UK: The Different Stages Of A Debt Restructuring Transaction And The Role Of The Agent

First published in Global Securitisation and Structured Finance 2006, published by Globe White Page. All rights reserved.

When a company announces a debt restructuring, this is in most cases the result of an extensive analysis of its debt portfolio involving important economic, legal, tax and accounting decisions. A debt restructuring is therefore a high-profile event, and it is crucial to the financial future of the company that the whole process is handled with great care and efficiency. This chapter illustrates the different stages of a debt restructuring and, more specifically, debt exchanges and tender offers, and provides some insight into the role of the agent.

A debt exchange is a proposal by a company to its security holders that they exchange their existing obligations for new securities and, in some cases, a pre-defined cash element. Any new securities offered may be issued by the same company or by one of the company’s subsidiaries.

A company may decide to make an exchange offer for several reasons – for example:

• to improve on the terms and conditions of the existing bonds;

• to pre-refinance maturing debt;

• to improve its liquidity position by extending the maturity of its existing debt; or

• to change the market for its debt.

A tender offer indicates the company’s intention to purchase its existing obligations from the market for cash. The cash amount offered to participating security holders is usually calculated as a spread over the yield of government bonds or similarly trading corporate bonds. A variation on the basic tender offer is the ‘modified Dutch auction’, whereby security holders are invited to propose a price at which they are prepared to tender their debt based on the yield of a specified debt instrument, which will not be calculated until the expiration of the tender offer. Bids above the final purchase price are rejected or scaled back depending on the subscription levels of the transaction.

Companies may undertake a tender offer – for example:

• to utilise an excess cash position on the balance sheet;

• to reduce total company debt; or`

• to improve their tax position without triggering debt extinguishment or for other reasons.

Sometimes a tender offer is combined with a consent solicitation. This is where a company requests the consent of its security holders to remove undesired covenants from existing debt, which, for example, may have been assumed in an acquisition or may have been issued when the company was in a weaker financial position, in order to harmonise the terms and conditions of its debt portfolio.

On other occasions a company may combine a tender offer for part of its debt with a debt exchange for the remainder.

Finally, there are situations in which a company’s debt restructuring options are limited, especially in the case of distressed or defaulted (Company Protection Act) debt. In these cases, schemes of arrangement are more likely to be put in place.

As transactions vary, so do the parties involved in them; but generally in a restructuring transaction the working parties would include the dealer manager or advisory bank (company advisers) together with co-leads on more complex transactions, the company’s agent (exchange/ tender/solicitation agent), financial experts (eg, accounting firms and investment advisers) and their respective counsel. The lead dealer manager is often appointed at the outset of the transaction, followed by the relevant financial experts, the legal counsel and the co-leads. The final piece of the transaction jigsaw is the appointment of the agent, who plays an integral part in the success of the transaction.

Typically, a restructuring transaction is carried out in two stages: planning and implementation.

The restructuring process is ready to begin as soon as the company advisers have been appointed.

Stabilisation: During the initial stages of a transaction, priority is given to identifying and remedying key pressure points within the company, and reviewing existing debt agreements and other key contractual arrangements with investors. Once this process is complete, the preparation stage can commence.

Preparation: The business is reviewed and, if necessary, strategic and operational changes are suggested. The implementation of strategic and operational proposals is usually carried out by consultancy firms and industry experts, while understanding the security holders’ motivations remains the responsibility of the company advisers.

Once the results of the review are available, the company advisers can formulate restructuring plans and present their proposals, which, subject to the company’s approval, leads into the implementation of the restructuring proposals.

It is at this stage – after the restructuring proposals have been accepted by the company and prior to the launch of the restructuring – that the agent is engaged by the company or the company’s advisers. Its primary role is to act as a liaison between the securities clearing systems, the security holders (or clearing system participants), the company and its advisers, to facilitate prompt and accurate delivery of information throughout the transaction. To achieve that, the agent needs to ensure that the transaction documentation reflects the correct market procedures, and it therefore needs to negotiate and agree the participation procedures with the relevant clearing systems. These are categorised as either international central securities depositories (ICSDs) or central securities depositories (CSDs).

ICSDs – The ICSDs are clearing and settlement systems for internationally traded securities. They provide cross-border securities services to banks, broker/dealers, custodians, agents and other institutions. There are two ICSDs: Euroclear Bank SA/NV and Clearstream Banking SA. The ICSDs provide the operating platform used by their participants to trade and settle securities and cash. The agent uses this same platform to settle securities and distribute cash to security holders that participate in a given restructuring transaction. If a transaction is taking place only within the ICSDs, the procedures to be adopted for their participants (the security holders) will be very similar.

CSDs – Unlike the ICSDs, the CSDs are clearing and settlement systems for domestic market securities. CSDs usually trade all types of securities in their domestic market, including government bonds, treasury bills, commercial paper, corporate bonds and warrants. However, in some cases they may only trade government bonds and locally listed securities. In the latter scenario, the agent must make sure that procedures for the holders of securities traded outside the clearing systems (or through another mechanism) are properly defined in the transaction documentation.

The CSDs provide securities services to banks, broker/dealers, custodians and other institutions in a local market, and usually maintain settlement and trading links with the ICSDs. Some of the principal CSDs are Switzerland’s SIS/Sega Intersettle AG, the United States’ DTC, Italy’s Monte Titoli, Spain’s Iberclear and Austria’s OeKB. The CSDs maintain trading platforms that agents and participants can use to settle securities during a restructuring transaction. In most cases the cash element of the transaction is processed outside the CSDs. National banks usually provide cash accounts linked to security accounts at the CSDs. Securities held in the CSDs are usually in dematerialised or immobilised form.

Irrespective of whether the transaction takes place in an ICSD or CSD, there are three possible ways for the agent to settle the restructuring in the clearing system on behalf of the company:

• internally, when the security holders (participants) and the agent/company maintain accounts in the same clearing system;

• via a bridge, when the security holders maintain accounts in different clearing systems; and

• externally, when the security holders maintain their accounts in the local markets.

Generally, an agent will look at the transaction proposals, determine which markets the securities trade in and ensure that all the relevant procedures are reflected in the transaction documentation. It is also the agent’s responsibility to ensure that the clearing systems have properly set up the restructuring process and that CSDs and central banks are aware of the forthcoming event.

(This section refers to international transactions. Local market transaction stages may differ according to local market guidelines and targeted bondholder groups.) The implementation stage is divided into four phases: pre-offering, commencement of the offer, offer period and expiration/settlement of the offer.

Pre-offering: Prior to the restructuring becoming public, the transaction documentation is prepared (eg, transaction prospectus, newspaper notices, listing/delisting requests). The company works closely with its advisers, the appointed agent and legal counsel to ensure not only that the transaction documents reflect market procedures and restrictions, but also that they communicate clearly the company’s offer to the market. At this stage the agent also undertakes to pre-advise the relevant clearing systems of the forthcoming restructuring process. Negotiations will also start between the clearing systems and the agent to agree the content of the electronic notices to be sent to the security holders. Once the transaction documentation has been agreed, the offer is ready to commence.

Commencement of the offer: At the commencement of the transaction, to encourage participation, the agent coordinates the distribution of the offer documents to the security holders and/or the clearing systems.

Offer period: During the offer, the agent acts as a single information source for security holders regarding entitlement and participation procedures.

It examines documents and instructions from the security holders, such as letters of transmittal, physical certificates, electronic blockings and guaranteed delivery instructions; checks for validity and correctness; and compiles the ‘participating holders’ list. Reports on participation levels and reconciliation progress are provided regularly, and can be designed to meet the specific needs of the company or its advisers.

Expiration/settlement of the offer: At the expiration of the offer, the agent performs the final reconciliation of the debt presented by the security holders in the restructuring. It confirms with the clearing systems that all the bonds have been blocked and that any physical deliveries of bonds have been processed.

When all the checks have been performed, the agent communicates the final position to the company’s advisers. Depending on the level of take-up and the terms of the restructuring, the agent may be directed by the company’s advisers to scale back the restructuring by an agreed percentage. The agent calculates the positions to be accepted in the restructuring and those positions to be returned to their original holders. After the amount of the restructuring has been agreed, the agent liaises with the company’s advisers for the pricing information. Once the pricing has been confirmed, the agent calculates the individual consideration due to each security holder whose debt has been accepted in the restructuring and pre-advises the clearing systems of the relevant cash positions. The agent also arranges for the press releases announcing the results of the restructuring, together with the final pricing, to be distributed to the investors through the clearing systems or financial news providers (eg, Bloomberg, Reuters, WM Datenservice).

On the settlement date, the agent arranges for the payment of the individual considerations (new securities, cash or both) to the clearing systems. Finally, the agent arranges for the cancellation of the restructured securities or their delivery to the company.

Other services an agent can provide in a restructuring transaction include the distribution of broker compensation (in certain markets), foreign exchange services for companies that maintain debt in a different currency to that of their country of incorporation, and escrow services for compulsory tender offers, schemes of arrangement or for funds received on pre-closing.

The following two case studies are examples of types of transaction that Deutsche Bank has worked on as agent in the past.

A media company launched an offer to exchange two classes of its €200 million senior notes due 2007 for new senior notes due 2012, plus ordinary shares and cash. The cash element was fixed and so was the number of ordinary shares attributed to participating security holders. The principal purpose was to improve the company’s financial position, creditworthiness and debt-to-equity ratio by reducing its outstanding debt.

Given the straightforward nature of the transaction, the company decided to rely solely on its legal counsel and agent to structure this deal. The company’s financial advisers were released as soon as the restructuring proposals were approved. Deutsche Bank as the agent took the leading role in ensuring that the transaction would work in the financial market where the company’s senior notes traded, together with the company’s legal counsel.

The agent determined that the notes traded in the ICSDs, negotiated the timings and the procedures with them, and assisted in the drafting of the relevant sections of the offering document. It liaised with the relevant stock exchange to coordinate its comments on the transaction documentation. It also provided local facilities where tendered securities could be presented over the counter in the country where the senior notes were listed. At the commencement of the transaction, the agent coordinated the distribution of the offer documents to the security holders and the clearing systems. During the offer period, it compiled the participating holders list and produced reports for the company, while at the same time acting as an information centre for the security holders that wished to participate in the transaction. Finally, on expiration of the offer, it confirmed the amount presented in the offer and calculated the security holders’ consideration. On settlement, it distributed the consideration – that is, new bonds, cash and ordinary shares – to the security holders, and arranged for the old securities presented in the debt exchange to be destroyed. The transaction had a 99.89 per cent success rate.

In 2000, a natural resources supply company faced the most severe liquidity crisis in its history. This crisis was exacerbated by large payments on its debt falling due in 2000 and 2001, debt which the company was unable to repay due to its low level of cash reserves, the deteriorating state of the economy and the continued unavailability of fresh financing through the international capital markets. The company had no choice but to request its creditors to exchange existing debt for new debt with extended maturities.

The key objective of the debt exchange was to improve the repayment schedule and financial viability of the company, while offering security holders a financial package that was equitable, credible and sustainable.

In this more complex restructuring, Deutsche Bank as the agent had to provide support in multiple markets. The company’s debt was listed on the New York Stock Exchange, the Deutsche Börse and the Bourse de Luxembourg, and traded in Euroclear, Clearstream, DTC and the German CSD, Clearstream AG. This required the agent to provide processing centres in New York, Frankfurt and London. To add to the complexity of the deal, analysis showed that the securities were held by the retail market, which meant that co-leads and local brokers had to be engaged in order to facilitate the solicitation of such retail holders in the local markets. This also meant that incentives in the form of brokerage fees had to be offered, which the agent had to distribute at the end of the transaction.

The transaction eventually required a lead dealer manager and four co-leads. The agent provided the services described above from all three processing locations and coordinated the transaction management, review of documentation and reporting from its central location in London. When the transaction finished, the agent had processed approximately 18,000 requests for participation in the debt exchange, collected €2.8 billion of the company’s old debt from the market and issued a total of €2.3 billion of new bonds back to the participating security holders. During the offer period, the agent dealt daily with approximately 180 security holder queries and reconciled 230 participation instructions. The positive response of the company’s creditors resulted in the exchange of 99.2 per cent of its old debt for new debt, which improved its debt repayment profile.

Given the high profile of a debt restructuring, a company needs to be confident that its transaction will be handled by experts and with total efficiency. It should therefore look for an agent with the following competencies.

It is important when a company is planning the restructuring of a cross-border debt portfolio that it chooses an agent that has a presence in the relevant local markets and can provide on-the-ground support to local security holders wishing to participate in the offer. On some occasions, transactions need to be coordinated across territories in very divergent time zones and the agent must be able to provide 24-hour coverage and support.

If the company is proposing a restructuring of bonds trading in separate markets, it needs to ensure that the agent engaged to facilitate the communication with the security holders has links to the appropriate clearing systems. For instance, the restructuring of debt trading in the international markets calls for a link in Euroclear and Clearstream, but for a restructuring occurring in a domestic market the agent needs to have access to that market’s clearing system – for instance DTC in the United States, Monte Titoli in Italy or Clearstream AG in Germany – and to be able to provide local market support. Having offices that could act as over-thecounter processing centres for definitive securities could be a necessity in certain markets. An agent should be prepared to provide those.

It is important when selecting an agent to review its credentials. Choosing one with a solid record of successful restructurings and public offers for wellestablished institutions is crucial. The greater the breadth of expertise the agent has, the more solutions it can offer to a company contemplating a debt restructuring.

In conclusion, every debt restructuring is different, and meticulous planning of the process is as important as the financial offer made to the security holders. If the company is to achieve the level of participation it requires in order to meet its objectives, security holders need to be able to access the appropriate information and communicate their intentions easily, which is the responsibility of the agent. Equally, the company’s reputation in the financial markets may be damaged if its restructuring is badly managed. Thus, the agent’s role is a key element in ensuring the success of the restructuring.

The views expressed in this article do not necessarily reflect those of Deutsche Bank AG or its group companies. Any similarities between the companies used in the examples and real businesses are purely coincidental.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.