Thought, transparency vital to insolvency process
 
Thought, transparency vital to insolvency process
02 DECEMBER 2020 9:54 AM

Hotel insolvencies have not been too prevalent recently, but that is set to change as cash flow and nerves run short.

LONDON—So far, the COVID-19 pandemic has resulted in few insolvencies in the hotel industry, thanks in large part to government aid.

But that might change as the pandemic rolls on, populations await the approval and distribution of vaccines and cash flow simply dries up.

Speaking at a webinar organized by business consultancy HVS London titled “Hotel insolvency: Why is this time so different?” Graeme Smith, managing director at AlixPartners, said the depth of the current crisis should have resulted in more insolvencies but for several key differences between 2020 and the Great Recession.

“Credit risk is held much more broadly across the market this time, from banks, to credit funds, to insurance groups, and they are better able to absorb issues as there is a lessened concentration of single-asset classes (amid owners’ portfolios),” he said. “Also coming into this crisis, leverage levels were less, the equity cushion greater, which provides for better flexibility and allows businesses to absorb shocks.”

Yet another reason is that there is a greater array of financial vehicles and financial complexity now, Smith said.

“But mostly there is still an expectation that there will be a rapid recovery next year when we see a vaccine rollout, and owners do not want to give up on the value they have created. So far this has been an equity crisis, not a liquidity one,” he said.

Ben Browne, restructuring specialist at Alix Partners, said the composition of stakeholders is critical to any company’s survival. What could hinder that composition includes owners being separated from the asset by third-party management and the brands continuing to focus on growing franchisees, not necessarily revenue, and often having protection to maintain the flag even if an insolvency occurs, he said.

Louise Gillon, head of hotel finance for Bank Leumi, said hotel insolvencies are being triggered by the amount of risk in the short term and how they are financed if they have less ability to trade.

“Questions will be raised in Q3,” she said of 2021.

Sharon Quinlan, head of corporate finance at fellow bank HSBC, said despite outside help, “the cost of getting some businesses back to operational efficiency will be extensive, (especially as that will incur) funding on the back of potentially high leverage.”

Other problems hindering staying the course include bureaucracy, liquidity and valuations, sources added.

David Kellett, senior director of hotel transactions at Invesco, said red tape is less relevant in the U.K., but in many countries in mainland Europe, it is a source of pain.

Liquidity
Arron Taggart, head of United Kingdom investment at Cheyne Capital, said the volatility of values and the difficulty in predicting trading volumes will be big issues in 2021.

“Liquidity is the biggest challenge, and cash flow, getting that going through (the next quarter) that would normally be quieter,” said Andrew Robb, chief business development manager at hotel management firm RBH.

Resolving all these issues to the benefit of all sides and the asset itself requires transparency, and lots of it, Smith said.

“What is the relationship between sponsor and bank? When you get into the need for cash, if you have that trust, you can find a way through,” Smith said.

James Salford, partner at law firm Bird & Bird, said he has seen stakeholders seeking second lines of liquidity, a trend banks likely would push against.

Browne agreed lenders are weighting up the risks of providing short-term debt.

“Lenders will want to assess the collateral cover and to increase the local diligence over a hotel’s business plan,” Browne said. “Covenants will remain key, and secure creditors have the control to fashion the insolvency, which might include funding to produce an accelerated sale. Shareholders obviously will want to protect their investments, but the problem is are they prepared to put in more capital?”

Landlords will remain focused on trading performances of hotels and long-term plans and keeping a close eye on management teams, he said.

Options include signing leases with alternative operators and contemplating change-of-use options.

Panelists said there were multiple considerations and implications surrounding insolvency and advised having a product best-positioned to preserve its value, including relationships with online travel agencies, capital expenditure, branding and having assets prepared for procedures around accelerated mergers and acquisitions.

Management needs to continue to pay OTA fees to make sure assets still can take advantage of the continuation of distribution channels and being “top of mind” for consumers, panelists said. Managers must weigh if the terms of operating agreements are acceptable against brands’ non-disturbance clauses.

Sources added such planning goes to the heart of whether a product is realistically sellable or maintainable, if a property is fully regulatorily compliant and if documentation is correct to permit speedier M&A activity.

Capital expenditures are also critical to preserve value, but panelists cautioned that that right now much of that cash is being funneled into health and safety.

Transparency
Transparency among all sides is critical, especially when nerves are frayed and revenue only trickles in, panelists said.

“This crisis has highlighted challenges that probably already existed. I would expect a reduction in fixed rents, and a greater introduction of variable rents in leased structures going forwards, and it has to come with transparency and openness that makes it more of a partnership,” Kellett said. “A crisis should bring about a better way of doing things in the future,” he added.

Taggart said the alignment of lenders is vital to buying into any restructuring or survival plan. Ideas such as interest holidays and other mechanisms can be worked out, but only if everyone knows every step of the strategy.

Gillon said teamwork is essential.

“You have to start working as a team, where before it was very much just tenant and owner,” she said.

During the Great Financial Crisis, the industry was very highly leveraged, but this time around that is not the case, Kellett said.

“In Europe, institutional leverage is not particularly aggressive, so it is less of a problem. The more leverage, the faster things fall down. That will always differ case by case, but this time around there is more leverage on the operational side,” he said.

COVID-19 is not anyone’s fault, which arguably the Great Financial Crisis was, Taggart said.

“That should be remembered,” he said.

Adding to COVID-19 complications in the U.K. is Brexit, a situation moderator Russell Kett, chairman at HVS London, called a “double shock with no known outcome.”

Perhaps due to the gravity of the pandemic, industry leaders seemed not to have fallen into a funk on the matter.

Panelists said the pound sterling could depreciate further and allow for more travel spend. Inbound capital from Asia and other regions might regard the U.K., and especially London, as remaining attractive. When recovery does start, the industry will be an obvious and great employer of talent.

“At the beginning 2020, Brexit was a big issue, especially as we have a large London portfolio, but the talent pool has increased dramatically due to COVID-19, so we are not so concerned,” Robb said.

Taggart said COVID-19 is such a profound shock that Brexit has paled.

“(Brexit) is not quite negligible, but most focus is on how COVID plays out over the next 12 to 24 months,” he said.

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