FIDEA advises companies which have been affected by losses from derivative transactions and hints that the Government establish special fund which will help systematically resolve financial problems of companies and banks connected with this issue 27 November 2008

Companies that entered into unfavourable options should not wait passively. Financial loss can be minimized by such measures as i.a.: adjusting delivery date of contracts, optimal choice of financial instrument eliminating currency risk, agreeing a longer debt repayment schedule, partial write-off of financial indebtness, debt to equity swaps or negotiating particular financial terms with banks. Ministry of Economy should consider launching a special fund aiming at refinancing of losses transpiring from  options – FIDEA Corporate Finance experts suggest.

Zloty has been weakening recently, unfortunately largely due to closings of options ahead of the financial year end, which leads to further deepening of losses from options. Therefore some companies have already exceeded or will soon exceed treasury limits in banks or will not be able to supplement margins required by banks. This can lead to loss of liquidity in many companies.

– says Marek Dojnow, Managing Partner at FIDEA Corporate Finance.

Another threat is a situation when total liabilities exceed equity in a company, as it provides ground to apply for bankruptcy. In bankruptcy procedures the group of creditors with whom an agreement has to be reached is widening significantly and the fact of bankruptcy undertakings negatively influences business continuity and undermines the company’s credibility towards its contractors.

The first step should be elimination of further losses and negotiating with banks optimal terms for closing of outstanding option contracts as well as terms and conditions for repayment of indebtness, so the company can safely run its business. Only subsequently, should the company consider assessment of various legal actions against the bank.

Banks have very effective execution means, that let them quickly collect all the liquid assets of the company, which exposes the company to loss of liquidity and consequently can lead to insolvency.

– reminds Adam Jabłoński, Partner at FIDEA.

Polish banks must respect their commitments towards foreign counterparties, with whom they entered into analogous options in order to cover outstanding exposures. Not fulfilling the option contracts by Polish companies would mean losses for Polish banks, which could impair the confidence in the Polish banking sector and might consequently put their stock prices under severe pressure.

Not honouring commitments towards foreign banks is as bad an idea as not honouring commitments to Polish banks by their clients. The first thing to do is to eliminate the risk of loss escalation and possible claims, and only after that analysis of legal position towards certain contractor can be performed.

– adds Adam Jabłoński.

Termination of option contracts is very risky and might in the future add to the financial losses. In case of a unilateral withdrawal from the contract by the company, bank can put all company’s financial liabilities into immediate maturity, suspend further financing and seize accounts. Furthermore, in case when the company entered into option contracts with more than one bank, putting all liabilities into immediate maturity by one bank is very likely to trigger similar actions by other banks by means of cross default covenent. As a consequence, every bank would pursue covering most of its exposure from company’s assets in minimum time frame, which would lead to state of insolvency and require immediate declaration of bankruptcy .

If there is no way to get out of the problem unhurt, financial loss can be effectively limited. It can be done inter alia by adjusting delivery date of contracts, optimal choice of financial instrument which eliminates currency risk, agreeing a longer debt repayment schedule, partial write-off of financial indebtness, debt to equity swaps or negotiating particular financial terms with banks.

– emphasises Marek Dojnow.

It is also in bank’s best interest to renegotiate option contracts. Negotiating position of a particular bank greatly depends on its exposure to a given client (both in absolute monetary terms as well as relatively to other banks), quality of existing collaterals, and on the fact whether the bank issued particular derivative instruments itself or acted as intermediary only.

Companies having problems because of option contracts are often enterprises with long history and very sound operational fundamentals. Reaching an agreement and letting for business continuity is a lot better solution for banks. Another advantage of reaching an agreement for the bank is significant reduction of the litigation risk from the company.

Ministry of Economy can comprehensively approach the existing problem by creating a special fund for refinancing of the liabilities from options.

This fund could operate on the basis of government warranties for Bank Gospodarstwa Krajowego, which would provide long-term financing or warranties for payables’ payments of following option contracts” – says Marek Dojnow.

A company could become eligible for financial help from the bank upon fulfilling certain criteria, i.e. lack of tax arrears. In order to participate in the program banks would have to accept partial write-offs of aforementioned liabilities and would have to close outstanding derivative exposures at cost, while simultaneously securing further operational liquidity for the company.

After some time, i.e. 5 years of regular debt service by the company, the remaining portion of the indebtness could be written-off. Furthermore, during the period of financing certain financial ratios / covenants of the company would be monitored, terms and conditions of refinancing should be set on market level (margin should reflect specific credit risk) and certain constraints for the shareholders ought to be introduced (i.e. dividend payments, equity disposal, control over the company’s assets etc.)

The debt raised by the company for refinancing of the options’ related liabilities, could be subordinated to regular (senior) bank financing, so the high level of leverage would not hinder company’s further functioning.