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Death, Dying and Debt Restructuring

The following article was published in the Chadbourne Project Finance NewsWire.

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A little over a decade ago, I was asked to deliver a luncheon speech to describe how financial restructurings work and how to avoid them.  

At that time, I was a managing director at the US Export-Import Bank and was dealing with the fallout from the Asian financial crisis, along with dozens of public agencies and private lenders.  As a veteran of a dozen or so debt workouts following the boom and bust of international coal and oil and gas investments in the 1980s, I had a somewhat unique perspective. 

The perspective I presented then and in which I still believe surprised everyone: the stages of a financial restructuring mirror the five stages of death and dying, as presented by Elisabeth Kübler-Ross in her seminal work On Death and Dying

The reaction to the speech –- raucous laughter –- was even more surprising.   Maybe it was just restlessness at a luncheon speech or nervous laughter elicited by talk of death –- always a source of comedy.   I had first heard of Kübler-Ross’s book through the movie Annie Hall, in which Woody Allen’s Alvie Singer forces the book on Annie, who breathes a huge sigh of relief as she pushes the book back to Alvie during their break up.  (He sneaks the book back to her.)   Maybe laughter ensued because someone else’s financial troubles are always more funny than our own.

Regardless, the speech struck a chord.  We in the financial industry care deeply about money and our jobs.  When there is a loss, it is personal and we do not let go without enduring the same process as when loved ones pass (which, before we go too far here, we should all acknowledge as more important).  I cannot promise that an article read outside of a luncheon speech context will elicit the laughs, but the insights are still helpful as we sadly enter a new age of debt workouts.

The first stage of death and dying is denial.  In dealing with personal matters, we rarely consider denial as constructive; it is foible we learned as children as a way to avoid problems.  But denial, like rationalization and convenient amnesia, are comforting things we all must have in times of need. 

In debt workouts, my experience is that denial satisfies basic interests and can be constructive.  Borrowers have an obvious interest in denial, as it helps keep one’s management, board and lenders at bay, but unless one has a real white knight to save the day, pushing problems aside is rarely constructive and can make problems bigger.  Denial is a form of concealment, and just as concealment led to the fall of Barings Bank, denial contributed to the global financial crisis and the fall of Lehman. 

Lender denial is more likely to be constructive.  It often takes the form of market and engineering studies, which often yield valuable insights about the cover value of an asset, and provides space to find solutions.  In my experience, studies have been used successfully for several deals, including a power plant loan in Kentucky and a mining deal in Australia.  All studies found value, but the lenders recovered the most when they used the time and space provided to stay together, stand their ground, and work things out. 

On to step two: anger.  As with a personal loss, anger is understandable, and as with personal loss it serves a purpose, but usually only to the extent that anger is a bridge to the other side, which is a viable solution.

To the extent that lenders are not being paid, they have a right to get angry, and part of the art of the workout is being able to express anger clearly and effectively.  However, tirades are rarely credible or useful.  For that reason, many banks separate the people making the loan from those working out the loan.  One would think that the original lender would be more likely to reconcile than the nasty debt restructuring specialist.  The opposite is true.  The people who made the original lending decisions are likely to feel personally betrayed by their old friends the borrowers.  Many banks believe this emotional baggage gets in the way and bring in a new team to “work out” the new terms of the debt. 

Borrower anger is an interesting phenomenon.  Defaulting borrowers are the ones not paying the debt and have no reason to get angry, but they do.  Borrowers inevitably know more about their business than their lenders and can, depending on the personalities involved, hold their lender in contempt and may not take lender threats to foreclose seriously.  

At some point, this anger boils over into their bringing in their restructuring lawyers, the borrower equivalent of the workout team.  Their purpose is to move beyond anger, to explain how disappointed the borrower is with the sad actions of its lenders and scare the lenders into submission.  When I was on the lending side, after getting over a moment of fear, we would seek to dismiss quietly the restructuring team and get back to business, but on deals with which I have not been involved, borrower teams have achieved some jaw-dropping outcomes such as converting debt into equity and buying assets for pennies on the dollar. 

Precisely because one cannot count on anger to solve one’s problems, debt workouts inevitably move on to stage three: bargaining.

Everything in a workout is negotiated and most of it involves minute terms that would bore most people to tears, such as cure and notice periods, default and remedy triggers, debt covenants, exclusions to covenants and carve-outs to exclusions.  You get the point.  

Often a business deal materializes early and both sides can move on.  But sadly for all except the attorneys who are billing by the hour, the final stage of the process of acceptance is two steps away, and both sides typically postpone the inevitable.  While workout negotiations are intriguing, deals move towards the next stage of depression.

As in life, stage four – depression -- can be the hardest stage to manage. 

Lenders become depressed with their lack of repayment, and borrowers become depressed by a lack of credit and limitations imposed on their businesses.  In macroeconomic restructurings and large-scale sectoral debt crises, depression often means economic depression.  The carnage dates to before the tulip bulb bubble of the 1600s and the recent list seems endless.  The Lehman default sent the US and global economies into the worst recession since the Great Depression.   Indonesia took decades to emerge from the Asian financial crisis.   Latin America lived with a stagnant economy for years after its debt crisis.  Greece’s financial problems have pushed Europe into economic stagnation.  The US oil economy took years to recover from the troubled 1980s and is poised for hard times again. 

Depression can be, should be, and usually is, the driving force toward acceptance –- the fifth and final stage toward fixing problems and starting over.  

For a bank to get 50¢ on the dollar is a bad outcome, but it is better than languishing with nothing.  A borrower may wish to squeeze out a better deal, but no business can operate in default with the type of flexibility companies need.  

In dealing with a financial loss, for acceptance to be the final stage and not to give way to more depression and anger, acceptance needs to include acceptance of responsibility.  Borrowers who got into trouble need to fix their businesses; lenders need to examine practices.  Those responsible for failures in private economies can lose jobs and stand accountable for any criminal wrong-doing.  Countries restructuring sovereign debt need to enact reforms, and the leaders responsible leave office.  

Failure to accept and enforce responsibility can have far-reaching consequences.  Just as failure to deal with a personal loss properly does grave harm to families, failure to accept responsibility has long-term consequences for borrowers, lenders and the economies touched by crises.  

Sadly and without trying to make any political statements, the record following the global financial crisis sparked by the fall of Lehman does not reflect acceptance of responsibility that would indicate anyone has learned anything.  Banks have taken bailouts without facing business restrictions, almost everyone has avoided criminal charges, and the movie version of Michael Lewis’s The Big Short suggests we are “blaming immigrants and poor people.”  This could all suggest a relapse into depression.  I hope I’m wrong – I prefer laughing audiences over crying ones.

Miki Flamenbaum