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The restructuring toolkit for corporate treasurers

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Treasurers, often navigating uncharted territories without extensive guidance, must approach restructuring not just as an unfortunate possibility but as a crucial facet of financial strategy that requires proactive engagement and understanding.

In an era marked by interest rate volatility, geopolitical tensions, the rapid evolution of artificial intelligence, and shifts in climate change policies, treasury and finance leaders navigate a complex landscape. Amidst these multifaceted challenges, the issue of corporate bankruptcy and restructuring emerges as a critical area often overshadowed by immediate concerns. While it’s an aspect that might not frequently command the spotlight, its significance cannot be overstated. 

In EuroFinance’s interview with Rajat Prakash, vice president, treasury and investor relations at the Texas-based power generation and infrastructure company, Talen Energy, shared some of his strategies used while handling corporate restructurings and transformations throughout his journey as treasurer so far. 

“The nuances of corporate restructuring are frequently misinterpreted, leading to missed opportunities and unnecessary setbacks for both businesses and their leadership teams.” Prakash told EuroFinance. 

EuroFinance: 

How have recent shifts in Federal Reserve interest rate policies and market predictions affected corporate debt management and economic stability, particularly in light of changing expectations for rate cuts and treasury yield volatility?

Prakash:

We will recall the borrower friendly rates during the pandemic when most companies increased leverage and are now facing maturities or extensions. Although the Federal Reserve raised interest rates since the pandemic to control inflation, the popular opinion until December 2023 suggested multiple rate reductions in 2024. Not only has that not yet materialised, most experts had to retrench on their expectations from as many as six rate cuts to merely one or two in the second half of the year. 

This has led to significant fluctuations in yields over the last six months, with the 10-2 treasury spread (difference in yields on treasury securities with 10-year and 2-year maturities) staying negative (a precursor to economic slowdown), near term stability in rates is not guaranteed. Although these economic uncertainties pose a threat to highly leveraged organisations with near term maturities, the ripple effects along with geopolitical tensions could also diminish operating margins for more flourishing corporations.

The risk is further exacerbated by the increasing direct or indirect reliance of most industries on commodities like power, oil, gas, etc. where even moderate price volatility could potentially jolt the foundations of well-run companies and leave them facing liquidation or restructuring.

EuroFinance: 

Can you outline any traditional strategies employed in corporate restructuring to optimise capital structure and address stakeholder concerns?

Prakash:

While many companies strive to steer clear of bankruptcy, viewing it as an unfortunate strategy, there are circumstances where embracing the restructuring process can significantly stabilise operations. Restructuring can often serve as a pivotal moment to not only streamline balance sheets and enhance operational efficiency but also to align stakeholder interests towards a common goal. Depending on the circumstances, treasurers have a variety of tools, ranging from traditional approaches to slightly shrewd manoeuvres, to optimise capital structure and liquidity while moderating disorderly stakeholders.

One such strategy is to explore the convertible debt market. Not an uncommon feature on traditional balance sheets, convertible debt could be especially advantageous for capital structures of distressed companies. Convertibles typically carry lower coupons given the embedded option to convert to equity. The lower interest costs and stronger balance sheet due to deleveraging upon conversion are blessings for distressed entities. Similarly, investors benefit from the downside protection of the debt component, with a potential windfall once stock price exceeds the strike threshold.

According to data compiled by Dealogic, convertibles comprised 31% of all equity issuances in 2023 compared to 15% in 2021. This resurgence is mainly attributable to the rising rate environment since the pandemic and an equity markets rebound in 2023 when S&P 500 index rose by 24%.

The equity upside is typically interesting for financial sponsors and other acquirers, who might target distressed businesses for strong underlying assets, macro tailwinds, synergies, or strategic rationale. Convertible debt is an inexpensive option to acquire distressed but fundamentally strong businesses/assets at bargain prices. While potentially facing dilution, existing shareholders realise higher cash flows due to convertibles and might otherwise receive nothing in distressed situations.

EuroFinance: 

While discussing convertible debt as a strategic tool during restructuring, could you also share about the role of loan agreements in the financing strategies of treasurers dealing with bankruptcy?

Prakash:

In addition to convertible debt, treasurers dealing with bankruptcy have another viable option in Term Loan C. This financial instrument, closely related to the more familiar Term Loan B, is structured with cash collateralization to provide credit support. Often financially challenged companies face counterparty demands for credit support via cash collateral, letters of credit, etc. which consume liquidity – an already rare commodity for distressed companies. The Term Loan C solution requires loan proceeds remain at restricted accounts, and collateralise letters of credit issued by lenders. As companies going through restructuring construct optimal capital structures in order to emerge, Term Loan C keeps credit support obligations off their balance sheets, is not considered debt given the restricted cash limitation, and the interest earned on deposits is credited to the company. Additionally, if the coupon is indexed to a short term benchmark rate, also earned by the cash deposit, the loan is naturally hedged from interest rate fluctuations.

EuroFinance: 

Could you also tell us about more unconventional tactics some distressed companies have used to renegotiate their financial positions?

Prakash:

Among the less conventional strategies, some distressed companies have creatively leveraged the threat of bankruptcy as a strategic tool against certain stakeholders. This approach centres around the tactical use of threats, in conjunction with credit default swaps (CDS). A CDS functions as an insurance mechanism where the purchaser, usually a bondholder of the struggling company, pays a premium to the seller of the CDS. This seller, in turn, promises to cover payments should the company default on its bonds. In the absence of a default, the CDS seller retains these premiums as profit. However, should a default occur, the seller is then obliged to compensate the buyer.

Certain distressed corporations have exploited this situation by effectively running an auction where they threaten to default on debt unless the CDS sellers pay these companies a negotiated amount (less than what CDS sellers would be obligated to pay CDS buyers in a default). Then the same corporations threaten to not  default on specific debts unless their CDS buyers pay (less than what CDS buyers would otherwise collect from CDS sellers in a default). The ultimate course of action is then instructed by the higher bid. While not always successful, many companies have raised capital with this strategy.

In an era marked by unprecedented challenges, the insights shared by Rajat Prakash offer a glimpse into the intricate world of corporate restructuring. Through this comprehensive dialogue, Prakash underscores the importance of a multifaceted approach to navigating financial distress, blending traditional methods with innovative strategies to safeguard and revitalise corporate health.

Mr. Prakash has over 20 years of experience in treasury and corporate finance functions with a track record in corporate restructurings, capital markets, capital structure, and strategic transactions (M&A). Prior to joining Talen Energy, he served as Vice President, Treasurer for Bed Bath & Beyond where he helped to establish a standalone corporate treasury function, led amendment and extension of a $1 billion asset-based credit facility, optimised capital structure through $1 billion in share repurchases and implemented effective risk mitigation strategies and insurance programs. Previous to his tenure with Bed Bath & Beyond, Mr. Prakash held treasury roles at Sears Holdings Corporation, a broadline retailer owned by ESL Investments (a privately run hedge fund). Mr. Prakash spoke at EuroFinance’s 9th annual Global Treasury Americas West Coast in San Jose from March 19-20th 2024.