Debt Restructuring Meaning Examples Top 3 Methods

Debt Restructuring Meaning

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Debt Restructuring Methods

#1 – Debt for Equity Swap

In debt to equity swapDebt To Equity SwapA debt/equity swap is an arrangement for financial restructuring in which the company’s debts get converted into stocks; this happens when the company is in a financial crisis. The existing lenders can take the option to get their debt converted into equity at a pre-decided swap ratio.read more, the lenders may choose to forgo the outstanding debt for a stake in the company. It is usually done in cases where the company has a large asset base and a large balance sheet,Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more and bankruptcy will create little value for the lenders.

Thus, the lenders take the company’s management and run it as a going concern. The lenders take a major equity stake and thus dilute the original shareholders, who may own a diminished stake in the company.

For example, the debt for equity swaps is one of the best ways to deal with subprime mortgagesSubprime MortgagesSubprime loans are given to entities and individuals by the bank, usually on a rate of interest much higher than the market, which has a significant amount of risk involved regarding its repayment in the specified amount of time.read more. A householder who cannot service his debt of $200,000 may agree with the bank to reduce the mortgage to 75%, i.e., $150,000, and the bank will receive 60% of the amount of the house’s resale greater than the percentage of 150,000.

#2 – Bondholder Haircut

A defaulting company with outstanding bonds may negotiate with the bond investors and offer payments at a discounted price, omitting or reducing the interest payments or principal payments.

For example, Wells Fargo owed $267 billion to the bondholders in its annual report Annual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company’s performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.read more of 2008. A 20% haircut may reduce its debt by $54 billion, creating an equivalent amount of equity that was good enough to recapitalize the bank.

#3 – Negotiating Repayment Terms

A company may negotiate repayment terms, including reducing the interest rate, writing off some outstanding loans, and increasing the time to repayment. That is a more affordable method and can be achieved by an agreement between the lenders and the company.

Advantages

Legal protection to the business from the lendersProtection of the company’s assetsProtection of the company from closing down will run as a going concernJobs of the employees are savedBetter recovery for creditors than bankruptcy

Disadvantages

Lower recovery by lowering interest payments and increasing scheduleWrite-offs Write-offsWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more may hit the balance sheet of the creditors.No assurance that the business will run smoothly and will make timely payments even after debt restructuring

Important Points about Debt restructuring

Debt restructuring is a process of restructuring the company’s obligation facing financial difficulties.It may include debt for equity swap, haircuts, an extended period of non-payments, and reducing interest rates.Although it may save the company from bankruptcy in the short term, there is no assurance that it will run smoothly after debt restructuring.