- Scale of corporate default and restructuring is expected to rise at the end of the loan moratorium period
- Financial restructuring will be complex and will require robust scenario planning
As Malaysian businesses prepare for a post-pandemic world, financial restructuring is perceived to be a key tool to recover and improve profitability in the immediate term.
In a recent live poll conducted during an EY webinar on Turnaround and restructuring: the banker’s perspective, 77% of the respondents shared that in the next 12 months, business profitability is expected to improve but unlikely to be at pre-COVID-19 pandemic levels. The poll findings also reveal that respondents recognize the need to fundamentally change their business model to reflect the current market environment (77%) and prioritize costs and revenue optimization in order to manage business and debt obligations in the next 12 to 18 months (68%). However, nearly half (43%) of the respondents do not think or are uncertain that the debt level they are carrying is sustainable, suggesting businesses may need to restructure their debts once the loan moratorium ends.
According to Khoo Poh Poh, Senior Executive Director, Turnaround and Restructuring Strategy, Ernst & Young PLT, “The Government has initiated a number of stimulus packages and relief measures such as the loan moratorium to support businesses during this challenging time. However, as some of the measures, including the loan moratorium, come to an end, there are clear concerns as to whether some of the borrowers would still be able to meet their obligations then.”
Scale of corporate default and restructuring is likely to be high
As businesses continue to be impacted by the ‘new normal’, many are expected to restructure their debts after the moratorium ends. Banks have been proactively engaging with their customers ahead of the expiry of the moratorium. Yet, as some businesses embark on a financial restructuring route, some may need to recapitalize their businesses through a “White Knight” participation, while others may prefer to retain control via ”self-rescues”, focusing on new business models and operational turnarounds.
“A “White Knight” is necessary when the business is operating in a weaker sector that requires new monies and business to recapitalize its business,” notes Sriram Changali, Partner, Strategy and Operations, Ernst & Young Solutions LLP.
“White Knights do not only bring in new monies and business, but in some cases, new competencies and skills to complement existing management. However, there are downsides when a White Knight is involved in a financial restructuring exercise. To ensure the White Knight’s investment is commercially viable, the existing shareholders and creditors tend to take higher haircuts and experience lower returns.”
A “self-rescue” goes beyond extending the loan obligations of a business; it is complemented by a new business model and an operational turnaround exercise to improve costs and revenue level. The key to a successful operational turnaround is robust stakeholder engagement with the aim of improving the liquidity and profitability of the business.
Khoo adds , “Banks too are in a position to support self-rescues, provided the business can demonstrate that it is viable. However, self-rescues also present challenges, in particular, when it comes to the question of whether management has the resources and skills to execute the turnaround and ensure a successful restructuring.”
Regardless of whether a White Knight or the self-rescue route, financial restructuring is dependent on the financial forecast of a business, which in turn determines the level of debt that the business can afford. Forecasting is both information and action-driven and centers on where the business intends to be. However, as the market environment remains uncertain and volatile, the accuracy of financial forecasting becomes challenging, impacting the ability of businesses to restructure their debts effectively.
Robust scenario planning
The key to developing sound financial restructuring is to have robustly designed scenario planning and to determine appropriate mechanics, triggers and recourses that can mitigate the risk of a post-restructuring default.
Sriram says, “Financial restructuring is not only dependent on a business’ financial projections; it is also driven by the design of the recourse or the mechanics to manage forecast risks and defaults. A well-designed mechanism should be able to close any gaps in the forecast by automatically converting the shortfalls to ordinary shares or equity-related instruments to effectively negate any future risk of default.”
Corporate rescue mechanisms
The complexity of financial restructuring is also dependent on whether a business is able to secure the necessary support from its creditors. There are existing corporate rescue mechanisms and forums that bind the creditors to the business’ proposed financial restructuring, provided a majority vote is secured.
Leong May Lee, Senior Executive Director, Turnaround and Restructuring Strategy, Ernst & Young PLT shares, “Restructuring can be carried out via a few modes of corporate rescue mechanisms, including Scheme of Arrangement, Judicial Management and Corporate Voluntary Arrangement. There is also the Corporate Debt Restructuring Committee (“CDRC”) platform established by Bank Negara Malaysia which corporate borrowers can turn to, to work out feasible debt resolutions with their creditors.”
“As the huge levels of disruption brought about by the pandemic continue to unfold, the ensuing economic uncertainties will result in significant financial and operational restructuring across many industries. Whilst the banks continue to extend support to viable businesses, it is paramount that companies equip themselves with the right competencies, experiences and resources to navigate the complexities of financial restructuring and turnarounds,” concludes Khoo.
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About the live poll
EY hosted a webinar on “Turnaround and restructuring: the banker’s perspective” on 18 September 2020. Participants at the webinar were invited to participate in a live poll where they were asked a series of questions on their expectations of future profitability, fundamental changes to their business models, priorities in the management of their business and debt, and sustainability.