Navigating turbulent timesRestructuring in Austria and CEEby Ben Trask, Deloitte Vienna, and Hein van Dam, Deloitte Bucharest

Multi-national restructuring

Across Central Europe the normally challenging process of de-livering a successful multi-national restructuring is made even more complex by the multitude of different legal systems, judicial rulings, management styles and lender approaches to work-out. This article gives an overview of the differences across the region and the challenges companies and practitioners face when trying to implement a financial restructuring.

Austria and CEE - so near and yet so far

To call Central and Eastern Europe (CEE) and Austria a single region is probably a misnomer, due to the significant diffe-rences in economic development, infrastructure, services and legal frameworks. As a consequence, when considering the restructuring market across the region it is essential to have a clear understanding of each jurisdiction. This article provides a brief overview of the economic landscape in Austria and the CEE region together with a comparison of the different restructuring environments operating across the area. For the purpose of this article, the CEE region includes the following countries: Poland, Hungary, Czech Republic, Slovakia, Romania, Bulgaria, Albania and the Balkan states.

Although there are significant differences, Austria and the CEE region do have very close economic ties, partly due to geographical and partly due to historical reasons. Austria, and Vienna in particular, is seen as a gateway to CEE for Western European companies looking to do business further east due to its robust and stable legal and political system, favourable corporate governance and regulatory environment, mem-bership of the European Union/Eurozone and availability of capital.

In addition, Austria’s economy has a significant banking and financial services sector and with over 740 financial institutions and a population of close to 8.5 million people, Austria has one of the highest concentrations of banks per capita in the EU.1

During the mid-2000s, Austrian investors, lenders and corpo-rates embarked upon a major expansion into the CEE region, which, given the significance of the banking sector in Austria, was principally credit-fuelled. By 2013, Austrian banks were the leading foreign lenders in the CEE region with over 11% 2 of the CEE banking market.

When the economic environment changed post-2007, a num-ber of loans and investments deteriorated. This resulted in a significant re-trenching of corporates and banks from the CEE region back into Austria via divestments of subsidiaries, sales of loan portfolios and some restructuring activity.

However, unlike other jurisdictions, the corporate restructu-rings across CEE that followed the financial crisis typically took an ‘extend and restate’ approach, rather than a fundamental restructuring of loans or an exit of the exposures. This has resulted in a number of unresolved issues remaining on the balance sheets of the banks in the region.

In the last 12 months, things have started to change: The AQR (asset quality review) process, combined with tougher EU/ECB regulations and a change in lender sentiment regarding the need to properly address higher-risk exposures, has resulted in

1 Eurostat; Statistik Austria; ECB2 CEE Banking Sector Report May 2014, Raiffeisen Research

an increased level of restructuring activity and NPL disposals across the CEE region and in the Viennese market in particular. We expect this trend to continue throughout 2015 and into 2016.

The recovery has been slow, bumpy and looks uncertain across the region

In 2009, Austria was hit by the global financial crisis, entering a recession in late 2008 and not returning to growth until Q3 2014. The most recent economic data indicates that Austrian growth is stagnating and forecasts for 2015 expect this trend to continue. This pattern has been replicated across much of CEE, although the impact of the downturn and the expec-tations for growth across the region are very different from jurisdiction to jurisdiction, as the graph below illustrates:

Real GDP Growth Rates

Economic growth in the CEE region is currently very mixed with significant and distinct differences between countries:

• Some CEE countries are out-pacing the Eurozone, with Slovakia, Hungary, Poland, Romania and the Czech Republic all registering healthy real GDP growth rates in 2014 driven mainly by domestic demand and rising investments.

• Some nations have returned a mixed performance, such as Slovenia, which started 2013 as the richest CEE nation, but saw negative real GDP growth throughout 2013 and only started to recover in 2014 following a government-led major recapitalisation (EUR3.2bn) of the country’s banking industry in December 2013 and a bounce in exports. Bulgaria has also only seen moderate growth, with weak exports and sluggish private consumption.

• And finally, countries such as Serbia and Croatia are faced with a new recession characterised by high unemployment, stagnant wages, constrained bank lending and fiscal tightening.

In addition, certain industries have been particularly badly affected by the downturn and have struggled to recover mo-mentum. For example, export dependent industries, including manufacturing, tourism, banking sectors and agriculture have all been hit by EU-Russian trade sanctions. Other capital-inten-sive industries that are highly dependent on bank-financing, including real estate and construction, have continued to be impacted by the ongoing lack of traditional financing from lenders across the region.

Weakness in the financial sector has held back growth

a. The region’s banks are slowly increasing provisions and rebuilding balance sheets

The financial crisis had two major consequences for the region’s banking system: first a reduced risk appetite from lenders and corporates; and second, tighter banking regu-lations, such as Basel III, which required banks to increase their capital ratios (i.e. to deleverage), and reduced the availability of credit.

The graph below illustrates that NPL ratios across the region have been increasing steadily since 2008, leading to higher provisions (coverage ratios), thereby further constraining credit growth.

Austria & CEE Regio: NonPerformin Loans vs. Coverage Rate (Provisions)

b. New sources of capital are starting to enter the market

The other key development we have seen in Austria and CEE is the emergence of Alternative Debt Providers, i.e. non-traditional lenders such as hedge funds, private equity and leveraged funds, seeking to provide debt finance to corporates or acquiring non-performing or non-core loans from the regions’ banks.

Alternative debt financing has been very common in the US for a number of years to the point where the majority of US corporates are now financed via alternative sources of capital, rather than traditional lenders, as the graph below demonstrates:

Financing of Enterprises* in 2013

Alternative lenders have grown rapidly in the UK over the past few years. This trend is starting to come to continen-tal Europe with the mainland European alternative lender market showing a 6% increase in deal flow in 2014.

Increased liquidity from mainly leveraged US funds entering the European alternative lender market is resulting in more competitive rates for better credits. There is strong momentum in fund raisings from newly set-up private debt teams. As a result, over the coming year, we anticipate a number of funds will continue to grow their European busi-nesses and we expect to see this as a growing alternative for lenders seeking to exit loans or corporates looking to refinance.

As regional lenders continue to deleverage and global investors seek new markets to deploy their capital, the number of NPL transactions in the CEE region continues to rise. Portfolio transactions are becoming increasingly attractive for banks seeking rapid and effective solutions to deleverage and meet ECB capital ratio requirements. Furthermore, the recent results from the ECB’s AQR suggest that additional provisioning of non-performing loans will be required for banks in the CEE region. We anticipate this will continue to be a growing market in the region in 2015 and beyond.

In 2014 we have started to see lending activity improving, with corporate lending increasing and surpassing retail lending in several key CEE markets such as Poland, Slovakia and the Czech Republic for the first time since late 2012.

Corporate insolvencies have increased across the region but at markedly different rates

The economic downturn affected the insolvency rates in Aus-tria only slightly with insolvencies decreasing in recent years to pre-crisis levels. However, as the graph below illustrates, the CEE region shows a completely different picture. The economic crisis as well as the reduction in availability of debt finance has led to an increased level of insolvencies across the region but especially in the South-eastern countries. We expect that this trend in CEE will continue in the medium term and that insol-vency rates will either increase or remain at these high levels throughout 2015 as banks address unresolved issues.

Insolvency legislation across CEE and Austria is very diverse

Across CEE there is significant divergence in the nature, type, speed and quality of insolvency and restructuring procedures available to directors and creditors. This makes delivering an in-court restructuring of a pan-regional group very challenging.

From a commercial stand-point, for an in-court restructuring to be successful, there are typically three key requirements:

1. Dissenting minority creditors can be forced to agree with the wish of the majority;

2. New money can be injected into the business to fund the restructuring (preferably on a super-senior basis); and

3. The proceedings will create a moratorium on creditor actions against the company, providing the business with a window in which to implement the restructuring plan.

As with all jurisdictions globally, a clear understanding of the applicable insolvency and restructuring legislation is essential in order to deliver a successful restructuring either in- or out-of-court. This typically necessitates instructing local legal counsel.

Austria has one of the most developed restructuring legislative frameworks across the region; however, even here, delivering an in-court restructuring can present a number of obstacles. Below is a short summary of the key aspects of the Austrian insolvency regime:

Austria & CEE Regio: Corporate Insolvency Development 2003-2013 Index. 2003 = 100

Requirement Impact CEE Comparison

Statutory test of insolvency

• Directors are obliged to start insol-vency proceedings if the Company is either „over-indebted“ or „illiquid“.

• Illiquidity is assumed when a debtor is unable to pay all of its debts as and when they fall due.

• Over-indebtedness exists, if a debtor’s assets are no longer suf-ficient to cover its existing obliga-tions, subject to the Going Concern Prognosis (see below).

• When determining if a company is insolvent, courts tend to place more emphasis on over-indebtedness than illiquidity, as illiquidity is generally considered the consequence, rather than the trigger, of insolvency.

If the directors conclude an insolven-cy trigger has occurred and there is uncertainty about going-concern, they are obliged to apply for the commence-ment of insolvency proceedings within 60 days.

Most CEE jurisdictions have similar cash-flow and balance sheet tests, however the timing for the commence-ment of insolvency proceedings varies significantly from country to country.

Rebuttals In case of over-indebtedness there are two possibilities for avoiding the com-mencement of insolvency proceedings, either:

• Show that the company can achieve a positive Going Concern Prognosis (a standardised business plan show-ing a return to solvency in the next 12 to 18 months); or

• Provide a positive statement of assets and liabilities proving that there are sufficient assets to cover its liabilities.

• If the company can achieve a positive Going Concern Prognosis or provide a positive statement of as-sets and liabilities, it is not required to file for insolvency.

• A positive Going Concern Prognosis is often a requirement for continued lender support in a restructuring.

In most CEE countries, specific docu-ments are not required; however the decision of whether insolvency procee-dings should be commenced will be at the discretion of the relevant insolvency court.

Requirement Impact CEE Comparison

60-day ‘window’ • Following confirmation of insolven-cy, either the company must solve the illiquidity and over-indebtedness or obtain a positive Going Concern Prognosis.

• Failure to achieve this will require the directors to file for insolvency.

Personal liability will attach to the owners and directors in case of a delay in filing for insolvency.

This time window can vary widely between CEE countries.

Cost of proceedings

Even if a company is determined to be insolvent, the court can refuse to start insolvency proceeding on the grounds that there are insufficient funds to pay for the proceedings.

• Austrian shareholders holding over 50% may be required to pay up to EUR 4,000 to fund court costs.

• If the proceedings are refused, the company is automatically dissolved.

• Any existing liabilities continue to be undischarged obligations and are a liability of the debtor – even though their collectability is unlikely in most cases.

In the CEE region, courts can decide not to commence insolvency procee-dings if there are insufficient funds to pay for the proceedings.

Indicators of insolvency

• Loss of more than 50% of share capital.

• Negative equity level.

• A 50% reduction in share capital triggers a special shareholders’ meeting or statement of assets and liabilities.

• Negative equity requires a positive Going Concern Prognosis.

Some CEE countries have similar indicators but, again, this is an area where there are a number of different approaches.

Types of restructuring proceedings

• Austrian legislation provides management with the possibility of either out-of-court or in-court restructuring proceedings.

• Provided insolvency criteria are not met, the decision whether to file for insolvency or initiate out-of-court proceedings is the decision of the directors.

Out-of-court proceedings provide the debtor with greater flexibility and main-tain optionality to commence formal in-court insolvency proceedings at a later date.

• Most CEE countries distinguish bet-ween in-court and out-of-court proceedings, although it is often the case that the in-court approach is untested and seldom used.

• The challenges regarding out-of-court restructurings across CEE are discussed below.

In-court restructuring

• To proceed with an in-court restruc-turing the company must have an equity ratio of less than 8% and be unable to pay back its debts from cash flow within the next 15 years.

• The debtor does not need to be technically insolvent. It is considered sufficient to start a restructuring proceeding if the debtor is facing a threat of insolvency.

• A debtor may apply for more than one restructuring proceeding, provi-ded the previous plan was success-fully implemented.

• The level of return available to cre-ditors will determine the procedure available:

- Below 20% - a restructuring is not possible and a liquidation procedure must be initiated;

- 20% - 30%: debtor-without-possession regime (an indepen-dent insolvency administrator will be appointed by the court to oversee the restructuring);

- Above 30%: debtor-in-posses-sion regime (company manage-ment remains in control of the business during restructuring proceedings).

• The company will be liquidated if the success of the restructuring plan is too uncertain or liquidation would generate a better return.

Although a number of CEE countries do have statutory provisions for in-court restructuring, it is often the case that court proceedings typically result in a liquidation. Exceptions do exist, such as the Czech Republic, which has a Chapter 11-style procedure.

Creditor rights • Any creditor has the right to start an insolvency proceeding if supported by sufficient evidence.

• It is prohibited to favour one credi-tor over another.

All creditors must be treated equally based on their level of statutory and contractual priority.

All CEE countries have a comparable legislation ensuring equal treatment of creditors under the law.

As shown with the example for Austria, there are a myriad of different legislative approaches across the CEE region. Very few jurisdictions provide for all three of the key requirements for an in-court restructuring highlighted above (i.e. the means to enforce a decision from the majority of creditors, the ability to fund the restructuring, and a stay on creditor actions). The Czech Republic is the principal exception which has implemented an insolvency process similar to Chapter 11 in the United States.

A number of CEE countries only provide for liquidation-style procedures, where the assets are sold as a gone-concern and proceeds are distributed to creditors, as opposed to a process which seeks to preserve the business or entity as a going-concern and continue trading as a means of maximising the return to creditors.

Given these legislative differences, an in-court restructuring across multiple CEE jurisdictions is nearly impossible to suc-cessfully implement and out-of-court negotiated settlements are typically the preferred restructuring solution in CEE.

Out-of-court restructuring usually affords the best chance of success in CEE

However, out-of-court restructurings in CEE come with their own unique set of issues, from both banking and corporate perspectives, which make delivering a restructuring of a CEE business highly complex. We have seen six key challenges associated with out-of-court CEE restructurings, namely:

1. Financing structure: Most large corporates in CEE tend to be financed with multiple bilateral, senior secured loans, with a number of different banks and typically with no inter-creditor agreements in place. In addition, the security is often not clearly structured, for example, multiple lenders may have security over different parcels of land that make up a single retail store. The result of this is that inter-creditor negotiations become hugely complex and fractious and necessitate the preparation of an indepen-dent, detailed, financial model to analyse the outcome for each lender under an insolvency scenario. This model can then be used as the basis for apportioning any write-off or recovery in an equitable manner.

2. Corporate management style: Local management is frequently reluctant to enter into open and honest dialogue with their lenders and prefer to take a more adversarial approach. Only the bare minimum of infor-mation is provided to lenders with bad news drip-fed at the last possible moment and discussions taking place on a bilateral (rather than coordinated) basis. In our experi-ence, to deliver a solution that will provide the business with long-term stability, being upfront with lenders, giving them the bad news as early as possible and working with them collectively is the best way to develop trust between the company and its creditors and achieve a successful outcome.

3. Cash-flow forecasting: Understanding the window of opportunity to deliver the restructuring is critical when seeking to determine the ‘art of the possible’. Without proper detailed weekly cash-flow forecasts this task is near impossible. Businesses that have experienced sustained growth and profitability typically don’t need to prepare detailed cash-flow forecasts. However, when a company’s fortunes change, clear visibility over liquidity and having the tools to effectively manage cash in a timely manner are imperative to delivering the restructuring. Most businesses we encounter in CEE have little visibility over short-term cash-flow and this expertise often needs to be introduced very rapidly.

4. Insufficient lender provisions: As discussed earlier, lenders across CEE have made significant increases to their provisioning levels, however, there are still notable diffe-

rences between lenders’ approaches to provisioning and it is often the case that, at the start of a restructuring, the level of provisioning is inadequate.

5. Lender focus on short-term solutions: Local lenders often prefer the short-term ‘quick-fixes’ which push the problem down the road, rather than properly dealing with the issue in a more painful, but sustainable manner. This is typically linked to the lack of provisioning, and, as the lender increases its provisioning level on the particular case, we see its willingness to deal with the issue in a more permanent manner increases.

6. Inter-bank relationships: The restructuring market in CEE, like the rest of the restructuring world, is a small place and the same banks, work-out bankers and restructuring advisors are often working together on multiple deals. The actions of one bank on a previous case can seriously impact the ability to negotiate an inter-creditor agreement on another, completely unrelated, case.

To deal with the above issues and build the foundations upon which to develop a successful CEE restructuring, the use of independent advisors, whether legal, financial or ‘company-doctor’ style turnaround directors is extremely helpful to rebuild the trust between the borrower and the lender and to deliver the information all parties need in order to be able to make the necessary decisions.

To conclude, as the market continues to change, more restructuring activity is expected

To summarise the current state of the restructuring market in Central and Eastern Europe, we see the following key trends:

• The economies across the area are divergent and remain in a state of flux; a number of countries in the CEE region are balanced on the edge of recession.

• The restructuring market in the CEE region is also chan-ging, with alternative forms of capital entering the market and regional lenders adopting new approaches to troubled credits.

• We anticipate more corporate restructuring activity in Aus-tria and the CEE region over the coming 12 to 24 months, with the South-east and Balkan parts of the region likely to see the greatest increases.

• Delivering an in-court corporate restructuring for a busi-ness operating across multiple CEE jurisdictions is highly challenging and an out-of-court process typically provides the best chance of success.

• We recommend that corporates adopt a proactive ap-proach by being up-front and open with lenders, opening communications in a timely manner, and seeking to present solutions that deal with their issues in a sustaina-ble, realistic and long-term way. In our experience, taking the alternative, reactive, approach and not addressing the company’s issues in a permanent way, is likely to end in failure.

• Using independent advisers is often very useful to support the restructuring process and creates the foundations for trust, provides accurate information for effective manage-ment decision-making and, ultimately, leads to a more successful restructuring.

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©2015. For information, please contact Ben Trask, +43 1 537 00-2950, bentrask@deloitte.com

Ben TraskDirector, Corporate FinanceDeloitte Financial Advisory GmbHRenngasse 1, Freyung, 1010 Wien, AustriaTelephone: +43 664 805 37 2950bentrask@deloitte.at

Hein van DamPartner, Financial AdvisoryDeloitte Central Europe4-8 Nicolae Titulescu Road, 3rd floor, Sector 1, 011141, Bucharest, Romania+40 21 222 1661hvandam@deloittece.com