Shark Radar

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Jun 23, 2020, 2:20 PM GMT

Wirecard Nose-Dives Towards Insolvency

The brewing scandal that the German financial services provider managed to get itself into, concerning a staggering 1.9 billion euros missing from the company's account balances, is weighing down heavily on the payment processor's share price. Wirecard's stock value plummeted by more than 72 euros per share since last Thursday, effectively wiping out more than 20 billion euros in market capitalisation.

The initial woes for Wirecard stemmed from the new information alleging the company to have lost the colossal sum. However, on Sunday, the central bank of the Philippines stated that none of the money appears to have entered the country. Previously it was speculated that the missing sum might have been placed in the accounts of two unspecified banks in the country.

Wirecard's Management Board released an official statement yesterday, hinting at potentially dubious actions undertaken by its third-party affiliates. More specifically, the company executives questioned 'the reliability of the trustee relationships'.

"The Management Board of Wirecard assesses on the basis of further examination that there is a prevailing likelihood that the bank trust account balances in the amount of 1.9 billion EUR do not exist."

This is arguably where the company's situation turned for the worse. Wirecard's new stance underpins the faulty accounting and bookkeeping practices that have apparently led to the general confusion revolving around those 1.9 billion, which might have never existed in the first place. The case has morphed from accusations of fraudulent behaviour into an examination of corporate transparency, which is not an improvement.

The ramifications from this could be quite severe for the company, but even more so, they could affect the German financial system as a whole negatively. That is so because the German financial regulator BaFin has failed to recognise the underlying issue early on, which casts further doubts relating to the financial body's propensity to make such detrimental mistakes.

Chiefly, investors are concerned that the regulator might have overlooked other misbehaviours of Wirecard or even other companies in the German financial services sector. So far, the fallout from such fears has not impeded the share prices of other companies in the industry. If these threats remain unfulfilled, the sector could very well stay on its path to recovery. Moreover, other companies such as Allianz might reap the investors' attention that was previously centred around Wirecard. This could solidify their own positions.

Meanwhile, the hard times for Wirecard are just beginning, as the company might find it increasingly more difficult to finance its operations. The specifics of the German law could thwart its own efforts to recover from the coronavirus turmoil.

At present, Wirecard is leading negotiations with many of its creditors to extend the loans of the struggling payment provider. Even if it's lenders agree to push further the deadlines in order to assess the situation properly, this would not necessarily save Wirecard from defaulting on its debt obligations.

Due to the aforementioned massive wipeout of the company's market cap, its financial circumstances worsened severely in just a few days. Unless Wirecard manages to break this cycle, it will spiral towards insolvency, and here is where the crux of the previous argument lies. According to German law, it is illegal to delay insolvency. In other words, Wirecard's credit lenders could be reluctant to extend the much-needed loans of the company, out of fears of infringing the law.

The problematic nature of the situation stems from its subjectivity. It boils down to whether the lenders and the financial regulators would perceive Wirecard's spiralling debt obligations as ensuring its eventual insolvency. If so, then the company would default on its debt obligations sooner or later, which would deter the lenders from extending the deadlines on Wirecard's loans. That would be so because the contrary would be perceived as nothing more than an attempt at delaying the inevitable insolvency. Such actions could even be treated as transgressions against German law.

However, due to the same subjectivity of the delicate subject-matter, Wirecard's situation might not be as gloomy as it seems. If the financial regulatory bodies in Germany and the EU are instead of the opinion that Wirecard's insolvency might yet be averted, then extending the deadlines of its existing debt obligations would not be perceived as violating the law. Likewise, such actions are even going to be encouraged in a bid to save the company from going bankrupt.

The underlying situation is every bit as precarious as presented. Even if defaulting could theoretically be prevented, this would not necessarily mean that Wirecard would be able to bounce back easily from the bottomless pit that it is currently staring right into. As it was already revealed, the financial company would find it increasingly more challenging to secure debt-financing for its operations. But even if it does, this would create future problems on its own.

One of the biggest takeaways from the 2008 credit crunch is that debt obligations cannot be resolved by undertaking new debt. All that such unsustainable strategies do is to inflate a debt bubble, which eventually bursts when the cycle of debt financing is no longer self-sufficient. That is why the risk of default is so real in the derivatives market, and Wirecard's current predicament is prompting investors to recall their worst nightmares from the last great recession. One such default of a major financial institution could break an entire system of established credit lines, which is how one company's misgivings could spill over entire industries.

At present, investors fear that if the situation is allowed to worsen, Wirecard's potential insolvency could lead to a whole new series of issues for the financial system. These could resemble in many ways the consequences that emerged in the wake of Lehman Brothers' bankruptcy.