Restructurings Are Coming: What Can Companies and Financial Institutions Expect?
March 27, 2023
Since the beginning of the COVID-19 crisis, the Official Credit Institute of Spain (Instituto de Crédito Oficial, or ICO) has guaranteed loans totalling 150,000 million euros in three tranches, with the last of these approved in March 2022. The Spanish government guarantees, on average, 80% of the risk inherent in these operations and established a moratorium that permitted the payment of interest only and the postponement of principal. Now that the moratorium is concluding for the majority of these loans, however, problems have begun to emerge.
Few corporate debt restructurings took place until last October, but circumstances have worsened rapidly since then. For a significant number of companies, the financial situation is deteriorating, which has led to a rise in debt restructuring processes under the new Insolvency Act (Ley Concursal) approved in September 2022. Many of these cases are filed by investment funds, both as shareholders and as creditors of troubled companies. This scenario is likely the prelude for things to come, as cases begin to multiply and as Spanish banks are urged to participate in the restructuring plans.
Many expect these conditions to intensify during the first and second quarters of the year, progressively becoming a more pressing problem. Gone will be the placid times of 2020, 2021 and most of 2022, when hardly any restructuring occurred.
The sectors most affected include food, distribution, transportation and agriculture — that is, producers, sellers, and distributors of fruits and vegetables — in general, the whole primary sector. The reasons are clear: prices of raw materials, fertilisers, energy and fuels have all risen sharply since 2021, a situation that was aggravated by the invasion of Ukraine. The firms that make processed products have seen the prices of cereals, oils and sugar (among other items) soar.
Initially, these extra costs were not passed along to consumers, as competition forced the majority of producers (especially big producers of commodities and large distributors) to withstand decreasing margins for many months. The pass-through to prices in mid-2022 materialised too late for many companies that had already suffered a sharp plunge in their margins.
In this situation, size is a key factor: the companies with the greatest risks are the medium-sized organisations with relevant volumes and the small suppliers of large retailers. Both types of companies face difficulties in financing their operations and require significant amounts of working capital — a liquidity that is inaccessible at present. Some have incurred further problems after decreased turnover due to poor harvests caused by droughts.
The companies with the greatest difficulties are those that were already in over their heads back in 2019, in a debt landscape that worsened when they requested ICO-guaranteed loans starting in 2020. These businesses will need to act quickly to initiate the debt restructuring process. The rise in consumer food prices in recent quarters, even when combined with the fall in fuel prices, may not be enough to prevent scores of companies in the aforementioned sectors from sliding into insolvency.
Meanwhile, default levels are still low overall for banks, which learned their lesson from the 2010 crisis and have diversified their risk in terms of both sector and company size. For this reason, the current corporate troubles will likely harm their balance sheets only to a lesser degree. Furthermore, banks in Spain enjoy a high level of loan-loss provisions. There is some concern among financial institutions about what may come in the months ahead, however, as small companies form a heterogeneous universe of customers that makes it difficult to establish individualised solutions.
The Bank of Spain has already issued a warning. According to the first-quarter 2023 Economic Newsletter (Boletín Económico), more than a fifth of the ICO-guaranteed loans granted are classified under a special surveillance situation. This designation covers loans for which a significant increase in risk has been observed since the time of granting, and the 21.2% surveillance situation rate more than doubles the average rate (10.4%) of total credit to companies at risk. In addition, while the percentage of ICO loans under surveillance grew in the third quarter of 2022, that percentage fell in terms of companies in the aggregate. The Bank of Spain supervisor specifically warned that the end of most ICO loan grace periods “could further increase their distressed asset ratios in the future.”
Against this background, the focus must shift to the independent expert role created by the new Insolvency Act — a position that ideally should be appointed by mutual agreement between the parties. Prior to the insolvency procedure, for example, the expert will have the agility to lead negotiations, at the request of either creditor or debtor, for the fast sale of a productive unit of the company in order to retain value. In developing a restructuring plan, decisiveness in changing the conditions or structure of the debtor’s assets, liabilities, or equity can be the key to avoiding further damage. The independent expert may propose the adoption of structural measures that it deems appropriate to ensure the viability of the company.
Another relevant issue, particularly after the battery of measures approved in the final Council of Ministers of 2022, involves the powers granted to the State Attorney’s Office (Abogacía del Estado) to enforce the rights derived from the ICO’s public guarantees. The State Attorney will now be able to step in upon request by the Ministry of Economic Affairs (Ministerio de Asuntos Económicos), without a previous ruling from the court. Even without any such request, the State Attorney’s Office may participate in proceedings regarding the approval of the plan — in particular, to oppose its judicial approval. The State Attorney may also oppose the approval of the continuity and restructuring plans, and naturally may intervene when there are indications of fraud or irregularities.
Although the future remains uncertain, the number of companies facing a restructuring process and new insolvency proceedings is sure to increase significantly in the coming months. The actions of the independent expert and the State Attorney’s Office may have profound consequences, as a quick response will be key to minimising damages.
March 27, 2023
Senior Managing Director, Spain Corporate Finance & Restructuring