Early Warning Signals and How to Handle Distressed Debt

DAY 1

Introduction to the aims of the course

Session 1 - Identifying Corporate Problem Loans Before They Turn Bad: Early Warning Signals Using Ratio Analysis and Quantitative Analysis

• Principal issues posed by non-performing loans

• Assessing the fundamental impact on the bank of nonperforming loans

• Impact on the SME and Larger corporate client

• Impact on problem loan shareholders and stakeholders

• Loan foreclosure versus debt restructuring – the lose-lose scenario

• Alternatives to foreclosure

• Debt restructuring and the potential win–win scenario

• Assess market problems and competitive forces

• Understanding competitive forces in the industry and the client’s position in the market

• Critical success factors and delivering success

• Poor corporate governance

• The importance of trend analysis as part of ratio analysis

• Spotting off-balance sheet items that will affect company risk profiles

• Spotting ongoing capital expenditure needs and identifying methods of financing

• Identifying potential corporate failure

Session 2 – Using Financial Analysis to Identify Key EWS of Financial Distress

• Ratio analysis as a key tool in early warning analysis for distressed debt: Key financial drivers, EWS and the need for constant vigilance

• The problems with overreliance on the financial statements and the importance of leading EWS

Developing the underlying assumptions of quantitative analysis

Trend analysis and the importance of identifying the trend

Red Flag lists and assessment of the three principal Red Flag areas covering:

• Financial red flags

• Business red flags

• Internal red flags

The Z score and its use in identifying potential corporate failure

Case Study: Review of a corporate case study’s financial statements. Delegates will review and identify key EWS risks associated with the company going forward.

Session 3 – The Importance of Liquidity and Spotting Signs of Overtrading & Poor Working Capital Management

• The importance of good working capital management

• The impact of poor working capital management on corporate liquidity and survival

• Calculating the net working capital needs of the company

• Methods for improving working capital generation

• The importance of liquidity in distressed client companies

• Methods for improving company liquidity and cash flow through improved working capital management

• Methods implemented by turnaround managers to increase liquidity in companies

• Introduction to different risks in emerging markets

• Credit risk, business risk, operating risk, management risk

• Risk identification in developing markets

• Risk profiling

• Risk mitigation through different strategies

• Case Study: During this session, delegates will analyse the working capital needs of a corporate client and assess how working capital problems can threaten the going concern. They will also assess how the corporation can increase its liquidity through intelligent working capital management.

Session 4 – Leading Early Warning Signals Arising From the External Environment and Management Behaviour

• Understanding the ‘big picture’ and potential pitfalls for the company

• Understanding a client’s general business environment: The application of the PESTEL model

Understanding the company’s SWOT

Assessing the competitive forces at work in an SME client’s industry with a view to understanding its ability to make profits:

• Application of Porter’s Five Forces

The assessment of the strength of a company’s product and service portfolio and its chances of survival as a going concern:

• Product Life Cycle

• Portfolio Analysis

What management behaviour can be one of the best leading signs of potential corporate distress?

Reviewing different management behavioural patterns that can be an indicator of potential distress

The importance of observing and monitoring client behaviour and its importance as EWS

EWS Qualitative Workshop

Workshop: Delegates in groups to undertake and present a qualitative analysis of a family-run company. Delegates discuss potential areas of assistance in debt restructuring for the company.

DAY 2

Session 5 – Identifying Potential Strategies to Assist the Distressed Client in Avoiding Default

• Taking immediate action when the company is showing signs of distress and engaging with management to understand the extent and cause of the problem

• Using decision tree analysis to understand what actions to take

• Review and application of the IFC matrix to a distressed borrower

• The importance of trusting management and the need for cooperation in deciding the optimum recovery strategy for the client

• What we can do with company management in the event of default: application of Butler’s Matrix

• Assessing in-court and out-of-court settlements as alternatives for corporate recovery

• Why the going concern solutions provide a great likelihood of exposure recovery

• Working with the borrower’s management to identify strategies for liquidity preservation and generation, and measures that the company can take to reduce the working capital cycle

• Workshop: We will review distressed case study scenarios and use the frameworks covered during the session to address distressed case study examples.

Session 6 – Assessing the Distressed Client’s Potential Viability, and Valuing the Non-Performing Loan Between the Serviceable & Non-Serviceability Elements of the Corporate Loan

• The need and importance of the preliminary assessment of the distressed corporate client’s viability to understand the design of the restructuring plan

• Reviewing the carrying value of the Non-Performing Loan on the bank’s balance sheet

• Review of two methods in understanding the carrying value of the distressed debt

• Identifying the serviceable element of the loan that can be repaid through the recovery cash flows

• Steps to take in auditing the client’s recovery plan and recovery cash flows

• Measures to improve the loan security and terms and conditions for the restructured debt facility

• Conditions under which banks may implement haircuts to assist in the preservation of the going concern with the view to maximising potential exposure recovery

• The importance of restructuring any problem loans in line with the Bank’s credit procedures and risk appetite.

• The sale of distressed debt as a means of exit for the borrower

• Strategies for dealing with the Non-Serviceable element of the distressed loan, including PIK, Warrants, Debt to Asset Swaps, Debt to Equity Swaps, etc: advantages and disadvantages of each

• Workshop: Examine how to calculate the serviceable element of the distressed debt from recovery cash flows. We will also assess a case study of how a bank decided to refinance the distressed loan and the decisions that led to its action regarding the treatment of the Non-Serviceable element of the loan.

Session 7 - Restructuring the Corporate Loan: Amend and Extend, Not Extend and Pretend & the Importance of the Operating and Financial Restructuring

• Assessing when the corporate client can and cannot be saved - Identifying the need to take action

• Assessing the costs of liquidation versus the costs of maintaining the going concern

• Conditions when Rescheduling and Moratoria are enough to avoid default, and when they are not

• The importance of the Operating Restructuring to improve company performance in the long term, and why it should precede the Financial Restructuring

• The importance of managing the actions of other bilateral lenders – the concept of Automatic Stay and Standstill

• Implementing the Moratorium through the Standstill Agreement

• Key concepts underlying the agreement and Automatic Stay

• Review of a draft Standstill Agreement

• Drafting the Standstill Agreement

• The use and importance of the Independent Business Review in assisting the banker to design the best recovery strategy for the medium-sized corporate

• Workshop: Delegates will draft a Standstill Agreement for a corporate case study developed during the course. The standstill agreement will be negotiated with a delegate team chosen to represent the interests of the company. The agreement of these negotiations will be presented in class. Review of the use and application of the IBR is finding a structured recovery solution.

Session 8 – Implementing the Recovery Plan

• Assessing the need for corporate stabilisation, emergency liquidity creation, and funding

• The importance of trusting corporate management to cooperate in the workout process

• Assessing the risk parameters and increasing financial covenants for the restructured loan going forward

• Reviewing the projected recovery strategy in detail with management

• Identifying key risks that will affect the corporate client’s recovery plan

• Using sensitivity analysis on the client’s cash flow forecast model to understand the impact of major risks on the company’s ability to repay its debts

• Understanding different corporate stakeholder interests and how to manage them as part of the process

• Using a 5-point plan for effective restructuring as implemented internationally by banks

• The importance of the primary review in assessing the viability of the problem loan

• Application of the IBR in implementing a deep dive Operating Restructuring analysis of the company to find long-term solutions for the survival of the distressed client

• Assessing the least cost alternative to debt recovery

• Protecting security throughout the workout

• Workshop: During this final workshop, we will review a major new distressed debt case study and apply the restructuring process discussed during the day to maximise the potential return of existing exposure to the bank. This workshop will require the application of frameworks to identify the optimum recovery strategy, identify actions that need to be taken to improve management and also work with the company’s managers to derive an effective recovery strategy.

Using an Excel forecast cash flow model, we will assess the likelihood of the company being able to restructure the serviceable element of the distressed debt and identify solutions that we could implement to maximise the repayment of the bank’s outstanding exposure. We will also identify strategies for the management of the unserviceable bank debt.

Course Conclusion and Evaluations

Training Objectives

The course objectives and areas covered during the course will include the following:

• Reviewing key Early Warning Signals that can show distress in the corporate client

• Identifying leading EWS that provide time for the banker to take action

• Identifying and assessing key leading EWS of distressed debt

• The importance of assessing the external business and economic environment to identify leading external risk events and taking action to mitigate these risks

• Assessing management behaviour and why this is an area of leading EWS in distressed debt

• Reviewing actions that bankers can take with managers to avoid problem loans and default

• Learning lessons from high-profile corporate failure

• Assessing different types of corporate loan default

• Assessing the importance of liquidity and working capital management in saving the going concern

• Assessing when the loan needs to be restructured, the client company turned around, or put into Corporate Recovery

• Understanding when you can salvage a situation and when you can’t

• Understanding which trigger events can lead to corporate restructuring

• How to choose the correct restructuring and workout strategy for each problem loan client. Then, applying the IFC restructuring strategy matrix

• Knowing when to ‘pull the trigger’ as a banker. Also, when to be pragmatic in maximising potential exposure return (when haircuts might be the best way out)

• The importance of management character and trusting management during the workout

• Applying an international framework to problem loan workout to assess how to treat and enhance management as part of the workout process

• Using cash flow forecasts from the recovery strategy to measure the serviceable and unserviceable elements of the problem loan

• Why the financial restructuring alone is often not enough to solve the root cause of the problem

• The need for an independent review (IBR) in designing the required operating restructuring of the problem loan

• How to deal with other bilateral lenders in a distressed loan situation (standstill agreements)

• The need for a cost-benefit analysis in choosing the best, low-cost restructuring plan

• The importance of negotiating with and gaining the support of other powerful stakeholders to implement a successful workout process

Training Course Summary

The principal objectives of this programme are to provide lenders with a developed understanding of the areas that need to be monitored in identifying signs of potential distress and default among clients and potential clients. The programme primarily focuses on those leading factors of distress and potential default that, once identified, provide bankers with enough lead time to engage with client management and to take corrective actions to avoid potential default.

We will also assess practical methods used in early problem loan workouts, and the steps that bankers can take to avoid default of their corporate borrowers.

It is assumed that the professional experience of the delegates attending this course is intermediate to senior, and therefore basic credit and financial EWS analysis knowledge is assumed, although we will be revisiting key areas of ratio analysis as part of the theoretical credit risk review.

The workshop will focus on the successful and practical implementation of this theory with real-life scenarios through case study analysis across a wide range of different industries. The EWS and distressed debt tools and techniques shared and applied through the programme’s workshops will provide the core learning tools for this course. We will be drawing on a range of international best practices for problem loan workout and applying these to the context of the existing business environment.