Introduction to Debt
Rank the following in order of risk (high to low): Revolver, Senior Secured Notes, Term Loan, Equity, Subordinated Notes
Equity, Subordinated Notes, Senior Secured Notes, Term Loan, Revolver
What size blocks does debt trade in?
1M and 5M
I have $1000 in EV, $500 TLA, $300 Senior Notes, $300 Junior Notes, and $300 in equity. What do the junior notes trade at?
66 cents.
Explain the exact requirements for Fraudulent Transfer/Conveyance:
Actual Fraud: Debtor makes a transfer/incurs obligation with actual intent to hinder, delay, or defraud any creditor
Constructive Fraud: The debtor did not receive reasonably equivalent value for the transfer of assets, AND the debtor is insolvent at either the time of the transfer or as a result of transfer
What are the mechanics of a Texas Two Step?
What is the most secure bond rating attainable? What is the threshold between investment grade and non-investment grade?
AAA is highest. BBB-/BB+ is threshold.
What is a yield spread? How are they affected as default rates increase?
What does it mean if a TL is quoted as Bid/Ask: 99/100?
Yield spread is the difference between bond yield and underlying treasury. Spreads increase as default rates increase.
They will buy it from you at 99 and sell it to you at 100 (par).
HoldCo has equity in OpCo 1. OpCo 1 has $500 in assets and $400 in debt. What is the equity holders recovery?
0.
2.) Explain what an Asset 363 Sale is and generally what the Junior/Senior creditor dynamics are when this takes place
Allows debtor to sell operations and assets free and clear of all liens, claims and encumbrances
Once the sale is complete, cash from sale goes into the estate and is distributed to creditors
Controversial as quick and do not require voting by creditors on a POR
Junior/Senior Creditor Dynamics:
Junior creditors argue 363 sales do not maximize value: sale process is rushed/before company stabilizes
Senior creditors argue liquidity and company deteriorating so quickly that quick sale maximizes value
More confrontational if secured creditors are bidding for the company
Why was Serta’s uptier struck down by the court but Mitel’s approved?
What are three key differences between BSLs and HY bonds?
BSLs: illiquid, floating rate, secured, traded by QIBs
HY Bonds: Liquid, fixed-rate, junior debt, can be traded by retail investors
What are two key precursors to high default rates?
1. Weak economic performance, 2. High amount of low rated bonds, 3. Low capital markets liquidity
HoldCo has $300 in assets and $200 in SSN. HoldCo guarantees OpCo1. OpCo1 has $200 in SSN. What do the notes at OpCo1 trade at?
75 cents.
Bond trading at 88 with 5% coupon maturing in 4 years; what is YTM?
8/95 or ~8.4%
Company B, a home decoration store, files for bankruptcy. Previously, you were the only lender, providing $100 of 1L debt at OpCo1, where all the assets are held. Earlier last year, another creditor had lent $100 at an unrestricted subsidiary that OpCo1 guaranteed. The unsub upstreamed the proceeds raised at the unsub via an intercompany loan. What is your recovery in BK?
What are the two ways that BSLs can be brought to market? What happens to a BSL after it is brought to market?
1. Fully underwritten 2. Best effort to sell loan
After brought to market, sold in pieces to consortium of banks and traded amongst QIBs.
Invest in the SSN; called the fulcrum security and gets post reorg equity
Let’s say that HoldCo has $100 of unsecured debt and OpCo1 equity, OpCo1 has $100 in unsecured debt and OpCo2 equity, and OpCo2 has $250 in assets and $200 in secured debt (backed by assets). HoldCo has upstream guarantees from OpCo1 and OpCo2. What are the recovery values for HoldCo, OpCo1, and OpCo2?
HoldCo Unsecured: 50 cents.
OpCo1 Unsecured:0
OpCo2 Secured: Par
5.) Explain what Lender Liability, Under-Collateralization, and Collateral Deterioration are and why are they used?
Use: Negotiating in the Shadow of Bankruptcy
The company will use the following to threaten creditors
Lender Liability/Equitable Subordination
Company can threaten creditors with litigation which may result in certain creditors becoming lower priority
Company can tell the court that the creditors acted in “bad faith” under the lender liability claim
This means the lenders actions were in part responsible for the debtor’s problems
Debtor would reason to court that because of these actions the bank/secured creditor should be subordinated
Under Collateralization
Risk to secured claims if the company asserts that it does not have enough collateral/assets to secure the creditors claims in full
The secured creditors generally will have a portion of their claims that are deficient become unsecured
How does this happen?
(i) Company will assert that the realizable value of the secured creditors’ collateral (WC/assets) is less than debt
(ii) Secured creditors do not have claims/liens on other intangibles, patents, trademarks, copyrights
Collateral Deterioration
When “automatic stay” is employed, the company continues its business using the secured creditors’ collateral (Inventory, AR, WC)
If the company does not raise more capital, then the value of the business and its collateral will diminish
Bankruptcy is subject to many time delays, expensive fees, and makes it difficult to raise additional capital
A clothing retailer has their stores, valued at $100, and their IP, valued at $300, in OpCo1 along with $300 in 1L debt and $200 in 2L, that you lent. Assuming no basket or subsidiary constraints, would you effectuate a downtier, exchanging your 2L claim at 80c on the dollar? What would your recovery be?
How does a CLO manager make money?
CLO manager make money on the spread between the HY debt in their portfolio and the secure debt that funds their portfolio. They use largely investment grade debt to fund the purchase of a HY portfolio but are able to do this due to diversification.
Why are debt markets inefficient (3 reasons)?
1. Inequal access to information, 2. Transaction costs prevent trading to equilibrium, 3. Irrational behavior (e.g. forced sellings)
HoldCo has 70% equity in OpCo1 and 100% equity in OpCo2. OpCo1 has $40 EBITDA, 10x multiple, and $300 in debt. OpCo2 has $60 EBITDA, 8x multiple and $500 in debt. OpCo1 guarantees OpCo2.
Would you rather buy all 100 shares of HoldCo at 50 cents or buy OpCo2s bond at 80, maturing in 1 year with a 10% coupon?
Ani will provide a live demo on how to answer this question!
Intuitively (no formula), whats the YTM of a 10% coupon bond trading at 70 maturing in 3 years?
price appreciation: 30/3 = 10
So YTM = Coupon + Price appreciation = ~24%
Company A owns paper mills and generates $200 run-rate EBITDA. One of their facilities responsible for 50% of EBITDA, has a fire that requires $150 to repair. The company has $50 cash on balance sheet, $100 in interest expense, $50 in maintenance CapEx, and $20 in lease expense. They have a $500 TL out, which you own 20% of. The debtor approaches you with the opportunity to do a non pro rata uptier, providing $150 of new money into a new 1L tranche, and exchanging your existing claim at 80c into a priming 2L tranche. Historically paper mills have been valued at 8x. Would you complete the transaction?