Restructuring
How do companies matinain liquidity heading into bankruptcy
Company will begin stretching its payables. Attempt to draw down on its revolving line of credit. Prearrange a DIP lending facility.
What ar ether main rules when judging a companies abilites to pay back
-Make sure the firm can pay back debt thorugh internally genrated funds -Make sure their is siginfigant asset coverage throughout the whole temr of loan -Make sure after capex EBIDTA can pay off intrest and has some room for vaility in wokring cpaital -See if there are abilities for a firm to refinance if needed
What adjustments to liabilities are made after chapter 11
-can reject executory contracts or unexpired leases.
Why do we use EBIDTA
-for comparability across companies regardless of capital strcture -closely relates to true cash flow
3. What do you companies do when they think they won't be able to meet their debt obligations?
1. Refinance and obtain fresh debt / equity. 2. Sell the company (either as a whole or in pieces in an asset sale). 3. Restructure its financial obligations to lower interest payments / debt repayments, or issue debt with PIK interest to reduce the cash interest expense. 4. File for bankruptcy and use that opportunity to obtain additional financing, restructure its obligations, and be freed of onerous contracts.
Universal truths about bankruptcy
1.)Hardly a surprise when a firm registers for bankruptcy protection. Firms may candidly send signlas like talking about possibly of it in calls / ect 2.)Some or all creditors will inccur some financial loss
Things that stuck out about 2000 distressed defaults versus 1930s and 1970s
1.)The number of fallen angle and dead angles... up 3% to 6%. This puts people in tough spots since investment grade portfolio managers are forced to sell and speculative grade portfolio managers forced to buy all making markets irrational 2.)Many more large distressed companies defaulting opening up opportunities to invest in smaller distressed bond investments. 3.)Most defaulting happened in telecoms and TMT which is tough since were are the hard assets to back something like that or get liquidation value.
Name 2 types of businesses that can borrow tons in distress
1.)a fallen angle since these typically don't hav eot give secured loans but thier may be negative pldege provisons 2.)Tech stocks or other stokcs wiht no assets or revs at first that issue convertible debt that is more invested i to make appreciation on equity. If the equity collaspes then they can offer assets as collateral to borrow more.
Factors that correlate with more defaults
1.)general economic weakness. Makes intuitive sense, weak demand means that business have trouble growing and turning profit. This points to big correlation between default rates and manufacturing rates. 2.)There is a high correlation between the amount of low rated bonds issued and the amount of defaults. Thinking is that there is a greater chance of defaults for lower rated bonds so if you issue more of these you will have more defaults. Low rated bonds grow by new issuances or downgrades. 3.)Capital markets liquidity- Highly leverage companies need to be able to purchase bonds on open market since their FCF typically is not enough to repay debts. IF they can't get this financing, they default.
4 main objectives when a bankruptcy starts
1.)stabilize company and provide for its immedaite liquidity concerns 2.)to develope a going forward buisness plan in order to maximize vlaue of assets and opreations 3.)to detemrine legitamte liabilities of firm and thier pirority 4.)if restrcuruing is end goal, to determine new ideal capital strcutre
how long do exchange offers typically take
60 days
What is leverages primary concern
The amount of debt relative to the amount of credit support (CFs and Collateral)
Credit support
The terms used to repay debt.... can be collateral or Cash fl
Why may interest expense be a cap
IF you can barely pay interest exp.... EBIDTA barely greater than Intrest epxense even with sufficnet asset coverage only the most aggressive leader would extend this loan.
Pre and postbnakruptcy
IN pre bankruptcy investors/creditors make moves based on company and bankruptcy is more or less companies choice unless in rare occasions, the creditors force them into it
Negative Pledge causes
Says that if there are no secured liner sand you offer secured ledning at a later date, all the unsecured ledners also get claim to that collateral. This protects the oringal unsecured holders who oringally had priority.
What do revenue metrics tell
They are often used since at a general level they tell about tjhe breadth of a companies traget customer relationship and accceptance of product EDBITDA/Rev: used to see qaulity of management as if a comapny can achieve 17% and another only 5% how may management make imporvements to achieve this ratio also use EBIDTA/EV
Why restructure
You have more liabilities than assets and you have 2 options 1.)You get more assets... tough since you are in trouble 2.)get less liabilities AKA restructure
Gaurntary
a promise to pay back the obligation of another. IT is for holding companies / shells of ocmapnies to make sure the real company will pay a very small divison that may not have assets if things go back.
Adjusted EBIDTA
adjusts earnings for one time charges like restrcutruing or other one time in nature charges EBITDAR- same idea behind adding back intrest to get the capital strcutre indepdent sicne that should not affect a businesses worth. You add back rent since restruatnst aht lease locations versus own will have very dif EBIDTA even if they generate same amount of money after depreciation
unrestricted v restricted subsidiaries
determine if a subsidiaries that can be created for any number of reaosns is subject to the terms of a loan or not
example of non coercive tender
doesn't make person worse off but gives. acomparable situation to encourage partcipation
If equity has a value of zero why may it have "value"
it does due to the option of equity meaning if a company turns itself around you can make a ton of money here
automatic stay
prohibits creditors from collecting debts that the bankrupt incurred before the petition was filed. Meant to secure value for unsecured creditor and prevent all assets being siezed on so operations can conitnue. May be good for secured creditors as it prevents a fire sale meaning they may get more back for thier recoveries. The debitor wins as it gets some flexiblity and protection so its assets cant be seized
Repricing provisions
protect against poor performance, you get paid more if a company prefomrance detroeitates and unlike a preofmrance convenat it doesnt forc ea default although a minimum preformacne may trigger default idea is additional IR provide a reasonable risk reutrn ratio
spread
the difference between the yields of two bonds (typically, the difference between a corporate bond and a U.S. Treasury Bond)
debitor in possesion
the fictional entity that the company operates as after bankruptcy. Management only job is to do day to day operations and it must receive special cosiderations to do anything else form bankruptcy court. The creditors though are typically not sold on managments abailities as they are blamed for the sitauion and you see many fires /resigations happen immediatly after bankruptcy. Outsiders with epxeirnce turning around companies are typically brought in to take the place of this fired managment
PIG
type of potentially uneraltisc business plan where you join an industry just becuase its growing so rapidly and should be able to support another player
11. What's the difference between Chapter 7 and Chapter 11 bankruptcy?
A Chapter 7 bankruptcy is also known as a "liquidation bankruptcy" - the company is too far past the point of reorganization and must instead sell off its assets and pay off creditors. A trustee ensures that all this happens according to plan. Chapter 11 is more of a "reorganization" - the company doesn't die, but instead changes the terms on its debt and renegotiates everything to lower interest payments and the dollar value of debt repayments. If we pretend a distressed company is a cocaine addict, Chapter 7 would be like a heart attack and Chapter 11 would be like rehab.
indenture trustee
A bond trustee is a financial institution with trust powers, such as a commercial bank or trust company, that is given fiduciary powers by a bond issuer to enforce the terms of a bond indenture Basically the bank who generates and underwrites loan
cross-default covenants
A borrow is put in default if they default on someone else For instance, a cross-default clause in a loan agreement may say that a person automatically defaults on his car loan if he defaults on his mortgage.
Tort claim
A tort claim is a claim against the National Archives or its employees for damage to or loss of property or personal injury or death. Such claims may be brought only for damage, injury, or death arising out of the activities of the National Archives. See The Federal Tort Claims Act, as amended, 28 U.S.C. §§ 2671-2680. Think Monsanto... these claims have killed healthy businesses Cahpter 11 protects you as this sets aside a set of assets that all claimers can make claim against nothing more
Chapter 11, who gets right to submit plan first
After the chapter 11 is filed, debtor has 120 days to submit a plan but will be extended as long as court feels in good faith, the debitor is trying to turn things around. After 120 days, the creditor / creditors can submit plans then peple must take sides of whose plan to back
Equity holders role in bankruptcy
Also have a role in bankruptcy although they have the least claim to assets. Soemtimes are able to vote on the restrucring plan. If there isa. case in which they may have some recoevery, a concil forms for thier intrests but if this isnt the case, they are ignnored.
How does timing affect liabilitites in bankruptcy
Anything before bankruptcy is unsecured and after is secured.Think if you slip on a banna peel and win a million dollar lawsuit. If you do this the day before bankruptcy your claim is unsecured and you get little but if its after, its secured and you will get it ll... so companies can time it rihgt and avoid huge payments.
How does progress for restructuring begin if debt is from bonds
Banks and advisers see company is in trouble and start trying to bid and say they can help. Typically company refuses saying that they will turn it around which doesnt happena nd they quickly hire advisers since comapneis are not expeirnced at restrcuruing
Why does valuation play such huge role in chapter 11
Because if the company is valued very lo then many creditors claims will be wiped out since there will preceived to be no vlaue for them. but if it is high then more creditors ahve claim to value due to the water fall idea so it crucial that parties negotiate valuations that get them paid. This also means dif traunches negotiate and may help one another out to get support for court to pass a plan not reject it or a vlaution why senior credtiors want low vlautaiton and junior want high
Why may secured creditors prefer chapter 7
Because these creditors have asset backing there debt so they may hav ea full recovery and they dont care about the unsecured holders
Dead angle
Investment grade debt that envtually defaults is known as a dead angle
Bondholder committee job
Is to analyze the company and find/negoitate a solution that maximizes the value for all bondholders... the more legimtate it is the better the chance it actually gets shit done. Idea is the bondholder committee are most expiernced and have done the work for you so you accept it
Credit risk analysis versus distressed investing
Credit risk analysis is when there are calm says esimating chances boat may capsize Distressed investing is being on that boat during a storm knowing it amy capsize and saying how much would i buy this boat for knowing the risk
Contractual provisions
DEclare who you are under not who you are above, since everyone cant say these super duper notes beat all else. LAw says everything is equal unless holders agree to subortinate thier claim. You need to see what is subronitate to once think transitive prpoerty so things get tricky
Indicators of distress
Debt ratings downgrades
What happens when chapter 11 starts
There is a. committee to oversee the management of a firm and the company needs approval to undergo any actions. A committee of unsecured creditors is formed. consists of seven largest creditors who are willing to serve. This comittee cosnists of creditors form the diffrient types of unsecured debt and thier job is to form a plan to reorganize of liquidate nad in conjuction with the debitor/trustee, oversee the business
What are some ways to get more leverage even if you violate rules of over levearge (think unique finaicial instruments)
Exchangeable prefered stock-You have finite repayments that make it more like debt, but the line is drawn where there are limited reprecussions if the payments are missed. This is used to extend more leverage. Issue these when there is very high leverage.Also if there is no income why would u issue more debt as you get very little tax reduction anyways. Convertible bonds- Have feature allowing these bonds to be converted into an amount of equity. Specified number of shares. The thining behind these is that the equity will advance and its expected these will all be converted. But now, the equity isnt worth this much so you are basically selling equity at a premium. But, if your share fails to increase, then this debt is very real and you are in trouble. PIK intrest/discount notes
Financial versus stratetgic aquirer
Financial acquires purchase since they think they can get solid risk adjusted return whereas strategic aquires buy to exploit revneue and cost synergies. Strategic aquires therefore pay more for businesses and these companies have higher EBITDA to EV multiples
Secured creditor groups in bankruptcy
Form commitees/cousnlels depending on the colletral they have
Official committee of unsecured creditors
Formed at the start of chapter 11. It is the 7 largest unsecured creditors willing to serve and but thier is discretiion for it to be dif if needs are dif. This committee oversees the debitor buisness in conjuction with them and drafts a plan for the reorganziation / liquidation of a comapny. This commitee hs a fidicuiary duty to all unsecured creditors.
negative pledge causes
Giving other creditors lien over assets means that unsecured creditors must also become benficaries of those adssets .... means if you make someone a secured creditor i become one too
How to group by classes
Group by interest of recovery (cash, stock) and by if they are secured or unsecured(although secured with not value since assets worthless treated as unsecured)
What types of companies do financial restructurings work on
One that business at the core is not flawed but one that needs to temporarily survive something
What is the preferred option of restructuring
Out of court is the preferred route for restructuring since chapter 11 is costly, time consuming, and carries the risk that vendors/clients perceive risk in having relations with a bankrupt company
What adjustments are made to assets after chapter 11 is filed
Over a relevant look back period of about 90 days, any preporty sized by creditors must be returne if its found to be voidable and the creditor is now like the others, trying to seek recoveries. Fradulent coveyance- if a company has seriously limited leverage and must sell for such.a low price it gets schemed, the deal may be required to be undone, which favors the estate. Lawsuits - can sue audutiros for missing red flags or managment who put you in the bad position in the first place.
What are the two options a debtor has when approaching creditors
Pay the creditors legal frees for restrcuruing lawyers and negioatie a deal Propose a deal without negoaitooing with creditors
PIK intrest
Payment-in-kind, meaning interest is not paid to the creditor in cash, but by adding to the principal (face-value) of the debt
Why do bonds get ratings
Ratings are not needed but issuers pay for them isnce it reduces cost of debt since highly rated bonds trade for less intrest payemnts Firms who do ratings get nonpublic info so these tend to be good predictors of a company health
Priority of payments
Senior secured- have collateral behind them term deposits senior unsecured- no collateral subordinate debt - owe to debtors that are insecure and can only be paid after senior creditors are paid back hybrid(convertibles ect) equity
25. Are shareholders likely to receive any compensation in a distressed sale or bankruptcy?
Technically, the answer is "it depends" but practically speaking most of the time the answer is "no." If a company is truly distressed, the value of its debts and obligations most likely exceed the value of its assets - so equity investors rarely get much out of a bankruptcy or distressed sale, especially when it ends in liquidation.
15. If the market value of a distressed company's debt is greater than the company's assets, what happens to its equity?
The SHAREHOLDERS' EQUITY goes negative (which is actually not that uncommon and happens all the time in LBOs and when a company is unprofitable). A company EQUITY MARKET CAP (which is different - that's just shares outstanding * share price) would remain positive, though, as that can never be negative.
If the market value of a distressed company's debt is greater than the company's assets, what happens to its equity?
The Shareholder's Equity goes negative (which is actually not that uncommon and happens all the time in LBOs and when a company is unprofitable) A company's Market Cap would remain positive (can never be negative)
Credit capacity
The amount of debt a firm can repay each month with cash flows. Used to describe unsecured debt... used relatively to risk so how much you lend to have a 99% chance of repayment verus a 50% chance is diffirient You dont know how much this is for certain since tough to predict cash flows so you do it on the basis of buisness to business and industry by indsutry basis
Going forward plan
The debtor develops it but anything outside the ordinary can be shot odwn by bankruptcy so this plan is devleoped in conjuction with credtiro committee if it has any hopes of being implemented. Things that can be done are -reducing labor force -selling noncore assets or businesses -renegotiating contracts -closing unporfitable factories
How does the court help DIP finances
They are granted super priority to previously pledged assets as collteral of other debt to DIP finacers. This is called priming.
convenants
Things that say in a loan agreement certain things that must be upheld. Ensures the protection of ivnetor who thinks buisness will do x and prevent then form doing y with thier moeny.
why may a company in distress raise more cash
This doesn't solve issue usually but it delays judgement day and managers always see more time as better (maybe sinc ethey conitnue to seek paychecks) investors like since it means there is more credit support but investors may not like isnc eit gives bad management more itme to erode value of buisness and pledges assets to other creditors (these would indirectly have previously been used to support unsecured creditors)
How to become unrestricted
To become unrestricted bond holders must hav ethe info they know have been dviludged in a 10k 8k or 10q. To remain unrestrfcited as long as possible, bondholders let thier conuslel take info and they wait to hear it til they must. The counsel then advises.
Bond holder committee
There are no rules who is placed on the bondholder committee. Also each memebr has no fiduicary duty to one another. The only thing that makes the group relevant is that it compireses most bondholders so company deems them relevant to negotiate with and deal with .... want bigger committee to get more elverage... mamangement typically wont deal with anything below 25% of bondholders no one gets paid to sit on bond holder committee but they do indeirectly thorugh having thier agendas completed.... thats why they sacrifice the time and effort
Critical vendor motion
When a vendor is so needed that a company has requested special premission by court to pay them so they can retian thier services moving forward. This is becuase chapter 11 freezes payments to vendors and intrest payments post petition
EV for distressed companys
When equity trades around under 1$ it is useless to use. You also souldnt take debt at its Fv it trades at but maybe take it at MV. Also if something is convertible it should be treaded as debt unless it is in the money, which is rare since a distresse company debt will be at extremely depressed levels and equity too
Why do you add back DA, Why do you add back Intrest, why may you add back rent in EBIDTA/EBITDAR
You add back Rent since this removes diffrineces in leases versus owned stores You add back Intrest since the cpaitalstrcture shouldnt have an effect on what your buisness is worth You add back depreciation since firms should be compared no matter waht there past investments have been.This overall is since these decisons on cap ex have realitvely little impact on how valueable a company shuld be as more effeicnet cheaper equitment could be better than more expensive ones and vice versa Also DA dont affect cash so it makes you over or understate CFs You add back taxes since you want to have comparability reagrdless of DA and Intrest exp and these both affect tax amount . Also tax savings / tax refunds can distort earnings
Performance linked pricing provisions
You can make a company pay more or less interest rate depedning on how well they are preforming
How to guarantee you sit on a bondholder committee/ stratgic thinking
You must buy tons of bonds to sit on committee since there isnta voting procress for who gets on You must review nonpublic infromation about the debtor menaing that you must sign confidentiallity agreements. This means that an investor cant trade without acknowledging it has confidnetial info... it doesnt disclose this info just says it has it and this means it cant hide its moves but investor does have hte best info possible. (called becoming restrcited)
What is PIK and why would you offer it
You offer these bonds when your constraint is the fact that you cant keep up with intrest payments. This instrument lets cash intrest be deffered. At the prinicpla date, this is paid off and its is assumed that the issuer has grown enough by then or is stable enough ot pay it off.
Common out of court restructuring
You reduce the amount of debt or inrtest owed and instead offer up the opportunity to be invested in equity/receive equity Also the issue with voluntary restructuring is that you can't change what someone who doesn't want to change does like you can in court
Tort claims
a claim against a company for personal loss or injury... can be unexpected and yeild huge rewards for plantiff... ex monsanto
sale back/ leaseback
a firm sells property to a 3rd party which elases it back.. gives cash needed and allows business to operate
Plan of reorganization
a legal document drafted during chapter 11 detialed wht happens to assets liabilites and ect after bankruptcy is exited. Details the claims of creditors against debitors and exlpains how they will be paid off. If the plan is approved by the creditors and then by the courts, then it has legal standing and alerts contracts , leabilties, ect
Put rights
at certain points in time a borrower can decide if it wants to remain in the deal (used to control for uncertainity of time)
partcipation strcutre for buying bank dbet
basically banks sell debt in this way so that no knows who buyer is
how to reduce leverage
buy debt on open makret renogitate with creditors sell off assets and repay debt
Leverage convanent
caps the amount o leverage relative to a multiple than be raised typically to EBDITA. The penality for brekaing is it prevents debitor form getting new debt, not a forced default.
free fall chapter 11
chapter 11 filing in which no plan has been negiaotied beofre. the impliactions of this are that it singals the reorgnaization may be tough as nothing could be agreed upon or that managmeent will be fired (1 -3 years if this happens)
coercive or non coercive exchange offers
coercive mean that if you don't join you are worse of and noncoercive mean you arent affected if you dont join
Asset coverage versus collateral
collateral infers that the PPE has been legally set aside as collateral whereas asset coverage just tlaks about worth of the companies assets and comapres it in debt ratios .... Asset coveage should be one to one with worth of debt as debt should not exceed value of a company since how would you repay that... therefore you get a good shorting opprunity
tender offer v open market
company makes offer to buy certain amount of shares at a certain price whereras open makret is you find sellers. a type of tender is a modified duth auction where. a firm buys x amount of bonds at y prices
Best intrest test
compares the liquidation value of company versus value if it were to be kept alive to mkae sure no creditor recieves less if company stays standing then if liquidated. it compares liquidation value veruss the going concern vlaue (DCF or something prepared by the debitor CFO)
discount debt
debt issued that at first has very low below market rate intrest then as time moves on it starts to increase to pay above market... used by startups.dsitressed companies who cant pay debt upfront... should be valued at carrying value if a company isnt distressed or market value if it is.
prenoegiatied chapter 11
debtors and creditors have a tenative plan when a company files for bankruptcy and the bankruptcy procress occurs much faster, more like 45 days
Explain some conflicting wants of junior and senior loan holders and conflicting wants of company v bond holders
distressed companies want longer term loans to lock in funding whereas creditors want short term to increase chances of payback Senior note holders want to be repaid before junior bondholders bonds expire or is the coverage is errored meaning they may get back less value.
Yield spread
explains cost of risk between an investment and a risk free treasury
DIP financing
happens at the beginning of bankruptcy. It is approved by the court and it is a financing agreement in a creditor slide sinto adminstrative claims meaning these are the highest but even now, many companies wont extend credit without colletral. The issue is most companies have already pledged all thier collateral.
How does a court determine if a company in chapter 11 can void an executory contract
if it will benefit the debtor except in cases like pensions in which there is more scrutiny and even if it benifts the debitor, it may not be voidable pension plans / retirement plans... cant screw over employees
absolute priority rule
is a rule that stipulates the order of payment in the event of corporate liquidation among creditors and shareholders. The absolute priority rule is used in corporate bankruptcies to decide what portion of payment will be received by which participants.
How successful is out of court restructuring
less than. 10% of the time successful
Corporate structure affect on bonds
many firms have multiple diffrinet shells they opreate out of. This is done for tax, liability reasons, and more. It also is used to renieforce caital strcutre activity. Some claims at top corperate strcutre are automatically more senior than equivlinet claims at lower corperate strcutres. By order of law value flows up in accoradnce with stock ownership
Bottom up distressed debt approach
means look at asset values first and then the appropiatness of the capital strucutre
big boy letter
means you express to the party you trade with you ackknowldeges they know you have nonpublic info about a distressed company
put rights
milestones in debt agreement where creditor can back out at any time and they must be repaid
What is the verdict for a class to accept the restrcuturing
more than 50% of claims resenting more than 66% in amount most vote in favor . AFter this all memebrs of this class are bound to the plan. This was put into place to avoid majority ruling everything (tyrany of majority) issue is thought that arbitrary classes could be created and used to get things passed
Keep employee retention program
new contracts offered to key employees who may leave since they are paid in equity which iss kind of useless if a company defaults. Creditors may reject this as too generous. also creditors see management using this to protec thtemselves and tehy think they cuased problem so they sometimes vie for an outsdie retrsuturing managemer to be brought in
Can bank debt restructuring be accomplishes through anything but negoiation
no
executory contract
one in which there is significant stuff to be done still and a defualt would be a material breach ex.)boxco etnered a contract with a company to put underground cable it no longer needs and the libaiblity is worth greater than the asset (cables) so it can void this contract. . This would give the contract holder claim as an unsecured creditor but again... get in line for recoeveries. The main / most common type of executory contract is unexpiered leases no longer need. ex.)Boxco downsizes and dont need its office it can dip
• Tender vs open market repurchases:
open market are preferred because they are simpler, faster and more discrete, require limited legal and professional expenditures. • If repurchase is for a larger amount tender is preferred. o When will the tender be successful: the amount of bonds remaining should be significant o The holdouts should have a relatively low probability of receiving a cash recovery of principal in the future.
where can a firm buy its debt for discount
open market, direct from holders ,tender offer (bascially an autction very public company puts it out)
Nonrecourse
opposite of guarantory, says in event of somthing bad happenieng you have no right to go after x. like an LLC between person and buisness but in this case its between buisness and business.
Plan of reorganization 2 major parts
part 1: identifies all the various claimants against company and then each is assigned voting and priority classes for payback part 2:indeitfies what each class will receive in payback
What are 3 most common near term liquidity issues
payment of interest due payment of principal due breach of convenant cuasing something to change or be defaulted on
Priority and the 2 types of convents used to ensure it
priority referes to keeping a loan at x level of repayemnt. you use restrcited payments and negative pldege cuases to do so restricted payments says you cant pay x or y this.... ex dont want someone in a coountry where you cant recoup money getting tons of dividends..
Types of financing
sales/lease where you sell property then lease it back fallen angles typically are asset rich and have borrowed on an unsecured basis so tehy can borrow alot tech sector ussually has convertibles soa ll of a sudden they can issue debt
What are the two most common ways for a distressed firm to raise cahs
sell assets , raise against assets
Why do debtors have a finite amount of time to propose a plan
since during bankruptcy a business can detoriate cuasing loss to business and creditors
Why can't you simply assume when bankruptcy will occur
since they are most of the time not surprises so this event is priced in already. Also the illiquidty of the distressed market menas its tough to aquire something at the time of the investors choosing
Credit risk
the probability that the terms of a payment or loan are broken (default) Credit risk determined by levearge,priority,time (all relative)
what happens to working capital from prepetion sources after chapter 11
they are frozen immediately son company needs to find liquidity
what do most investors require for return on distressed securities
they require 15-25% for risk and most assume 0-4% growth rate to be conservative
Types of unexpected liabilities
tort claims contract liabilities fraud
Why is distressed debt market inefficient
unequal access to information- distressed debt trades OTC and many offerings have no coverage. Also much fewer disclosures. rational behvario- a lot of the time people are forced into selling. Some banks need to have certain ratios of bonds that are unsafe so they have loan sales and sell bonds at discounts. Or think situations in which you write down a bond to zero but it recovers soy want to sell to record. a gain.Mutual fund customers are able to pull funds and managers must have cash on hand to pay what is owed resulting in forced selling. Transcations costs- High transactions cost so there isn't much movement and constant price ticker so the fair price ema not be figured out
blocking
when a secured creditor has performance conveneats blocking intrest payments to more junior debt if it starts unpreforming (to ensure it gets its money back) If you block these loans then you can accelerate and forc ea company into bankruptcy
Priming
when court grants DIP financiers super prioirty over previously pldeges assets of other secured loans. To prevent being undercut and have there secured funding cut, many secured loan holders become dip financers.
How does a bankruptcy start
when. company files a legal petition with a bankruptcy court. It is most of the time filed by debetor and is voluntary and it gets ocntrol of the case sometimes creditros can file an involutary poetition for the debitor to put it in bankruptcy but even then the debitor can file and gain control of the case
Security agreement
where a creditor basically confirms and makes claim to specific assets of debetor to ensure itself in the case of a default, it will get its money back
forced call in event of downgrade
you an force. a company to pay back if they are donwgraded past X
tort liabilities / what do you do with post petition liabilites
you basically value them and set up a trust so they can be repalced and it makes it so the amount of money owed is cappe dan predictable not an endless and unpredicatbale stream of actions agains thte company.
example of coercive tender
you offer to trade old unsecured debt for fration of the cost of new secured debt so if you dont partcipate you are in trouble nad may get no value adn business reduces its debt. you need 90% partcipation to pass it.
how many a company be smart in filing for bankruptcy
you want to file in a jurisdiction that matches your goals (side with debitor, have quick procress, ect) You want to carefully time the planning. A company wants to file before it has broken debt conventats so it can be in control. Liquidity- A comapny may file for bankruptcy to avoid making intrest payments or payments to vendors to conserve cash.Also a firm may draw down or tap out revolving credit then file to have as much cash as possible.
What does more bank debt mean for an active investor
• The greater the bank debt, the less likely it will be that the investor can get involved in a meaningful way other than purchasing a large block of the bank facility. o Bank debt tends to have all-encompassing covenants o Even though automatic stay prevents the bank from seizing collateral, they are still protected by the powerful concept of adequate protection. o Can be used to demand postpetition interest.
Why do banks look for double support on loans (ability to pay bakc loan on cash flows and collateral)
Since a business closes all of a sudden there are no cash flows only collateral
Rollups
Type of potentially unrealistic business plan in which you consildate industry attempting to benifit from eocnomies of scale
Backstop
When you a have a hedge fund step in and buy any equity not purchased by investors when a company in distress sis raising money
Performance convents versus restrictive covenant
In a restrictive convents if a company detertiorates you cant force the company to go ahead and default but it bars it form actions If there is a prefomrance conventats and a company begins to underpreform, you can renigotiate the loan .They can force a default but this is rarely done.
4 tests that must be passed by restructuring plan
Best interest of creditor test: If a creditor votes against the plan of solitication the the debitor must provde that the plan is just as good for creditor as it otherwise would have been in the case of chatper 7. issues if creditor is secured since they will recoup alot but no issues if unsecured since they in trouble either way good faith test:requires plan of reorginzation be issued in good faith. It is very vague so it gives opponets alot of room to raise qaulms agains the case but also is tough for anything to happen since its easy to fight against and establish good fatih. Feasbility test:The court must find that the plan will most likly not result in liquidation or further reorginzation. This is typically the most contentious part of a case as any creditor can raise a challenge. This can also be used for a creditor to get waht it wants by saying things like oh the valuation is too high thier is too much debt so now more is given to secured or unsecured ledners may say vaulation is too low meaning less is given to secured and more to unsecured consent or cramdown:Cramdwon is the procress by which a reorginaztion is imposed on an impaired class that has voted to reject the plan. In the case of this, one impaired class or class that disagrees may now agree with plan. This means that companies must make allocations for junior unsecured people who may typiclaly oppsoe
Chapter 7 v chapter 11 bankruptcy
Chapter 7 assumes the court will oversee liquidation of assets whereas chapter 11 assumes the court will oversee reognaiztion of amangement and activites Both debitor and creditor prefere chapter 11 as managment wants to keep job and creditors think that a company is worth more if it is carefully sold off or reorgnaized veruss sold in a firesale (chatper 7 bankruptcy)
What are the four main ways to establish priority
Collateral, term structure, corporate structure, contractual provisons
How does progress for restructuring begin if debt is from bank
Company CEO/CFO calls bank and restructures / amends legal terms of bank loan
Why is it hard to raise debt in distressed scenarios I
If debt is greater than asset value their is hypothetically no equity value so poeple wont take equity nad if a company is preceived to not be able to pay back debts why would a company invest if th asset coverage isnt great enough to secure it
Forced callsign event of a downgrade
If there is a downgrade by Moodys or SP below a certain level some bonds may be called back a company must pay them off
Why would a company do an all equity excahnge for debt
If they are unlikely to have stable cash flows or want to borrow in the future since companies are quicker to lend to those with no debt.
2 ways to go about restructuring
In court- Chapter 11 and Chapter 7 Outside of court- Voluntary agreements between creditors and debtor
Customer based valuations
In industries where there are constraints on custoemrs or who can serve who ((think utilities) you use custoemr based multiples. Lots of regulation in these indsutries. Think about something like electrciity. You already have a powergride capable of covering X land to buy the other company or contract means you can use it on more custoemrs effectivly making more. Economies of scale.
How to determine who speaks on creditor behalf
In situation where there is bank debt, the bank prettty much does it if there are multiple creditors they form a committee and then they negoitate and then indenture trustee will only act when they beleive they are acting on behalf of the credxitors or a large precentage of them so this committee mmust first hash out what they want to happen A large bondholder will contact and solicit the help of the other bond holders and negiotiate on thier behalf
Confrimatation hearing for the restructuring plan
Includes a few things that must be included 1.)plan adheres with bankruptcy code 2.)proponent of plan is appropiate 3.)all fees paid to profressionals are reosnable 4.)plan reveals indentity of postconformitaional officers and directors. 5.)any required regulatory approval has been aquired 6.)U.S trustee fees are provided for 7.)retiree benfits are appropiately disclosed more procedural stuff... compliance
Limitations of EBIDTA
It has many limitations and must be adjusted frequently and used sparingly. Limitations EBIDTA fails to reflect changes in wokring capital.If companies buy up inveotry, have tons of accountings receinveable or pay down accounts apyable actualy cash differs. EBIDTA ignores CAPEX needs and DA reflect the cost of CAPEX and therefore the cost of using it. This is defered since poeple think that capex is discretionary and can be defered. If this isnt the case sometimes people argue to use EBIT or EBDITA-CAPEX EBDITA must be adjusted for thing that are one time like restrcuturing charges which include things like serverance, inveotry write downs, uncollectiable Accounts receivable menaing EBIDTA overstaes CFs If the firm is under diress you may want to rely on future or nromlaized EBIDTA as in distress a b usiness amy temportilry close segments of its business
How does a majority investor help bond holders
It is in their interest to figure out a companies prolbems.... smaller shareholders wont care about it since too much time money nad it lets other sfree ride
What prevents out of line bevhario by firms in restrcuring scenario
It is.a small community so things are remembered and people have personal relationships Could have nuclear option where copany will only do.x if something like 90% of creditors do soemthing
Maturity structure
More important for bonds then bank loans. Bank loans ussually have floating intrest rates so they have less credit risk whereas corpearte bonds are fixed.
Why may you not want to be on bondholder commitee
Since no one will trade with you if you have nonpublic info and then you cant increase position or leverage Ussually on a bond holer comitte you cant avoid beocming restrcited since reviewing company is key part of job.
Holdout problem
Since out of court exchanges are voluntary,it is often impossible for them to occur since certain companies holdout . This is since you dont have to give up your rights if you dont partcipate but it is game thoery, if too many holdout everyone is worse off. This is since without full partcipation a comapny can recover but with too little it defaults and everyone is in toruble
Why do debtors initiate negation firsts
Since they have leverage, they are in trouble and if you want your moeny listen. A creditor cant inaiatiate it since they have no leverage unless the company has broken a covenat or term of loan. You only meet with a creditor if they are very large and feel they may gain more leverage down the line in the future
Why are banks risk adverse
Since they make small spreads on paying investors to deposit and loaning to indivuals so they cant afford loses Also, the goverment insures loans so they dont wnat ot be reosnbile for bailing out banks plus if a bank defualts that is terrible for the eocnemy and investor conifedence
Why do firms hold cash
Some firms need liquidity. Think a fast food chain.... it needs cash in its registers Not all businesses can have a working cpaital line of credit and this comes with costs
What are typical multiple rates in restructuring scenarios
Typical ratios are 4x-8x since DR are high since a company is in peril
What do banks limit EBIDTA to Debt ratios to
Typically on secured basis don't extend much past 2.5x
What sensitivity table is used to judge credit risk
Use leverage to Edbita versus EDBITDA growth to see repyment chances in CFs Also sidenote, more volatility in CFs the harder it is to detemrine whether a company can pay back debt ... intuitive
Performance convenants
Used to manage risk and hedge risk form time specifically. PReformance convenants require a company to reach certain preformance measures... you extend these to comapnies you expect to grow and look drastcially diffirinet in the near future
Liquidation value
Used when company simply can't continue operating and thier best route is to liquidate.You dont use EDBITA as why would you estimate something that wont recover or be negative. IT may be hard to estimate value of items so it is highly speculative.
Asset Based valuations
Used when profession of a clear key possesion is a clear competitive advantage . This relates to scarcity so you often see this in a natural resrouce or real estate. Here you look at how much you have and for what margin you can sell at
31. What's the difference between a Distressed M&A deal and a Restructuring deal?
"Restructuring" is one possible outcome of a Distressed M&A deal. A company can be "distressed" for many reasons, but the solution is not always to restructure its debt obligations - it might declare bankruptcy, it might liquidate and sell off its assets, or it might sell 100% of itself to another company. "Restructuring" just refers to what happens when the distressed company in question decides it wants to change around its debt obligations so that it can better repay them in the future.
Matinece versus incurrance convenants
A covenant is a term used in loan documents (for example in an LBO) and any other kind of bond issuance and it dictates any terms of a corporate takeover or acquisition or bond repayment. Covenants are a critical part of credit analysis, and it's important to understand how covenants work for private equity interviews. Maintenance Covenant A maintenance covenant requires the borrower to maintain a certain level of activity. Example: The borrower must maintain a debt to ebitda ratio of less than 5.0x The ratio will be tested for compliance on a quarterly basis If the borrower is not in compliance, they are in default Incurrence Covenant An incurrence covenant only takes effect if the borrower is taking a specified action. Example: The borrower must not incur new/additional debt unless the borrower's debt to ebitda ratio is less than 5.0x after giving pro forma treatment for the new debt This covenant will not be tested on a regular basis and does not have to be "maintained," it will only be tested in the event that the borrower incurs new debt So if the borrower has this covenant and issues new bonds that bring debt to ebitda to 6.0x, the borrow is in default (in other words, they can't take this action) If the borrower's debt-to-ebitda ratio goes above 5.0x because EBITDA is declining and not because the borrower incurred new debt, then there is no default under this covenant
Debitor in posession
A debtor in possession (DIP) is a person or corporation that has filed for bankruptcy protection but still holds property to which a creditor has a right. It is part of U.S. bankruptcy law and is the term used to describe a corporation that continues to do business while under Chapter 11 bankruptcy proceedings. Creditors to a debtor in possession have a legal claim to their assets and property under a lien or other security interest. The DIP continues to run the business and has the power and obligation of a trustee to operate in the best interest of any creditors. A DIP can operate in the ordinary course of business, but is required to seek court approval for any actions that fall outside of the scope of regular business activities. The DIP must also keep precise financial records, insure any property and file appropriate tax returns.
30. What is the end goal of a given financial restructuring?
A restructuring does not change the amount of debt outstanding in and of itself - instead, it changes the terms of the debt, such as interest payments, monthly/quarterly principal repayment requirements, and the covenants.
Term loan
A term loan is a loan from a bank for a specific amount that has a specified repayment schedule and either a fixed or floating interest rate.
What is credit
At the most simplistic level, Credit refers to the debt that companies and governments issue to investors. Credit investors focusing on investing in these securities, which could include performing and non-performing loans, distressed debt, mezzanine debt, senior bank loans, structured credit and other value-oriented fixed income products.
What are the 2 different "sides" of a Restructuring deal? Do you know which one we usually advise?
Bankers can advise either the debtor (the company itself) or the creditors (anyone that has lent the company) money Note that the "creditors" are often multiple parties since it's anyone who loaned the company money, and there are also "operational advisors" that help with the actual turnaround
What are the 2 different "sides" of a Restructuring deal? Do you know which one we usually advise?
Bankers can advise either the debtor (the company itself) or the creditors (anyone that has lent the company) money. It's similar to sell-side vs. buy-side M&A - in one you're advising the company trying to sell or get out of the mess it's in, and in the other you're advising buyers and lenders that are trying to take what they can from the company.
chapter 11 bankruptcy
Chapter 11 is a form of bankruptcy that involves a reorganization of a debtor's business affairs, debts, and assets. Named after the U.S. bankruptcy code 11, corporations generally file Chapter 11 if they require time to restructure their debts. This version of bankruptcy gives the debtor a fresh start. However, the terms are subject to the debtor's fulfillment of his obligations under the plan of reorganization. Chapter 11 bankruptcy is the most complex of all bankruptcy cases. It is also usually the most expensive form of a bankruptcy proceeding. For these reasons, a company must consider Chapter 11 reorganization only after careful analysis and exploration of all other possible alternatives. During a Chapter 11 proceeding, the court will help a business restructure its debts and obligations. In most cases, the firm remains open and operating. Many large U.S. companies file for Chapter 11 bankruptcy and stay afloat. Such businesses include automobile giant General Motors, the airline United Airlines, retail outlet K-mart, and thousands of other corporations of all sizes.
Facts about DIP financing
DIP financing is frequently provided via term loans. Such loans are fully funded throughout the bankruptcy process, which means higher interest costs for the borrower. Formerly, revolving credit facilities were the most utilized method — a favorable arrangement for the borrower, as it offers good flexibility and the option of reducing interest expenses by actively managing borrowings to minimize funded amounts.
19. How would a DCF analysis be different in a distressed scenario?
Even more of the value would come from the terminal value since you normally assume a few years of cash flow-negative turnaround. You might also do a sensitivity table on hitting or missing earnings projections, and also add a premium to WACC to make it higher and account for operating distress.
Why would company go bankrupt in the first place?
Here are a few of the more common ones: • A company cannot meet its debt obligations / interest payments. • Creditors can accelerate debt payments and force the company into bankruptcy. • An acquisition has gone poorly or a company has just written down the value of its assets steeply and needs extra capital to stay afloat (see: investment banking industry). • There is a liquidity crunch and the company cannot afford to pay its vendors or suppliers.
38. Let's say we're doing a Liquidation Valuation for a distressed company. Why can't we just use the Shareholders' Equity number for its value? Isn't that equal to Assets minus Liabilities?
In a Liquidation Valuation you need to adjust the values of the assets to reflect how much you could get if you sold them off separately. You might assume, for example, that you can only recover 50% of the book value of a company's inventory if you tried to sell it off separately. Shareholders' Equity is equal to Assets minus Liabilities, but in a Liquidation Valuation we change the values of all the Assets so we can't just use the Shareholders' Equity number.
26. Let's say a company wants to sell itself or simply restructure its obligations - why might it be forced into a Chapter 11 bankruptcy?
In a lot of cases, aggressive creditors force this to happen - if they won't agree to the restructuring of its obligations or they can't finalize a sale outside court, they might force a company into Chapter 11 by accelerating debt payments.
The 2 basic ways you can buy a company are through a stock purchase and an asset purchase. What's the difference, and what would a buyer in a distressed sale prefer? What about the seller?
In a stock purchase, you acquire 100% of a company's shares as well as all its assets and liabilities (on and off-balance sheet). In an asset purchase, you acquire only certain assets of a company and assume only certain liabilities - so you can pick and choose exactly what you're getting. Companies typically use asset purchases for divestitures, distressed M&A, and smaller private companies; anything large, public, and healthy generally needs to be acquired via a stock purchase. A buyer almost always prefers an asset purchase so it can avoid assumption of unknown liabilities (there are also tax advantages for the buyer). A (distressed) seller almost always prefers a stock purchase so it can be rid of all its liabilities and because it gets taxed more heavily when selling assets vs. selling the entire business.
What do restructuring bankers do?
Model different strategic scenarios based on negotiations with creditors & debtors Determine mix of restructuring plans that reorganize a company's capital structure to emerge from distress, done through negotiation and agreed upon by all parties Guide Board of Directors and company management teams through the process, helping them to understand their liability and options
How would a distressed company select its Restructuring bankers?
More so than M&A or IPO processes, Restructuring / Distressed M&A requires extremely specialized knowledge and relationships. There are only a few banks with good practices, and they are selected on the basis of their experience doing similar deals in the industry as well as their relationships with all the other parties that will be involved in the deal process. Remember that a Restructuring involves many more parties than a normal M&A or financing deal does - there are lawyers, shareholders, debt investors, suppliers, directors, management, and crisis managers, and managing everyone can be like herding cats. Lawyers can also be a major source of business, since they're heavily involved with any type of Restructuring / Distressed scenario.
What is PIK interest and why is it used in Restructuring?
Payment-in-kind interest is deferred interest that accrues as a liability and paid out in the future Typically is a toggle structured into certain tranches of debt Higher interest rate than standard debt given deferral of payment (think time value of money) Reduces cash interest expense and alleviates the cash burden of the distressed company, allowing it to meet other obligations, reinvest cash, pay salaries, etc.
8. What are the advantages and disadvantages of each option?
Refinance - Advantages: Least disruptive to company and would help revive confidence; Disadvantages: Difficult to attract investors to a company on the verge of going bankrupt. 2. Sale - Advantages: Shareholders could get some value and creditors would be less infuriated, knowing that funds are coming; Disadvantages: Unlikely to obtain a good valuation in a distressed sale, so company might sell for a fraction of its true worth 3. Restructuring - Advantages: Could resolve problems quickly without 3rd party involvement; Disadvantages: Lenders are often reluctant to increase their exposure to the company and management/lenders usually don't see eye-to-eye 4. Bankruptcy - Advantages: Could be the best way to negotiate with lenders, reduce obligations, and get additional financing; Disadvantages: Significant business disruptions and lack of confidence from customers, and equity investors would likely lose all their money
What are the advantages and disadvantages of each option a company has when in distress
Refinance - Advantages: Least disruptive to company and would help revive confidence; Disadvantages: Difficult to attract investors to a company on the verge of going bankrupt. Sale - Advantages: Shareholders could get some value and creditors would be less infuriated, knowing that funds are coming; Disadvantages: Unlikely to obtain a good valuation in a distressed sale, so company might sell for a fraction of its true worth Restructuring - Advantages: Could resolve problems quickly without 3rd party involvement; Disadvantages: Lenders are often reluctant to increase their exposure to the company and management/lenders usually don't see eye-to-eye Bankruptcy - Advantages: Could be the best way to negotiate with lenders, reduce obligations, and get additional financing; Disadvantages: Significant business disruptions and lack of confidence from customers, equity investors would likely lose all their money
What options are available to a distressed company that can't meet debt obligations?
Refinance and obtain fresh debt / equity Sell the company (either as a whole or in pieces in an asset sale) Restructure its financial obligations to lower interest payments / debt repayments, or issue debt with PIK interest to reduce the cash interest expense File for bankruptcy and use that opportunity to obtain additional financing, restructure its obligations, and be freed of onerous contracts
What actually is restructuring?
Restructuring advisors advise distressed companies to try to help them fix their capital structure. The purpose of this is to help companies emerge from bankruptcy, avoid bankruptcy, or sell off assets (or the entire firm). There are two types of restructuring transaction: debtor-side, and creditor-side. Debtor-side restructuring deals typically involve working directly with the firm that owes money to help them negotiate with creditors to fix their capital structure. Creditor-side restructuring deals typically involve working directly with private equity funds or hedge funds to help them negotiate repayment of debt they invested in. Restructuring bankers typically work closely with lawyers and operational restructuring advisers to help companies improve operational and financial viability. Notable operational restructuring advisers include FTI Consulting, AlixPartners, Berkeley Research Group, and Alvarez & Marsal.
1. How much do you know about what you actually do in Restructuring?
Restructuring bankers advised distressed companies - businesses going bankrupt, in the midst of bankruptcy, or getting out of bankruptcy - and help them change their capital structure to get out of bankruptcy, avoid it in the first place, or assist with a sale of the company depending on the scenario.
Debt repayment levels
Secured Debt: a bond that has a claim to specific assets of the debtor 2. Unsecured Debt: a bond that is not backed by any specific claim to a company's assets 3. Mezzanine investors: debt/equity hybrid, gives creditor right to convert to ownership in event of a default 4. Equity Investors: ownership of the company but lowest priority in event of bankruptcy
Capital Strcture
The capital structure is how a firm finances its operations. A typical capital structure includes a mixture of long-term debt (i.e. bonds), short-term debt (i.e. a revolving credit facility, more on this later), common equity (i.e. the publicly traded or privately held shares of a company), and preferred equity (i.e. equity with a higher claim on a company's assets than common stock).
What is the fulcrum security
The fulcrum security is the last security to recover less than par value under a capital restructure and is the one most likely to be converted into equity. Traditionally, unsecured bonds were considered the fulcrum security while senior secured notes and bank debt were kept whole.
the fulcrum security
The fulcrum security is the most senior security that will not r eceive a full recovery in a bankruptcy. This is best explained by an example. Let's say Apple Inc. has taken on too much debt and needs to be restructured. The debt totals $100 and is broken down as follows: $50 senior bank loan, $25 senior secured notes, and $25 subordinated notes. After a thorough analysis, we decide that the company will generate EBITDA of $10 and is valued at 6x EV/EBITDA. In order to repay the creditors, we now have the $60 EV of the business to distribute to the creditors. In this over- simplified example, the bank loan will receive a full recovery of $50. There is now $10 left for distribution of the $60 EV of the business. This entire amount will go to the senior secured notes because they are owed $25 and there is only $10 left for distribution.Thus, the senior notes will receive $10 left and also receive ownership control (equity) of the business. The subordinated notes receive nothing. In this example, the senior secured notes are the fulcrum security.
Recently, there has been news of distressed companies like GM "buying back" their debt for 50 cents on the dollar. What's the motivation for doing this and how does it work accounting-wise?
The motivation is simple: use excess balance sheet cash to buy back debt on-the-cheap and sharply reduce interest expense and obligations going forward. It works because the foregone interest on cash is lower than whatever interest rate they're paying on debt - so they reduce their net interest expense no matter what. Many companies are faced with huge debt obligations that have declined significantly in value but which still have relatively high interest rates, so they're using the opportunity to rid themselves of excess cash and cancel out their existing debt. Accounting-wise, it's simple: Balance Sheet cash goes down and debt on the Liabilities & Equity side goes down by the same amount to make it balance.
40. How would an LBO model for a distressed company be different?
The purpose of an LBO model here is not to determine the private equity firm's IRR, but rather to figure out how quickly the company can pay off its debt obligations as well as what kind of IRR any new debt/equity investors can expect. Other than that, it's not much different from the "standard" LBO model - the mechanics are the same, but you have different kinds of debt (e.g. Debtor-in-Possession), possibly more tranches, and the returns will probably be lower because it's a distressed company, though occasionally "bargain" deals can turn out to be very profitable. One structural difference is that a distressed company LBO is more likely to take the form of an asset purchase rather than a stock purchase.
9. From the perspective of the creditors, what different strategies do they have available to recover their capital in a distressed situation?
These mirror the options that are available to the company itself in a distressed scenario: 1. Lend additional capital / grant equity to company. 2. Conditional financing - Only agree to invest if the company cuts expenses, stops losing money, and agrees to other terms and covenants. 3. Sale - Force the company to hire an investment bank to sell itself, or parts of itself. 4. Foreclosure - Bank seizes collateral and forces a bankruptcy filing.
How are Restructuring deals different from other types of transactions?
They are more complex, involve more parties, require more specialized/technical skills, and have to follow the Bankruptcy legal code - unlike most other types of deals bankers work on The debtor advisor, for example, might have to work with creditors during a forbearance period and then work with lawyers to determine collateral recoveries for each tranche of debt Also, unlike most standard M&A deals the negotiation extends beyond two "sides" - it's not just the creditors negotiating with the debtors, but also the different creditors negotiating with each other
10. How are Restructuring deals different from other types of transactions?
They are more complex, involve more parties, require more specialized/technical skills, and have to follow the Bankruptcy legal code - unlike most other types of deals bankers work on. The debtor advisor, for example, might have to work with creditors during a forbearance period and then work with lawyers to determine collateral recoveries for each tranche of debt. Also, unlike most standard M&A deals the negotiation extends beyond two "sides" - it's not just the creditors negotiating with the debtors, but also the different creditors negotiating with each other. Distressed sales can happen very quickly if the company is on the brink of bankruptcy, but those are different from Bankruptcy scenarios.
34. What happens to Accounts Payable Days with a distressed company?
They rise and the average AP Days might go well beyond what's "normal" for the industry - this is because a distressed company has trouble paying its vendors and suppliers.
24. Normally M&A processes are kept confidential - is there any reason why a distressed company would want to announce the involvement of a banker in a sale process?
This happens even outside distressed sales - generally the company does it if they want more bids / want to increase competition and drive a higher purchase price.
29. Why might a creditor might have to take a loss on the debt it loaned to a distressed company?
This happens to lower-priority creditors all the time. Remember, secured creditors always come first and get first claim to all the proceeds from a sale or series of asset sales; if a creditor is lower on the totem pole, they only get what's left of the proceeds so they have to take a loss on their loans / obligations.
"Rescue Financing" or "Debtor-in- possession financing"
This tranche of debt will slot in at the very top of the capital structure and is used so the company can continue generating cash flow from its operations while it continues with its restructuring processes.
Precusors to defaults
Weak economic performance - general economic yield there is a high correlation between defaults and poor industrial performance Relative Qaulity of Low-rated bonds signfigant correlation between number of low rated bonds and future defaults low capital markets liquidtiy- highly leverage companies are reliant on having acses sto capital markets. to refinance obligations -yeild spread
What's the difference between acquiring just the assets of a company and acquiring it on a "current liabilities assumed" basis?
When you acquire the assets of a distressed company, you get literally just the assets. But when you acquire the current liabilities as well, you need to make adjustments to account for the fact that a distressed company's working capital can be extremely skewed. Specifically, "owed expense" line items like Accounts Payable and Accrued Expenses are often much higher than they would be for a healthy company, so you need to subtract the difference if you're assuming the current liabilities. This results in a deduction to your valuation - so in most cases the valuation is lower if you're assuming current liabilities.
21. Normally in a sell-side M&A process, you always want to have multiple bidders to increase competition. Is there any reason they'd be especially important in a distressed sale?
Yes - in a distressed sale you have almost no negotiating leverage because you represent a company that's about to die. The only real way to improve price for your client is to have multiple bidders.
Why are you interested in Restructuring? (Common themes across answers)
You gain a very specialized skill set (and therefore become more valuable / employable) and much of the work is actually more technical / interesting than other forms of banking You also get broader exposure because you see both the bright sides and not-so-bright sides of companies If you're coming in with any legal background or have aspirations of doing that in the future, there's a ton of overlap with Restructuring because you have to operate within a legal framework and attorneys are involved at every step of the process
How would valuation change for a distressed company?
You use the same methodologies most of the time (public company comparables, precedent transactions, DCF) Except you look more at the lower range of the multiples and make all the accounting adjustments we went through above You also use lower projections for a DCF and anything else that needs projections because you assume a turnaround period is required You might pay more attention to revenue multiples if the company is EBIT/EBITD A/EPS-negative You also look at a liquidation valuation under the assumption that the company's assets will be sold off and used to pay its obligations Sometimes you look at valuations on both an assets-only basis and a current liabilities-assumed basis. This distinction exists because you need to make big adjustments to liabilities with distressed companies
17. How do you measure the cost of debt for a company if it is too distressed to issue additional debt (i.e. investors won't buy any debt from them)?
You'd have to look at the yields of bonds or the spreads of credit default swaps of comparable companies to get a sense of this. You could also just use the current yields on a company's existing debt to estimate this, though it may be difficult if the existing debt is illiquid.
Callable Bond
a bond that can be redeemed (i.e. "called" back) by the issuer before maturity, usually occurs if debtor wants to refinance for a lower interest rate
lien
a claim a creditor has on a debtor's assets
preforming versus nonprefomring loan a
a preforming loan s making payments onetime whereas a nonprefomring loan is close to default or in default
Fallen angle
an investment grade bond that becomes speculative grade(high yeild)
From the perspective of the creditors, what different strategies do they have available to recover their capital in a distressed situation?
hese mirror the options that are available to the company itself in a distressed scenario: Lend additional capital / grant equity to company Conditional financing - Only agree to invest if the company cuts expenses, stops losing money, and agrees to other terms and covenants Sale - Force the company to hire an investment bank to sell itself, or parts of itself Foreclosure - Bank seizes collateral and forces a bankruptcy filing
Yield-to-Worst
lowest potential return (yield) an investor can realize on a bond here is a lot more to investing in bonds than simply looking at the stated, or coupon, interest rate. Many bonds are callable, which means that the issuing company has a right to buy the bonds back early at a predetermined date or dates. If this happens, your effective yield of holding the bond could potentially be lower than you expect, so it's important to analyze the worst-case, known as the bond's yield to worst. Here's how to calculate this for your bonds. Can be bought back in 2 years so you actually only have 2 years of interest payments not 5 so the bond doesn't yield 20% maybe only yields 10%
incurrence vs maintenance covenants
matinence means you need to keep a certain ratio and incurrence is you can't do anything to cause something to go above a certain ratio, but if it happens it happens. For example, a maintenance test could be a maximum gearing ratio of 50%, which if the company exceeded, would result in default. However, using the same example, an incurrence test would only be violated if the company actively incurred additional debt to the point where gearing exceeded 50% but not if total capital declined and caused gearing to increase.
Reorganization plans in chapter 11
n a Chapter 11 bankruptcy, the individual or business filing bankruptcy has the first chance to propose a reorganization plan. These plans may include downsizing of business operations to reduce expenses, as well as renegotiating of debts. In some cases, plans involve liquidating all assets to repay creditors. If the chosen path is feasible and fair, the courts accept it, and the process moves forward. The plan must also be in the best interest of the creditors. If the debtor does not suggest a program, the creditors may propose one instead.
Moodys bond rating system
ranges AAA to D AAA AA A BBB BB B and so on... cut off between speculative and investment grade occurs at BBB and BB
Tell tale signs of distress in a company stock price and unsecured bondss
stock trades around / under 1$ and unsecured bonds trade around 40% par or below
What kind of recovery can you expect for different assets in a Liquidation Valuation?
• Cash: Probably close to 100% because it's the most liquid asset. • Investments: Varies a lot by what they are and how liquid they are - you might get close to 100% for the ones closest to cash, but significantly less than that for equity investments in other companies. • Accounts Receivable: Less than what you'd get for cash because many customers might just not "pay" a distressed company. • Inventory: Less than Cash or AR because inventory is of little use to a different company. • PP&E: Similar to cash for land and buildings, and less than that for equipment. • Intangible Assets: 0%. No one will pay you anything for Goodwill or the value of a brand name - or if they will, it's near-impossible to quantify.
Let's say a distressed company wants to raise debt or equity to fix its financial problems rather than selling or declaring bankruptcy. Why might it not be able to do this?
• Debt: Sometimes if the company is too small or if investors don't believe it has a credible turnaround plan, they will simply refuse to lend it any sort of capital. • Equity: Same as above, but worse - since equity investors have lower priority than debt investors. Plus, for a distressed company getting "enough" equity can mean selling 100% or near 100% of the company due to its depressed market cap
18. How would valuation change for a distressed company?
• You use the same methodologies most of the time (public company comparables, precedent transactions, DCF)... • Except you look more at the lower range of the multiples and make all the accounting adjustments we went through above. • You also use lower projections for a DCF and anything else that needs projections because you assume a turnaround period is required. • You might pay more attention to revenue multiples if the company is EBIT/EBITDA/EPS-negative. • You also look at a liquidation valuation under the assumption that the company's assets will be sold off and used to pay its obligations.
Why is distressed debt investing not suitable for the general investor
-very volatile -very illiquid so high transactions costs -sell in massive blocks of 1 to 5 million so tough to diversify -unequal access to infromation
. Let's say a distressed company approaches you and wants to hire your bank to sell it in a distressed sale - how would the M&A process be different than it would for a healthy company?
1. Timing is often quick since the company needs to sell or else they'll go bankrupt. 2. Sometimes you'll produce fewer "upfront" marketing materials (Information Memoranda, Management Presentations, etc.) in the interest of speed. 3. Creditors often initiate the process rather than the company itself. 4. Unlike normal M&A deals, distressed sales can't "fail" - they result in a sale, a bankruptcy or sometimes a restructuring.
How much bigger is credit market than equity
2x
How would a DCF analysis be different in a distressed scenario?
Even more of the value would come from the terminal value since you normally assume a few years of cash flow-negative turnaround Might also do a sensitivity table on hitting or missing earnings projections, and also add a premium to WACC to make it higher and account for operating distress
How would you adjust the 3 financial statements for a distressed company when you're doing valuation or modeling work?
Adjust COGS for higher vendor costs due to lack of trust from suppliers Add back non-recurring legal / other professional fees associated with the restructuring and/or distressed sale process Add back excess lease expenses (again due to lack of trust) to Operating Income Working Capital needs to be adjusted for receivables unlikely to turn into cash, overvalued/insufficient inventory, and insufficient payables CapEx spending is often off If it's too high that might be why they're going bankrupt, if it's too low they might be doing that artificially to save money
What is restructuring?
At a high level, restructuring is advising distressed companies that are facing, going through or recovering from a bankruptcy scenario You are the advisor to either a creditor (or committee of creditors) or the debtor (the distressed company) Role is to determine the best outcome for the client in a variety of scenarios as they negotiate the value of the company and different positions in the capital structure Restructuring is a product vertical with investment banks, with bankers typically choosing to specialize in that space
Why is Distressed investing like chess
Because you have multiple moves and you move based on what opponents do Also each piece has a specific set of actions it can take due to contracts laws ect But unlike chess there are many players each with a different goals
13. How would you adjust the 3 financial statements for a distressed company when you're doing valuation or modeling work?
Here are the most common adjustments: • Adjust Cost of Goods Sold for higher vendor costs due to lack of trust from suppliers. • Add back non-recurring legal / other professional fees associated with the restructuring and/or distressed sale process. • Add back excess lease expenses (again due to lack of trust) to Operating Income as well as excess salaries (often done so private company owners can save on taxes). • Working Capital needs to be adjusted for receivables unlikely to turn into cash, overvalued/insufficient inventory, and insufficient payables. • CapEx spending is often off (if it's too high that might be why they're going bankrupt, if it's too low they might be doing that artificially to save money).
36. Will the adjusted EBITDA of a distressed company be higher or lower than the value you would get from its financial statements?
In most cases it will be higher because you're adjusting for higher-than-normal salaries, one-time legal and restructuring charges, and more. ????
12. What is debtor-in-possession (DIP) financing and how is it used with distressed companies?
It is money borrowed by the distressed company that has repayment priority over all other existing secured/unsecured debt, equity, and other claims, and is considered "safe" by lenders because it is subject to stricter terms than other forms of financing. Theoretically, this makes it easier for distressed companies to emerge from the bankruptcy process - though some argue that DIP financing is actually harmful on an empirical basis. Some DIP lending firms are known for trying to take over companies at a significant discount due to the huge amount of collateral they have. One reason companies might choose to file for (Chapter 11) bankruptcy is to get access to DIP financing.
What is debtor-in-possession (DIP) financing and how is it used with distressed companies?
It is money borrowed by the distressed company that has repayment priority over any other claim in the capital structure (including all other debt & equity), and is considered "safe" by lenders because it is subject to stricter terms than other forms of financing Theoretically, this makes it easier for distressed companies to emerge from the bankruptcy process However it can be harmful, some DIP lending firms are known for trying to take over companies at a significant discount due to the huge amount of collateral they have One reason companies might choose to file for Chapter 11 bankruptcy is to get access to DIP financing
How would a distressed company select its Restructuring bankers?
It requires extremely specialized knowledge and relationships, there are only a few banks with good practices, and they are selected on the basis of their experience doing similar deals in the industry as well as their relationships with all the other parties that will be involved in the deal process Remember that a Restructuring involves many more parties than a normal M&A or financing deal does, and managing everyone can be a huge pain
28. What kind of companies would most likely enact debt buy-backs?
Most likely over-levered companies - ones with too much debt - that were acquired by PE firms in leveraged buyouts during the boom years, and now face interest payments they have trouble meeting, along with excess cash.
14. Would those adjustments differ for public companies vs. private companies?
Most of the above would apply to public companies as well, but the point about excess salaries does not hold true - it's much tougher for public companies to manipulate the system like that and pay abnormal salaries.
How does debt trade on the market? (3x more trading volume in debt vs equity markets)
Mostly in the form of bonds in primary (issuance) market or in secondary markets (buying / selling debt) Can also trade notes and bills Not listed on exchanges, but rather traded through broker-dealers and financial institutions) in a decentralized over-the-counter market Different types of tradeable debt Corporate Government and agency Municipal Mortgage or asset backed
In a bankruptcy, what is the order of claims on a company's assets?
New debtor-in-possession (DIP) lenders (see explanation above) Secured creditors (revolvers and "bank debt") Unsecured creditors ("high-yield" bonds) Subordinated debt investors (similar to high-yield bonds) Mezzanine investors (convertibles, convertible preferred stock, preferred stock, PIK) Shareholders (equity investors) "Secured" means that the lender's claims are protected by specific assets or collateral; unsecured means anyone who has loaned the company money without collateral
Would you use Levered Cash Flow for a distressed company in a DCF since it might be encumbered with debt?
No. In fact, with distressed companies it's really important to analyze cash flows on a debt-free basis precisely because they might have higher-than-normal debt expenses.
23. Sometimes a distressed sale does not end in a conventional stock/asset purchase - what are some other possible outcomes?
Other possible outcomes: • Foreclosure (either official or unofficial) • General assignment (faster alternative to bankruptcy) • Section 363 asset sale (a faster, less risky version of a normal asset sale) • Chapter 11 bankruptcy • Chapter 7 bankruptcy
How are you going to use your experience in Restructuring for your future career goals?
The legal and "better technical skills" angle + you can also use the experience to work at a Distressed Investments or Special Situations Fund Or you could just go back to M&A or normal investing too, and still have superior technical knowledge to other bankers
Waterfall concept of debt
The tranches (categories) of debt at the top of the above list have the highest priority in a bankruptcy situation. Think about it like a waterfall. If a company goes bankrupt, the creditors must be paid back their money. So, debt holders at the top of the capital structure get paid back first. If there is any money is remaining, the next debt holders on the capital structure get paid back. This continues until there is no more capital to distribute. Often times, equity holders are left with no payback and lose the entire value of their investment. Money flows down tranches
Why are you interested in Restructuring besides the fact that it's a "hot" area currently?
You gain a very specialized skill set (and therefore become more valuable / employable) and much of the work is actually more technical / interesting than M&A, for example. You also get broader exposure because you see both the bright sides and not-so-bright sides of companies. If you're coming in with any legal background or have aspirations of doing that in the future, there's a ton of overlap with Restructuring because you have to operate within a legal framework and attorneys are involved at every step of the process - so that can be one of your selling points as well.
How do you measure the cost of debt for a company if it is too distressed to issue additional debt (i.e. investors won't buy any debt from them)?
You'd have to look at the yields of bonds or the spreads of credit default swaps of comparable companies You could also just use the current yields on a company's existing debt to estimate this, though it may be difficult if the existing debt is illiquid
distressed
businesses going bankrupt, in the midst of bankruptcy, or getting out of bankruptcy
Why doesn't the efficient market hypothesis apply to restructuring
equal information:no where close to the same information for high yeild debt makrets... so many issuances with little to no coverage of them rational behavior:forced selling does not reflect rational behvarior
Why do companies go bankrupt?
• A company cannot meet its debt obligations or interest payments • Creditors can accelerate debt payments and force the company into bankruptcy (for example, a private equity firm might employ this strategy in order to gain ownership of the distressed company during the course of the bankruptcy process — they do this buy buying into the "fulcrum security", the debt tranche that does not receive full repayment in a bankruptcy) • An acquisition has gone poorly or a company has just written down the value of its. assets steeply and needs extra capital to stay afloat (see: investment banking industry). • There is a liquidity crunch and the company cannot afford to pay its vendors or suppliers (vendors and suppliers are usually considered part of the "Unsecured Creditor" group, just like bondholders in a sense)
16. In a bankruptcy, what is the order of claims on a company's assets?
1. New debtor-in-possession (DIP) lenders (see explanation above) 2. Secured creditors (revolvers and "bank debt") 3. Unsecured creditors ("high-yield" bonds) 4. Subordinated debt investors (similar to high-yield bonds) 5. Mezzanine investors (convertibles, convertible preferred stock, preferred stock, PIK) 6. Shareholders (equity investors) "Secured" means that the lender's claims are protected by specific assets or collateral; unsecured means anyone who has loaned the company money without collateral. For more on the different types of debt, see the LBO section where we have a chart showing the differences between everything.
7. What options are available to a distressed company that can't meet debt obligations?
1. Refinance and obtain fresh debt / equity. 2. Sell the company (either as a whole or in pieces in an asset sale). 3. Restructure its financial obligations to lower interest payments / debt repayments, or issue debt with PIK interest to reduce the cash interest expense. 4. File for bankruptcy and use that opportunity to obtain additional financing, restructure its obligations, and be freed of onerous contracts
What's the difference between Chapter 7 and Chapter 11 bankruptcy?
A Chapter 7 bankruptcy is also known as a "liquidation bankruptcy" The company is too far past the point of reorganization and must instead sell off its assets and pay off creditors Chapter 11 is more of a "reorganization" The company doesn't die, but instead changes the terms on its debt and renegotiates everything to lower interest payments and the dollar value of debt repayments
Why would company go bankrupt in the first place?
A company cannot meet its debt obligations / interest payments Creditors can accelerate debt payments and force the company into bankruptcy An acquisition has gone poorly or a company has just written down the value of its assets steeply and needs extra capital to stay afloat (see: investment banking industry) There is a liquidity crunch and the company cannot afford to pay its vendors or suppliers
What is a credit default swap
A credit default swap is designed to transfer the credit exposure of fixed income products between two or more parties. In a CDS, the buyer of the swap makes payments to the swap's seller until the maturity date of a contract. In return, the seller agrees that - in the event that the debt issuer (borrower) defaults or experiences another credit event - the seller will pay the buyer the security's value as well as all interest payments that would have been paid between that time and the security's maturity date. ????
33. How could a decline in a company's share price cause it to go bankrupt?
Trick question. Remember, MARKET CAP DOES NOT EQUAL SHAREHOLDERS' EQUITY. You might be tempted to say something like, "Shareholders' equity falls!" but the share price of the company does not affect shareholders' equity, which is a book value. What actually happens: as a result of the share price drop, customers, vendors, suppliers, and lenders would be more reluctant to do business with the distressed company - so its revenue might fall and its Accounts Payable and Accrued Expenses line items might climb to unhealthy levels. All of that might cause the company to fail or require more capital, but the share price decline itself does not lead to bankruptcy. In the case of Bear Stearns in 2008, overnight lenders lost confidence as a result of the sudden share price declines and it completely ran out of liquidity as a result - which is a big problem when your entire business depends on overnight lending.
Restructuring versus classical IB
restructuring: Typically focused on finding optimal strategic and financial plan, and then executing it with all parties Usually takes longer than typical M&A processes Assist in negotiations Win business through senior-level relationships Analyst work: Assess financial viability of the debtor and model future projections Determine fulcrum in capital structure and ownership under different scenarios Create Restructuring Support Agreement Provide financial and legal analyses to senior bankers and clients Handle process-related work Classic IB: Typically focused on deal structuring and execution Find buyers and sellers for clients Prepare for bake-offs against other firms Pitch to clients to win business Analyst work: Assess financial performance of client / target and model future projections Create book for bidding process or roadshow Build potential buyer's log and due diligence tracker Organize data room files and access restrictions Provide financial and operational analyses to senior bankers and clients Handle process-related work