Corporate Restructuring and Turnaround completo

CORPORATE RESTRUCTURING AND TURNAROUND

5 PARTS

- MACROVIEW

- FINANCIAL TOOLS (HOW TO AFFORD THE CASES)

- CRISIS MANAGEMENT FROM TOP MANAGEMENT VIEW, LEADERSHIP SKILL TO BE USED IN

THESE SITUATIONS

- LEGAL STRUCTURES, FALLIMENTO, CONCORDATO PREVENTIVO, BEST IN EACH CASES

- PERSONAL LEADERSHIP, WE HAVE TO BE WELL EQUIPED TO AFFORD THE SCENARIO

MARKET CRISIS

1637 – tulip bubble, at a certain point in time prices dropped,

1929 – a lot of money supply, prices too high, raising of interest rate, spre

1994 – mexico, and so on one crisis at year. Link between pesos and US dollar.

1998 – sovraign debt crisis

2000 – dot. Com crisis, bubble of the market, picco in 2000, new economy, because in contrast

with piliphs curve, the unemployment was very low but the inflation was very low too (relation of

new economy). In new economy price/earingns was above 40 (before around 20/25). (price

earnings is also 1/(risk free+ERP-g), if denominator is infinite. According to FED, assuming that

equity risk premium is equal to g, price earnings is only (1/risk free))

Bubble has a huge deviation from 10 years average prices index.

To evaluate if American market is overvalued or undervalued, with FED model we conclude that

there is no overvaluation, confronting the formula of FED with effective price earnings.

In Italian market same exercise result in undervalued stock market. (P/E = 12, 1/i=33) (long term:

P/E=16, 1/i=31).

2008 – the credit crisis, different reaction from central bank wrt 1929

2010 – Sovreign debt crisis, from countries with huge amount of public debt and no possibility to

devaluate currencyà impact on real economy

In these days we are facing the problem of turkey.

Biggest debt wrt GDP in Japan. Next crisis maybe is in Japan.

Are market crisis rare events?

Any volatility from financial market affect real economy, and in specific the single company:

- More competition

- Higher default risk

Company crisis

From 1920 to our days we can see that nether company crisis are rare events, if we take the last

10 year we have more than 1000 default of large corporates, in Italy more than 10000 of small

medium companies.

Famous names:

- Worldcom, eron

- In Italy, Parmalat, Cirio, moto morini, ILVA,

what is important in corporate management?

How to solve a crisis, if we take 25% cases of default, no solution.

- 50%, affort at least one big crisis with internal solution.

- Remaining 25%

inflection point can be passage from father to son, and nowdays there is one every 5 years, can

conclude in success or bankrupt.

Crisis management is not an extraordinary event.

Before default events:

- Run financial analysis

- Early warning

- Have an action plan to afford a crisis

- Crash program, best instrument to solve crisis

After default situation: (can be defaulting coming from bank, from credit rating.)

In summary the two main situation of default are …. If not able to solve crisis we are in danger rate

- Unlikely to pay,

- Non performing loans, banks has started with legal actions to collect the loans.

In I am a distressed asset manager I can profit from NPL.

Accounting perspective: Separation of world before default event (going concern) and ….

Manager perspective, losing power, what I do is to apply some techniques or changes in

ENRON – if there is a big dorp of credit rating in short time, the reduction of rate is gradually

PARMALAT – immediate downgrade of bonds grade.

LEMHAN BROTHERS – strategy used: in 2008 , ratio E/A = 4%, at limit. The bank sold assets to

buy… diminuzione fittizia degli asset per arrivare ad un rate del 4%, che invece era 3%. (creative

ratio).

Deuthes bank – same path of leman. The bank is too big to fail, so the Germany is trying to solve

the problem.

Ristrutturazione debito in continuità o Piano di risanamento, negotiate with lenders

to avoid bankrupcy

Fallimento, we don’t negotiate anything, Crisis management internal solution.

Price of fiat in stock market. A huge dorp. If we focus on operating results, EBITDA was negative in

2003, the major impact was from core business, automobiles, and if we look to growth, it was

negative. Big restructuring program,

2004: debt/ ebitda = 10x, measure used by bank to evaluate financial equilibrium of company

2018: debt/ ebitda = 0,8x

Super Marchionne, form 4 euros to 15 euros in stock market.

LEZIONE 2 – 14/09

Terminate the first part, macroview, why our world is changing:

Technology

a lot of inventions, GPU is the last one, used for autopilot of automobiles. Fiat has to take in

consideration this sector. In addition, genetic engineering, that cause that human decisions will

decrease in organizations.

The organization change at a log rate, so can not capture all the progress.

- How to evaluate an industrial plan?

- If tech change in so speedy way, what will happen in next 10 days?

Demografy

Average life will increase, big impact on public debt.

Consequences are that the age of over is increasing.

In Italy suppose an house cost 1000 euros, the bank gives us maximum 80%, and the maximum of

interest/Income is 30%. In addition there is need a warranty (fideussione).

In USA, the famous NINJA (no income no job) Subprime mortgages, the banks gave credit without

garanzie, if not repayed take the house, the value of the house after 2 years was higher, so banks

had convenience in do that.

Financial crisis fallout - SUBRIME MORTGAGES

Looking at banks’ balance sheet we can explain the bank transitions from one business model to

an other. Banking business model:

- Originate and hold (OLD)

- Originate to distribute (NEW)

Assets Sources

Credit (100%) Debt

Equity

Basilea regulamentation put limits to the debt the bank can hold, with respect to the credit it have

in activities. For each class of credit (more risky or less risky) it corresponds a level of required

equity (%). So, banks in classic business model originate and hold can give limited amount of

credit.

The new business model, originate to distribute, implies that the banks monetize their credit,

make cash, and with the new cash give other credit to new clients. This strategy is called

turnaround of assets.

Contagion form real estate crisis of US to Europe through Germany.

What happens if we have problems in RMBS? The problem start to spread in all structure credit,

so it will affect CDS.

CDS (credit default swap) like an insurance, protect a company from credit risk, the price is

à

more or less Default probability of the company*Loss given default in case of loss

à

In financial markets LGD on an unsecured position is on average 70%. If I look at CDS market, and

for example CDS is 1%, how much is the default probability? CDS/LGD = 0,01/0,7 = 1,4% (PD)

à

If we give a look to CDS in the time, we can see that something is going very bad, if we talk about

investment grade(very low risk of default), index associated with it is i-Troxx MAIN, if we talk

about high yield the index is i-Troxx Xover, and which is the PD underlying an I-Troxx Xover? The

same mechanism of CDS, we know the LGD, we know the market prices, and we can calculate the

PD implied for these market prices.

On Bloomberg, in the slides it is shown the price of CDS I-troxx main, so we talk about the

investment grade companies. At the beginning we are around 20 basis points, so we can calculate

the PD. 0,2% = PD * 70% PD = 0,285%, very low probability.

à

à

At the end of july big jump, a lot of people looked it as a technical problem, then there is a

normalization… (below)

We arrive in march 2007 that CDS index reach 1,6% than PD is much higher than before, 10 times

more. The PD in much higher than before, 10 times more. Then we have the discussion between

two kinds of operators:

- Market operators: looking the CDS market they expect a collapse of equity market

- A lot of people thought about it as a market mistake, they did’t believed the crisis,

because looking on fundamentals there was a good situation. So they believed to technical

misperception. But looking at fundamentals means look at the past. The current and future

info are delayed in fundamentals.

We know that fundamentals are backward looking and market prices are forward looking.

At this point equty markets starts to react, so it is very important to see what happens on credit

derivative market in order to understand what will be direction on the equity market.

When there is the crisis there is no more trust between the banks. ZOMBIE BANKS, no lending

à

in interbank market, the most liquid market in world. With no liquidity the crisis reachs its peak.

Consequences Equity market collapse, credit crunch ecc..

à

Problem of Central bank, what have to do?

Du pont approach: ROE = Earn/Sales * sales/Assets * Assets/Equity

Use to see the difference between business models originate to distribute and originate to hold.

If originate to distribute Earn/Sales is fixed for the competition, Assets/Equity fixed by

à

regulations. So to make money if you are CEO of bank act on Sales/Asset, increase Capital

turnover, velocity of reemployment of capital.

Refer to movie TOO BIG TO FAIL, in 2008 à

1) problem was no liquidity in the interbank market, banks going to collapse, bankruptcy.

2) if all principle banks goes bankruptcy, people can’t retire their money, in US near to point

of no return. look at FED (CB) balancesheet. Monetary base guaranteed by Gold

but also assets, real estate and also gov bonds.

3) convince FED to inject 800 billions in the banking system to cover TARP (Troubled assets).

Congress refused, hence Lemhan Bro failed. From a technical point of view the CB would

have to increase its liabilities (monetary base), but in change of what? To save this

situation in change of toxic assets. But what happens if CB switch Toxic assets with dollars?

If FED would buy toxic asset in change of monetary base, USD dollar suffer an huge

depreciation, then it is positive for US corporation form the point of view of export, at the

same time inflation goes up, so real estate prices goes up and toxic assets became good.

Hence who is paying in this situation? Looking at the investor composition in US Treasury bondsà

1/3 China, 1/3 Japan, 1/3 others. If FED decide to buy subprime RMBS there would be problems

with who is investing in US dollars.

Look at Asset side of FED from 2007 until 2012:

In this period of time we have:

- Emergency lending: big increase, because after Lemhan collapse, Fed gave liquidity to

other banks to allow to make credit and avoid commercial banks fail

- LT treasury purchases: buy country’s bond to finance fiscal policy and promote growth.

Expansive monetary policy plus expansive fiscal policy.

- Federal agency debt mortgages backed security purchases: how much of toxic assets have

been bought by Fed to save the fin system.

Difference of ECB is the last part. Why Draghi didn’t do that?

The huge injection of FED in financial system pushed at the minimum historically the interest

rates. If interest rates goes down, prices goes up. All the liquidity was in financial market, so

market inflation much higher than real inflation, then there is a bubble in the markets. Higher

prices in financial market but no benefit in real. Increase moreover in the value of equity and

bonds, clear negative correlation with wages as share of GDP.

If we put togheter all informations we can answer to the question “why our world is changing?”

1) Technology: Martec’s law, the organization grows logarithmically while the tech growth

exponentially. So there is a gap, who is the best able to catch this gap win competition

(amazon, little stores but huge sales).

2) Demography: no more children, working age population will shrink, this category is the one

that produce GDP, so GDP will shrink, grows at lower rate. Demography is very easy to

predict.

3) Financial crisis fallout: a lot of people understand that the value of money is only a matter

of trust in central bank. Big question mark, so born of cryptocurrency is a consequence of

reduction in trust.

New challenging world

Secular stagnationà economic theory that say that if GDP is linked to demography and working

age population is shrinking also GDP will shrink in the future. If ECB has an inflation target of 2%,

maybe is wrong, because is not forward looking. Forecast regarding future evolution of GDP (see

slide 38) each year were too optimistic.

We said that companies’ life is limited.

Enter in RATING AGENCIES

Every time we have tables that measure the default frequency. That is a statistical approach of big

number, based on probabilities. Tables indicate the 1 year default probability. Divide:

- Investment grade PD lower than 0,5%

à

- High yield PD higher than 0,5%

à

If a company rise from high yield to investment the terms is RAISING star, otherwise falling angel.

So this is the judgment of rating agencies regarding PD.

But we saw before that looking at CDS price (credit default swap market) we can derive the PD

associated with company. If looking at CDS relative to the company and the result of PD goes in

contrast with Rating agencies who is correct? Usually the CDS market wins the rating agencies

The increase in CDS is the first step, then there is a drop in equity prices and then there is the

downgrade of rating agencies.

During the crisis if the i-Troxx Mean, means investment grade, is equal 2% and LGD is 70% the PD

consistent is higher than 50 basis point. to The biggest lesson from financial crisis is that there is

not a risk free asset.

Take a look on credit default swap of Italy to understand the PD of Italy (using also LGD).

TERNA now is BBB, what is the PD in 10 years (at the end of ten year I don’t recollect the capital)à

5,5% which is remuneration to compensate my risk?

à à

We have two opportunities:

1) we invest 100€ in BTP which is risk free, with a 3% return probability of this return is

à

100%, risk free

2) if I buy a bond from TERNA I have 5,5% probability that if I invest 100€ I will recover from

this default 100€ less LGD (70% by assumption) collect 30€ (worst scenario.

à

Then I have 94,5 % probabilities I will collect 100€ + x%. This is an equation for x and the

result should be at least x= 6,7%. X is the compensations for the credit risk, break even

point below that investor will not buy bonds and viceversa.

5,5% I collect 100*(1-0,7)=30€

100 € in TERNA BONDS 94,5% I collect 100€ + x%

With big number law we use to work:

good companies Bad companies

Debt/equity <2% >5%

Cash/Assets >20% <5%

EBITDA/Sales >15% <10%

What if we have some index good and other bad?

To give credit bank would be compensated with a premium for the higher default risk.

The evolution of the company is every period Default or not Default. Survive probability is the

probability of not default.

SP(n) = (1 – PD)^n -à it ends up, multiplying 0,x for n that goes to infinite that the results is 0 à

this means that the life of company is limited.

In Steady state, so if PD doesn’ t change through the years, expected life of a company is given by:

1/PD. So the higher the PD the lower the expected life of the company.

Gordon approach is a clear overestimation of the life of the company.

Week 2

Banking business model

Having a look on ROE:

ROE = Earnings/Equity = Earnings/Assets * Assets/Equity

- Earnings/Asset is also called ROA. (e.g. 0,8%)

- Assets/Equity is a measure of Financial leverage. (e.g. 10x or 20x)

If I want to increase ROE I can use financial Leverage, taking a lot of debt. What is the limit to

financial leverage? The price of higher leverage is that the bank become more risky and its default

probability increases. Since the banks manage money of people there is the need to put a

discipline on financial leverage, the BASEL REGULATION:

BASEL 1

Very simple approach:

- Minimum of Equity/Asset must be 8% and this means that the maximum multiplier should

be 12,5x (assets maximum 12,5x times equity).

With our previous ROA ROE = 0,8% * 12,5 = 10% (this is a CAP).

à

ROA comes from competition, it is fixed. Financial leverage come from regulatory, equity capital

requirements.

Bank balancesheet

- Assets: 100 %

- Liabilities: Debt (max) 92%, Equity (min) 8%

BASEL 2

Difference is that the minimum of Equity/Asset of 8% was computed according to the nominal

value of the assets. (maximum financial leverage of 12,5x)

We have to differentiate according to the level of risk of assets, if we are able to calculate risk of

our assets, if we have:

- Low risk Assets: Equity/Assets reduced up to 4% max Lev is 25x

à

- High risk assets: E/A, minimum of 25% more equity required, max Lev is 4x

à

Bank 1 BS: (invest in low risk)

- Assets 100, Equity 4%, Debt 96%

Bank 2 BS: (invest in high risk)

- Assets 100, Equity 25% Debt 75%

Higher ROE for bank 1 if we have the same level of earnings. After Basel 2 a lot of banks tried to

reduce their risky assets. Given that small medium companies are more risky than big ones, this

was an incentive to credit crunch.

BASEL 3

Following the financial crisis, they introduced, in addition to E/A, to evaluate the riskiness of

banks:

- the liquidity coverage ratioà ratio that if even if there are no more liquidity in interbank

market, banks are able to survive at least 2 months. ST index.

- net stable funding ratio just a matter of correlation of duration of the assets and

à

durations of liabilities and equity, if you invest in long term assets, you must have LT

funding sources.

Basel 4

Cap on regulatory savings how much capital you can save if you apply the new regulation.

à

By definition when we jump from basel 1 to basel 2, why the bank system were incentivated to go

through basel 2? To increase ROE, but penalty for less safer banks.

This CAP is 20%.

Basel 2 put a high incentivation for safe banks, they can push more on leverage and increase their

ROE.

ROE = Earn/Asset * Asset/Equity -à they are constant<