Barclays plc’s recently announced loan restructuring could have important implications for its shareholders, but the restructuring raises some puzzling questions.
The restructuring involves the sale by Barclays of a portfolio of loans with a market value of USD 12.3 billion to a newly-formed partnership called Protium Finance.
Having bought the loan portfolio, Protium will then have to pay Barclays for it. To facilitate this, Barclays will make a USD 12.6 billion ten-year purchase money loan to Protium, USD 12.3 billion of which Protium will return to Barclays as the purchase price of the portfolio. The loan portfolio will remain pledged to Barclays as collateral for Protium’s obligations under the Barclays loan.
Over time, Protium will collect amounts that fall due on the loans in the portfolio. It will use those collections firstly to cover Protium’s management fees and to fund profit distributions to Protium’s partners. Only after Protium and its partners have been paid will any cash left over be used to repay interest and principal due on the Barclays loan. Moreover, Protium will be entitled to keep any surplus remaining once the Barclays loan has been repaid.
Barclays says that the loan sale will enable it to remove the loans in the portfolio from its accounts, and that it will not consolidate Protium in Barclays’s group accounts. But Barclays dismisses the notion that the restructuring has been done for accounting reasons. Barclays concedes however that its accounts will continue to reflect the loan to Protium as an asset, the value of which will fluctuate with the changes in Protium’s creditworthiness. This will in turn be based on the value of Protium’s loan portfolio.
Shareholders benefit
Barclays explains that the purpose of the restructuring is to ’manage down the quantum and volatility of its credit market exposures as it seeks to protect and enhance the interests of shareholders’. But it is unclear that the restructuring terms do indeed advance shareholders’ interests.
Barclays will remain indirectly exposed to the credit risk of the portfolio loans sold to Protium, because the value of the Barclays loan will depend on the value of the portfolio loans. So if the portfolio loans were to fall in value, that loss would be passed through to Barclays through its marking to market of the Barclays loan. Moreover, because Protium would likely have few if any other assets out of which to repay the Barclays loan, the loss incurred by Barclays would not merely be an accounting loss, but also an economic loss which would be borne by Barclays shareholders.
On the other hand, increases in the value of the portfolio loans will benefit the partners of Protium rather than Barclays shareholders. Errol Danziger of corporate debt consultants Danziger Capital Partners LLP comments ’It seems that the Barclays shareholders have taken a “heads they win, tails we lose” bet.’ If credit markets were to improve and the value of the portfolio loans was to increase to say $15 billion, the profit of $2.7 billion would to go Protium’s partners, not to Barclays&srquo;s shareholders.
Even the accounting results that Barclays has aimed for look to be doubtful. With the Protium portfolio pledged to Barclays, and Barclays effectively in control of Protium through its rights as a creditor, it is unclear whether consolidation of Protium in the Barclays group accounts can be avoided. If it cannot, then the restructuring could turn out to be a risky and possibly costly error, from Barclays’s shareholders’ perspective.
A report by loan rating agency Standard & Poor’s on the level of losses incurred by lenders on corporate loans to UK companies, will have directors of many UK companies and their lenders mopping sweat off their brows. S&P predicts that over the years 2009-2011, losses on loans to UK corporate borrowers will amount to between six percent and nine percent of the total value of UK corporate lending. Explaining its forecast, S&P says that in a recession there is a link between falls in GDP, business failures, and bad debts. But it takes time for the effects of this link to become apparent. If the biggest quarterly fall in GDP occurred in first quarter 2009, then defaults on corporate loans will probably increase during the rest of 2009 and peak in the first half of 2010.
The rating agency predicts that during the current recession the corporate liquidation rate will reach an annual high point of four percent of all UK companies. Between 2009 and 2011 it predicts that nine percent of all UK companies will be liquidated. If that is not disconcerting enough, S&P envisages a possibly worse scenario in which the annual corporate liquidation rate will peak at 6 percent, with liquidations between 2009 to 2011 totaling 14 percent of all UK companies.
Linking company liquidations to corporate debt defaults, S&P says that is expects the loss rate on general corporate loans to run at around two-thirds of the rate of liquidations. But losses from loan defaults do not only follow on liquidations. They also occur in the wake of restructurings, administrations, and other major corporate events. Because a company need not be liquidated before its lenders incur a loss, the total corporate loan loss rate could even exceed the company liquidation rate, says S&P. It predicts total corporate loan losses between 2009 and 2011 to amount to between six and 10 percent of all outstanding loans.
Property sector
Even more telling are the losses forecast by S&P for UK property-related loans. Property and construction loans are loans made for commercial and residential property investment and development, and to fund construction. When there is no recession on, losses to lenders from these loans run at rates that are similar to losses from general corporate loans. But in a recession, property loan loss rates are different. In the early 1990s recession, these loss rates were almost three times the loss rates on general corporate loans. Why the difference? Partly because loans made to finance property development have variable quality, says S&P. That quality depends on stage of development and prospects for planning permission. And commercial property development loans are highly cyclical, because of the long lead time between project commencement and completion. Typically the general level of property construction is at its highest just before the start of a recession. This means that as demand falls to its weakest in the depths of the recession, the market experiences a supply glut. This is the reason why in a recession property developers find it hard to generate cash. They are then forced to sell their heavily discounted property assets into a market that has little spare cash to buy property.
These trends lead to property prices in general falling rapidly. The value of property collateral that lenders are relying on to back their secured loans also falls. With many developers unable to service their loans and defaulting, lenders are left holding property assets that they are forced to sell for a fraction of their former investment book values. S&P thinks that commercial property prices have already fallen 25 percent from their peak, and that over the recession they could fall by up to 60 percent. It predicts that losses on property loans will be 50 percent higher than losses on general corporate loans. The result - a property loan loss rate of between nine percent and 15 percent of the total value of property lending.
Renegotiate and modify
These figures will send an icy chill through the boardrooms of many highly leveraged companies. ’Companies that have outstanding loans and think that they could become financially distressed, should be speaking to their lenders,’ says Errol Danziger of corporate debt advisory specialist Danziger Capital Partners LLP. Many lenders would rather renegotiate loan terms than force a solution. They would rather preserve existing loans under new but realistic terms. Most lenders would prefer payments under modified terms to selling collateral or forcing the borrower company into administration.
The reason - in the long run, lenders earn more by keeping distressed loans alive, than by foreclosing on loan collateral. ’Rather than sit back and hope for some solution to appear’, says Danziger, ’corporate borrowers should be proactive.’ An approach to a lender with suggestions on how loan terms could be modified, or a proposal to exchange existing debt for a new agreement or for equity in the borrower, could achieve an outcome that preserves value for both lender and borrower.
Dr Manish Sinha, one of the City of London’s leading credit-based quantitative analysts and deal structurers, has joined the advisory board at corporate debt advisory firm, Danziger Capital Partners LLP. He will support the firm’s debt consultancy business, focusing on the quantitative analysis and structuring of convertible debt deals for clients of the firm.
Dr Sinha is an expert on structured credit. He has worked as a quantitative analyst and deal structurer at both Citigroup and Nomura International. He has also been involved in deal generation and transaction analysis at credit fund Structured Credit Advisers Ltd. He holds a Masters in Finance from the London Business School and a Ph.D. in Aerospace Engineering from Princeton University, USA.
Errol Danziger, managing partner at Danziger Capital Partners, said: ‘We are delighted to welcome Manish Sinha as a valuable addition to our team. His expertise and practical experience in structuring debt transactions will be appreciated by our clients, particularly those who are launching convertible debt deals or restructuring their loan relationships.’
Danziger Capital Partners LLP is a corporate debt advisory firm, based in London. It advises UK companies on all aspects of corporate borrowing, including obtaining loan finance, structuring and negotiating loan agreements, servicing debt and dealing with defaults and refinancings.
Copyright 2009-2012, Danziger Capital Partners LLP, London.