The Guest Blog

Henes: Rules of Debt Restructuring

Jonathan S. Henes, P.C. |Partner, Kirkland HKSCKPVIamp; Ellis LLP

"Waste your summer praying in vain

For a saviour to rise from these streets"

—Bruce Springsteen, Thunder Road

The Euro zone finance ministers are having a critical debt crisis meeting today. They are trying their best. But the situation is difficult and complex, both from a financial and political perspective.

As if the Greece sovereign debt crisis were not enough, now the markets are focused on Italy. The spread on Italy's 10-year bonds over German bunds is a record 303 basis points. This puts Italy in the cross hairs and sends shivers down the spines of the EU finance officers.

Then there's Spain and Portugal. The spread on Spain's 10-year bonds over German bonds is 339 basis points, and the spread on Portugal's 10 year bonds is 1,071 basis points. The market is worried. Yet, none of this should be surprising.

The EU has a massive debt problem, and it is likely that Greece, Portugal, Spain and Italy will need to de-lever at some point and maybe sooner rather than later. The questions can be boiled down to when does the de-leveraging occur and how does the EU protect its banking system.

Euro bills

The EU's issues are difficult to resolve but easy to understand. First, there is too much debt. Greece's debt to GDP is more than 150 percent and Italy's is not far behind.

Portugal's debt is only about 95 percent of its GDP, but its private debt to GDP is an eye opening 230 percent.

During the next 3 years, it is estimated that Portugal's debt to GDP will be more than 130 percent. And debt to GDP may not even be the right metric to be looking at.

The real question is how much revenue are these countries generating from their GDP—i.e., tax receipts—and how does that revenue compare to its debt. This metric is much closer to the corporate world's debt capacity ratio of debt to EBITDA.

The second issue is that these countries are cutting spending—i.e., austerity—and raising taxes when they already are suffering from an economic downturn. An economy will slow, not grow, when spending cuts are coupled with tax increases. These actions take money out of the economy, rather than putting it in.

It's with this in mind, that two rules of debt restructurings should be remembered.

Rule #1: The only way to fix a debt crisis is to reduce the debt.

Rule #2: A multi-party debt restructuring is complex and takes time.

In the corporate world, when a company begins having financial problems, it will cut spending and focus on its core businesses. This makes good sense. However, once a company recognizes it has a debt crisis—as opposed to a liquidity crisis or a cyclical issue that can be remedied when the cycle turns—it follows these rules and, after hard fought negotiations, good planning and careful debt capacity analysis, fixes its balance sheet so it can grow and compete.

Oftentimes, the balance sheet restructuring is coupled with an operational restructuring, e.g., pared down business units, etc., but the key is reducing the debt. In the sovereign world, it is not that easy, especially in the EU, with so many nations weighing in as they understandably look out for their own citizens and own banks. In this world, politics comes into play, which leads to a third rule.

Rule #3: Don't play politics with a debt crisis.

A debt crisis needs to be solved through financial analysis, not political analysis. Financial analysis focuses on the long term, while political analysis focus on the short term. A debt crisis cannot be fixed through short-term measures. A sovereign debt crisis, by its nature, is rife with uncertainty and dangers.

The EU needs to figure out how to reduce the debt of its member countries and adequately capitalize its banks. This requires a complex restructuring through careful planning, extensive analysis and precise execution. With 17 Euro zone finance ministers trying to determine the best course of action, this restructuring will not be easy and the markets will need to interpret the political rhetoric it will hear.

This situation needs a savior—a leader with the will and the courage to make decisions that will position Europe for the long term and with the power of persuasion to convince the members of the EU to restructure the unsustainable debt. The time is now to start planning and to begin Europe's debt restructuring.


Jon Henes is a partner in the restructuring group at Kirkland & Ellis LLP where he has led some of the most complex restructurings in the United States and abroad across a variety of industries, including media, chemicals, energy, manufacturing, real estate, retail and telecommunications. Jon has also frequently appeared on CNBC's "Worldwide Exchange" as a guest expert on various financial and economic topics, federal, state and local fiscal issues.