The emergence of “troubled” debt restructuring

Defining "Troubled" Debt Restructuring
The three factors that are always present are:
1. The existing credit facility agreement is renewed, extended and/or modified formally. Informal agreements do not constitute a restructuring because the terms of the credit facility agreement have not contractually changed.
2. The borrower must be experiencing severe financial difficulty. Indicators of severe financial difficulties, include:
• The borrower has defaulted on debt payment schedules;
• Absent the restructuring, the borrower is in the process of declaring bankruptcy;
• The borrower’s cash flow is not sufficient to service existing debt based upon actual and/or projected performance.
3. The lender grants a concession that it would not otherwise consider. Concessions can take many forms, including the lowering of the effective interest rate, interest and/or principal forgiveness/haircut, modification or extension of repayment requirements, and waiving financial covenants to enhance cash flow.
In Cyprus, even though all three factors are present in many cases, we have yet to see a proper TDR. Financial institutions' lack of qualified personnel and expertise in performing troubled debt restructurings are the main reasons for the failures in recent debt refinancing. As a result, businesses are shut and unemployment rises to exceptionally high levels. Things will get even worse in 2014 if the financial institutions do not proceed with proper debt restructurings.
TDRs, however, should remain within a financial institution’s internal credit risk ratings until repayment is reasonably assured, well-defined weaknesses have subsided and loss is not anticipated.

Financial Institutions and TDR procedures
Sound risk management plans are an important aspect when considering the issues and risks associated with TDRs. The foundations of these plans include the development and implementation of appropriate policies, procedures and limits; sound management information systems; and adequate internal controls.
A financial institution’s credit policies and procedures must provide a clear understanding of what a troubled debt restructuring is (as yet unclear), how it is to be handled, who has the ability to authorise such transactions and what associated limits are in place including authority and risk tolerance limits. From a management information systems perspective, procedures must be established to ensure that restructurings are correctly reported and accounted for. In addition, reporting should keep senior management and the directorate apprised of the extent of this activity and its relative success. Effective internal control systems, such as internal audits and credit review, should be in place to effectively identify and manage associated risks.