Economic Times Main Syracuse ambulance company files for bankruptcy; change won’t likely …
Douglas E. Castle‘s insight:
After reading the article, it struck me as fascinating how the Economic Times was callng this Chapter 13 abankruptcy (as if it were a death knell for the ambulance company), and that the ambulance company spokesman, out of political training, or out of ignorance, called the proceeding "a routine reorganization….the company’s service will not be affected." The reason for the publication taking a more fatalistic view is that most companies of small to medium size ultimately wind up transitioning [atrophying] into Chapter 7 (a liquidation of asets, usually by auction), with a complete cessation of activities, The "reorganization" is basically a court intervention which just forestall (in most cases) a liquidation.
This fatalistic perception has permeated all of society because of the sad fact that those companies which are not "too big to fail" do not do anything constructive during the Chapter 13 reorganization period in terms of formulating and implementing an Emergence Plan to leave Chapter 13 and emerge as a streamlined, smarter, better-run enterprise. It takes an expert with a great deal of knowlege to get into the company, correct its trajectory objectively and candidly, in order to navigate through the "reorganization" into a newer, better way of doing business.
Lamentably, most businesses tend to just use Chapter 13 as an excuse to continue making the mistakes that brought them to the courthouse in the first place. That’s very foolish. They need to be turned around by a visionary from the outside with an objective view and a firm hand regarding suggestions and implementation.
As part of the Action Plan in any business turnaround, or in any plan of emergence from Chapter 13, reduction and restructuring of debt will play a key role, provided that the business involved in the emergence or “rescue” effort is inherently profitable by its nature — in other words — has an otherwise viable business model which was just mishandled or mismanaged in its execution. If debt can be reduced or eliminated, that is optimal; however, the second alternative which is more palatable to most lenders involves debt restructuring.
You have two restructuring objectives in dealing with lenders or bondholders – one is to defer the payment of the principal (the “balloon”) of the debt and to try to pay it on an interest-only basis for a business recovery period; the other, which is far more popular and easier to negotiate is to restructure the debt amortization or payment schedule. This second alternative permits you, as the acting Chief BusinessRestructuring Officer, to offer your creditors an option where the debt can be paid in a self-liquidating schedule, but simply over a longer time. In fact, if the length of the loan payoff schedule is sufficiently lengthened, you may even offer the creditors a small sweetener, such as a slightly higher interest rate on the loan or bond principal amount as a risk premium for their patience. Even after doing this, your payments to retire the debt in full may still be substantially lower than they would have been at a shorter (i.e., more rapid) amortization schedule.
Let’s see how this rescheduling of amortization works, Mr. Turnaround Expert:
Firstly, we’ll assume that the remaining principal amount of debt on one of our client’s loans is $80,000,000, and that at present, the client is paying off the loan at an interest rate of 8% over a five-year amortization period, fully self-liquidating. This means that the client’s monthly debt service due on the loan is approximately $162,211.
Going further, let’s assume that the client’s Chief Restructuring/ Turnaround Officer has projected (conservatively) that the cash flow available to service the loan will be approximately $175,000. This gives us a narrow margin for error. If we calculate the debt service ratio [divide the available cash flow by the the monthly loan payment obligation], it comes out to be a very, very uncomfortable 1.07884. As a lender, I would much rather see a debt service ratio that approaches 1.50000… that would make me quite comfortable, assuming that the available cash flow projections are reasonable.
If our Chief Restructuring/Turnaround Officer is a very good negotiator, and convinces the lender to reschedule the amortization of the remaining balance over a nine-year term, with a rate of 9% (our turnaround expert has given the lender an extra 1% as a risk premium for lengthening the amortization timeline), the monthly debt payments would now be $108,343.27 — we’ve cut $53,867.73 from our monthly fixed debt payment by doing this. Our new debt service ratio (assuming the $175,000 cash flow available to service the debt is the same, as it should be) will be 1.615236 instead of 1.07884. I now have a debt service ratio which exceeds the 1.50000 standard.
Amortization gives you the opportunity to stay alive longer, but yet to generate sufficient cash flows to pay off this debt, simply by changing its associated amortization schedule. We have restructured the debt brilliantly, assuming no other changes in terms on the part of the creditor, and no additional concessions to the creditor (with the exception of the 1% risk premium) on the part of our turnaround advocate, The Chief Restructuring Officer. Note that he might have chosen to cal himself the Chief Turnaround Officer, but that is too obvious and is on the edge of being Politically Incorrect. “Restructuring” sounds more positive than “Turnaround,” which conjures up images of the grim reaper following the client company’s president around.
This has given us additional cash flow margin (for coverage of other expenses of more than $53,000 per month.
Why would the creditor (a bank, represented by the officer who approved the original loan and who is responsible for handling the relationship with the client) agree to this?
Our negotiator simply took the bank officer aside and apprised him of the following facts and conclusions, gently but firmly:
1. If the client company were to go out of business and liquidate (Chapter 7, perhaps), the proceeds left to pay the bank would be less than 50% of the remaining loan principal. That would mean a substantial loss to the bank attributable directly to the officer’s decision to extend credit;
2. The foregoing could be very injurious for the officer’s career objectives, or perhaps the ability to remain employed by the bank at all;
3. If the client company remained in business, there would be no write-down or loss relating to the loan (the principal would be paid in full), and the officer would have made a good financial and career decision. His decision to allow the rescheduling of the loan has made it possible for the client company to stay in business and pay off the loan in full. Plus, the officer can speak about how “good a deal maker he was” by adding a loan premium of 1%, increasing the bank’s yield on the loan;
4. The client company keeps its deposits, its payroll account, all of its 100 or so employees have consumer loan, credit card, car loan or lease, deposits, checking or other business with the bank, all of which will now will definitely stay intact due to the officer’s “goodwill gesture to keep the company in business and everyone employed”. Interestingly, the officer also gets a credit for funds supplied to the bank (i.e., deposits — especially to demand deposit accounts (i.e., business checking), and this client has kept an average total balance in the bank of close to $1.5 million, all of which the bank earns interest on (this is called in the banking trade “playing the float”) while the client, who receives no interest waits for funds to “clear” and the bank puts this money out on overnight interest-bearing transactions with its under-reserved or slightly illiquid brethren;
5. It becomes apparent that the Chief Restructuring Officer can make the bank officer (with his own stationery, business cards, lapel pin and pens) look like a clever, prudent potentially promotable businessperson in the eyes of the client and his superiors in the bank, whom the Chief Restructuring Officer has promised to speak with (in laudatory terms) in his behalf.
The theme is not only that amortization is like fiscal alchemy — it is also that if a focal point of a turnaround Action Plan can be addressed with everyone emerging benefited (or at least not damaged as much), it can be negotiated.
Debt restructuring is a crucial part of most turnaround operations. Now you’ve gained a better insight.