we haven’t seen a huge increase at the top end of the market. We are starting to see significant stress in the leverage market for many of the funds who made acquisitions during the strong M&A period pre GFC – some of these funds have been able to roll-over debt as an interim measure but are now facing renewed challenges as financiers look for a level of debt reduction or an exit. Given those roll forwards are coming up next year we could see a level of stress hitting parts of the market at that point. A few factors in this scenario will provide a great opportunity for involvement of distressed debt investors such as the reluctance of banks to extend (given the performance of those assets) and the fact that some of the banking syndicate members present at the loan stage are no longer there.
FW: Is Australia’s credit market supporting refinancing options for troubled companies, or are opportunities limited? How would you describe the appetite of banks and other creditors to explore refinancing efforts with debtors?
Hinchen: Wherever possible, the Australian banking market generally remains supportive of pursuing workout and refinancing options on a solvent basis with troubled companies. That said, this will of course only occur where the credit metrics support the continuing operation of the underlying business. In the early part of the global financial crisis, this approach was partly dictated by the lack of market appetite for distressed assets.
Hodgkinson: There has not been a lot of support and appetite within the Australian credit market to refinance distressed companies with most stressed situations seeing existing lenders having to consider extensions given lack of genuine exit options. The majority of genuine refinancing funds are coming from offshore, principally Hong Kong, which acts as a representative office for US and UK based funds. These investors are attracted by Australia’s relatively high interest rates, and the Australian dollar has not been a major detractor. The larger Australian banks have generally been supportive of non-insolvency restructuring options and open to considering compromise positions where this is necessary to allow new funds to be raised.
FW: What role have distressed debt funds played in this market over the past 12 months? Do you expect this to change going forward?
Hinchen: Distressed debt funds have played a significant role in the higher profile and larger distressed situations in the Australian market over the last 12 months. While the Australian market is in its relative infancy in dealing with these distressed debt players, they have taken significant positions in a number of the larger workout and restructuring situations and led those restructuring efforts in an aggressive and flexible manner. The ability of these funds to take equity positions, through debt-to-equity swaps and the like, have led to restructuring results vastly different than those experienced in the last downturn, where banks were the primary players in these situations and had limited ability to adopt flexible restructuring positions given their internal and capital requirements.
FW: To what extent are underperforming Australian companies seeking to restructure their operations? What key trends are you seeing in this area?
Hodgkinson: We are seeing more open invitations from companies for distressed investors to take positions. A recent example is Hastie Group, the global building services company, and the proposed rescue by Lazard Private Equity looking to come in as a cornerstone investor. That deal reflects the sort of opportunities that are available for skilled teams who are able to analyse risks and back their ability to work with a management team through a turnaround program. One of the benefits of this sort of transaction is that it offers an alternative for Boards to potential impacts of the black and white insolvency law that exists in Australia as far as insolvent trading is concerned.
Hinchen: Reducing debt seems to be the main game for most highly geared Australian corporates since the onset of the global financial crisis. This has led to a general de-risking of the corporate sector but, on the flip side, an accusation that some Australian corporates are now carrying ‘lazy’ balance sheets. Given the free capital a number of Australian corporates are currently holding on their balance sheets, we expect that activity in the M&A space will expand significantly over the coming 12 months.
FW: What are the main challenges facing administrators in insolvency cases?
Hodgkinson: One of the biggest challenges facing administrators in insolvency cases is the High Court decision that was handed down on Lehman Brothers in Australia. There was a question over whether or not a deed of company arrangement could be binding on third parties, and in complex financial arrangements, third parties are often involved. There may be, for example, third party guarantees from related party companies involved in the business. In the Lehman case the Australian entity, when it went under, was relatively solvent compared to the rest of the group. The contingent creditors launched a challenge which went all the way to the High Court, which in turn decided that the Corporations Act did not actually allow third party releases to be included in a deed of company arrangement. Potentially that may mean for any complex agreement between creditors and a company (in a formal sense) if third party releases are to be included, it will have to go through the court and a scheme of company arrangement. More broadly it remains challenging for insolvency practitioners to generate acceptable returns from sale processes as a result of continued softness in the M&A market and the obvious impairment that surrounds insolvency.
Hinchen: Over the past 12 months administrators have been faced with a number of highly complex insolvencies arising out of the global financial crisis, particularly in the field of managed investment schemes. There is currently no comprehensive statutory framework in Australia addressing the insolvency of such schemes, so administrators have faced a difficult task of resolving the competing interests of investors and creditors. This has lead to administrators being frequently involved in litigation regarding actions they have taken. The recent increase in distressed debt trading has created opportunities for Australian banks but it has also created some challenges for receivers in dealing with more diverse lending syndicates whose members may have different objectives. At present, the weakness in the Australian retail market is also creating challenges for administrators and receivers in seeking to sell retail businesses as going concerns.
FW: What are your predictions for restructuring and administration in Australia through the second half of 2011, and beyond?
Hodgkinson: Australia is in a generally strong position but there are some risk areas. Whilst the resources sector is strong, retail, property and manufacturing remain challenging. We may see more defaults as this softness carries into the refinancing risks for next year, which will expose the degree of leverage some of these companies can manage. We expect to see continued interest from the distressed debt funds and a number of mid market companies that will be faced with the need to contemplate equity raisings or some form of hybrid issuance to deal with pressure on their financing structure. There is a risk that the number of formal insolvencies in this part of the market will increase and we also expect to see some increase in M&A activity as some of the private equity houses start to become active again and well placed larger companies pursue consolidation strategies.
Hinchen: I predict some further pain across certain industries, in particular retail and some nervousness around market sentiment as we enter 2012. A number of the larger leveraged transactions will enter into a refinancing phase and we should see a significant pick-up in M&A activity which, perversely, may lead to lenders not supporting distressed situations as much as they would have early in the global financial crisis, given the existence of an active market for distressed assets. I expect some challenging restructuring situations being resolved as well as some early ‘post-mortems’ into how the market behaved through this difficult period and an assessment being done as to the need for any further regulation or amendment to laws as a result of the transactions conducted.
Clint Hinchen is a senior partner at Allens Arthur Robinson. He is the co-leader of the firm’s national Corporate Insolvency and Restructuring Group and practices in restructuring, corporate insolvency, security enforcement, the management of non-performing assets and banking litigation, and advises on directors’ duties (particularly insolvent trading). He has advised leading Australian insolvency practitioners, financial institutions, unsecured creditors, shareholders, directors and parties purchasing assets from companies under insolvency administrations. He can be contacted on +61 3 9613 8924 or by email: Clint.Hinchen@aar.com.au.
Damien Hodgkinson is a partner at KPMG, and heads the Sydney office of the firm’s National Restructuring Practice. For over 22 years he has advised distressed corporates and directors throughout Australia, Asia and South America. His breadth of experience with both large multinationals and listed Australian corporations has provided him with the background essential to quickly identify and articulate the root cause of distress and the most effective means to recreating enterprise value. Mr Hodgkinson can be contacted on +61 2 9295 3877 or by email: email@example.com.
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