Distressed Debt Investing

Bankruptcy Concepts: Rule 2019

noreply@blogger.com (Hunter) — Fri, 10 Feb 2012 04:39:00 +0000

It is my pleasure to introduce readers to a net set of contributors to Distressed Debt Investing. As I've spoken about in past months, I've been trying to add a number of regular guest writers that cover topics ranging from advanced distressed / bankruptcy concepts to European distressed debt situations. It's my pleasure to introduce three lawyers from the bankruptcy practice at Dewey & LeBoeuf LLP: Martin Bienenstock, Phil Abelson, and Vincent Indelicato. Dewey has a fantastic practice in the restructuring / bankruptcy space and we are absolutely thrilled to have them as regular contributors. Enjoy!

Distressed Debt Investors Beware: Amended Bankruptcy Rule 2019

With the increasing participation of distressed hedge funds in chapter 11 cases through the collective action of ad hoc committees and groups, Federal Rule of Bankruptcy Procedure 2019 (“Bankruptcy Rule 2019”) ignited vigorous debate over the scope of its disclosure requirements in recent years.

The controversy set in motion a titanic collision between bankruptcy judges who wanted to know which litigants held short positions and wanted the debtor’s estate to fail or diminish, and a distressed investing community that has fiercely guarded proprietary trading strategies.

In an ostensible effort to shatter the judicial uncertainty surrounding the application of Bankruptcy Rule 2019 in modern day chapter 11 cases, the Committee on Rules of Practice and Procedure of the Judicial Conference of the United States proposed a series of amendments which the Supreme Court of the United States adopted into law last April, effective December 1, 2011.

Although the drafters of amended Bankruptcy Rule 2019 sought to bring much needed clarification, the new rule did not directly address its target. The new rule could have required that each group member simply declare whether it owned any economic interests that would increase in value if the debtor’s estate decreased in value. It does not do that.

Rather, the new rule requires listings of each group member’s economic interests. In some cases those listings will make clear whether the member benefits from the estate’s diminution (i.e., short sales of debt). In other cases the court will only be able to scratch its head (i.e., synthetic total return swap).

Among other considerations, distressed debt investors must consult their legal advisors to consider the implications of the following new requirements:

Parties Required to Disclose: Amended Bankruptcy Rule 2019 requires disclosure by “every group or committee that consists of or represents, and every entity that represents” multiple creditors or shareholders “acting in concert to advance their common interests.” Fed. R. Bankr. P. 2019(b)(1)(A).

Notably, the new rule defines “represents” as “to take a position before the court or to solicit votes regarding the confirmation of a plan on behalf of another.” Fed. R. Bankr. P. 2019(a)(2). A group of creditors or shareholders that retains a law firm to monitor case developments without a court appearance does not fall within Rule 2019 disclosure requirements absent its solicitation of votes or other acts in concert to advance their common interests.

Significantly, amended Bankruptcy Rule 2019 contains numerous ambiguities that present a fertile source for litigation as bankruptcy courts begin to enforce the new rule. For example, when and if it takes a position in court as a group, Rule 2019 disclosure would be triggered. Other acts to advance the group members’ common interests are subject to many meanings. Does it mean discussions with parties in interest by or on behalf of the group? Negotiations with parties in interest by or on behalf of the group? Are entities that execute a plan support agreement or secured lenders that submit a joint credit bid “acting in concert” in a manner that compels 2019 disclosure? Indeed, the answers to these and other questions may ultimately determine the strategies that distressed debt investors pursue at the outset of and throughout a chapter 11 case.

Scope of Disclosure: Those parties required to make disclosures under the amended rule must file a verified statement that shall include “the pertinent facts and circumstances” surrounding the formation of the group or committee. See Fed. R. Bankr. P. 2019(c)(1) (as amended). Specifically, in the case of a committee or group, each member must provide (i) its name and address and (ii) the nature and amount of its “disclosable economic interests” held in relation to the debtor as of the date of the statement on a member-by-member basis, and not in the aggregate. See Fed. R. Bankr. P. 2019(c)(3) (as amended). Members of a statutory committee, however, must only provide this information as of the date of committee formation. See Fed. R. Bankr. P. 2019(c)(2)(B) (as amended).

Although the new rule does not require a group member to disclose (i) the price paid and (ii) the specific acquisition date for each of its disclosable economic interests, a member of a committee or group that claims to represent an entity that is not a committee or group member must disclose the quarter and year in which it acquired each disclosable economic interest, except for those disclosable economic interests acquired more than one year before the petition date. See Fed. R. Bankr. P. 2019(c)(2)(C) (as amended). The phrase “claims to represent” may relate to those situations where an ad hoc group purports to speak on behalf of an entire class of creditors or shareholders without any instrument evidencing the express authority to do so. Most importantly, distressed debt investors must understand that nothing in the new rule eliminates the ability of a judge or party in interest to discover the price paid and the precise date of acquisition for each of an entity’s disclosable economic interests.

Like old Bankruptcy Rule 2019, the new rule does not require disclosure by indenture trustees or agents or class action representatives. See Fed. R. Bankr. P. 2019(b)(2) (as amended).

Disclosable Economic Interests: While amended Bankruptcy Rule 2019 does not require a party to disclose the price paid for its holdings, the new rule expands the scope of disclosure to include any “disclosable economic interest.” The amended rule defines “[d]isclosable economic interest” as “any claim, interest, pledge, lien, option, participation, derivative instrument, or any other right or derivative right granting the holder an economic interest that is affected by the value, acquisition, or disposition of a claim or interest.” Fed. R. Bankr. P. 2019(a)(1) (as amended). Translated, this definition encompasses all long and short positions, including, without limitation, all options, swaps, derivatives and other claims relating to the debtor’s securities and other debts.

Supplemental Statements: Amended Bankruptcy Rule 2019(d) requires a party to file a supplemental 2019 upon the material change of any fact previously disclosed in a Rule 2019 statement whenever it takes a position before the court or solicits votes on the confirmation of a plan. See Fed. R. Bankr. P. 2019(d) (as amended). The conspicuous absence of any definition of “materiality” in amended Bankruptcy Rule 2019(d), however, makes compliance with this section of the new rule very challenging. Parties required to disclose under amended Bankruptcy Rule 2019(d) may look for guidance to the reporting requirements approved by the United States trustee in a trading order governing their respective case.

For those entities with numerous trading desks, it appears that amended Bankruptcy Rule 2019(d) would only apply to material changes that impact the holdings of the entity that serves as a member of the respective committee or group, and not those resulting from trading activities of non-committee or group personnel on the other side of the trading wall.

Failure to Comply: Bankruptcy courts do not take the failure to comply with Bankruptcy Rule 2019 lightly. Specifically, amended Bankruptcy Rule 2019(e) recognizes the authority of the bankruptcy court to impose sanctions for any violation of the new rule. See Fed. R. Bankr. P. 2019(e) (as amended). Vote designation may conceivably be used by judges as a sanction that would also facilitate confirmation of a plan the group members oppose. Beware!

Conclusion: While the contours of amended Bankruptcy Rule 2019 largely remain undefined, one fact appears certain: the debate over the appropriate scope of 2019 disclosure will create much jurisprudence. Accordingly, distressed debt investors will need to think carefully about the implications of the new rule before they decide to participate in a chapter 11 case as a member of a committee or group.

Martin Bienenstock
Phil Abelson
Vincent Indelicato

Capital Structure Arbitrage: Part 1

noreply@blogger.com (Hunter) — Wed, 08 Feb 2012 03:38:00 +0000

Capital structure arbitrage is a strategy used by many directional, quantitative, and market neutral credit hedge funds. In essence, it is going long one security in a company's capital structure while at the same time going short another security in that same company's capital structure. For instance, "long sub bonds, short senior bonds", or "long equity, short CDS", or maybe "long 1st lien bank debt, short 1st lien bonds." A portfolio manager can express many different view points inside a single company's capital structure that exploits things like variations from mean differences, covenant irregularities, market supply/demand technical, etc. This is the first part in a number of posts I plan to do on this topic over the next few months (with others focused on secured vs unsecured, covenant differences, basis trading, etc)

The capital structure arbitrage trade is, in theory, less risky than going outright long one security or the next. With that said, because a number of cap structure arbitrage strategies require leverage (via repo, TRS, etc) to hit firm's target IRRs, a trade going against you can be devastating.

One of the more common capital structure trades seen in the market is long senior paper versus short subordinated paper. All else being equal, in very bullish times the difference between the spreads of the two bonds will be tighter than in very bearish times. This is because in bull markets, investors search and reach for yield thereby increasing demand for the more yieldy paper.

One of the most common functions I use in Bloomberg is HS < go >. This function is dubbed the "Historical Spread Graph/Table" You can pull in two bonds and look at the difference in spread between the two (these can be any bonds...in fact you can pull in all sorts of statistics, but for this exercise we will focus on a select few).

Below is a chart of the FDC's 9 7/8% of 2015 (Seniors) vs FDC 11.25% of 2016 (sub) over the past year. The top part of the chart lays out the spread to treasury of each of the bonds with the bottom chart showing the difference between the two.

What is not shown are the relative statistics. Over this period (since 2/8/2011) the mean spread difference between these bonds was ~350 bps. Today it stands at 268 bps. The low occurred on 5/10/2011 with a spread differential of 92. The high occurred at 843 pm 9/29/2011. Here is another chart of those two dates highlighted:

The above chart is a chart of the VIX over the same time period. As you can see when markets are bulled up (i.e. VIX is low), the spread differential between the senior and sub bonds are tight. When markets are bearish (i.e. VIX is high), the spread differential between the senior and sub bonds are wide.

The question then becomes: What is the right spread differential? Or better, what should be the intrinsic compensation and investor receives for taking on additional leverage and further subordination? There is a term in credit analysis: Spread per turn of leverage (or in some cases, yield per turn of leverage). If XYZ issuer has $100M of EBITDA, $200M of Senior Debt and $300M of Sub Debt (so $500M of total debt, with both notes maturing on the same day and trading at par), senior leverage would be 2.0x and sub or total leverage would be 5.0x. If the Senior Bonds were yielding 6% and the Sub Bonds yielding 10%, you would be receiving 300bps of yield per turn (6%/2.0x) and for the sub bonds you'd be receiving 200bps of yield per turn (10%/5.0x). All else being equal, the seniors would be a better value.

But let's add a little bit of complexity to the issue. Let's say the business of XYZ is worth 10x EBITDA. In that case, in a simple world, the recovery on both bonds would be par+. Then wouldn't the subs be better value? You are picking 400 bps for the same recovery. With that said, determining the recovery rate of each security becomes fundamental to determining if yield / spread differentials are appropriate. The situation dramatically changes when one layer of the capital structure is levered 2-3x and another is levered 8-9x. More leverage = more swings in recovery. If one bond is pricing in a recovery rate significantly different than you are calculating, this could create opportunities on either the long or the short side.

And just to add a little more complexity (because this is getting fun): Depending on if the bond is trading above or below par changes the equation as well. This is more relevant for higher quality issuers, but if you have two pari bonds of the same issuer trading at 120 and 100 respectively, the bond trading at 120 will have a higher spread than the bond trading at par. Assume this issuer's recovery rate in a restructuring is 30 cents. If you buy the 120 bonds today, you stand to lose 90 points whereas if you buy the par bond, you stand to lose 70 points. You thus have $20 extra dollars at risk (Price bond 1-Price bond 2). If the average spread on the bond is 300 bps, and our recovery rate is 30, the implied default rate = 9%. 9% * those 20 extra points at risk = 180bp of extra compensation needed. Lets say the 120 bond is trading 250 bps wide of the 100 bond. Well that would be an interesting opportunity that could be arbitraged by going long the 120 bond, and short the par bond.

As a quick side / corollary point to the above analysis: In his most recent letter, Howard Marks notes that:

"...we don't undertake the tactical actions described above in response to what we or some economists think the future holds, but rather on the basis of what we see going on in the marketplace at the time. What things do we react to?

The simplest signs surround valuation. What's the yield spread between high yield bonds and Treasurys? And between single-B and triple-C? What are the yields and premiums on convertibles? Are distressed senior loans trading at 60 cents on the dollar or 90? ..."

Here is a chart from JP Morgan's Peter Acciavatti depicting the difference in yields between bonds rated B and CCC:

As you can see, in very bearish times (late 2008-mid 2009, as well as 2001-2003), this spread blows out. In bullish times the spread is smaller. Currently at 465 bps versus a median of 508 bps, it stands the market is probably slightly overvalued (we have silently moved into the low 4s on my "risk pendulum scale"), which is not to say the market will not continue grinding higher - I just don't think you are getting compensated for taking that risk. Some strategists are starting to throw in the flag (Goldman Sachs just got marginally constructive on credit). Full capitulation which equates to bubble territory has not happened yet with still many parties on the sell side calling for a pull back which would have been blasphemy in 1Q 2011.

Distressed Debt Weekly Links of Interest

noreply@blogger.com (Hunter) — Sat, 04 Feb 2012 23:24:00 +0000

Here is what we are reading this weekend at Distressed Debt Investing

Fairholme Funds' 2011 Portfolio Manager Report [via Fairholme Funds] (Editor Note / Disclosure: I have a position in FAIRX)

General Maritime's Chapter 11 Disclosure Statement [General Maritime Docket]

Interesting analysis on Facebook's IPO [Ragnar is a Pirate Investing Blog]

More rumors that Petroplus' refineries are drawing more bids [Reuters]

Primer of Valuation Multiples [found via Wall Street Prep blog]

Analysis of Colonial Bancgroup's fight with the FDIC with regards to setoff rights [Weil Bankruptcy Blog]

Speaking of Colonial Bancgroup, an amazing analysis of the 8.875% sub notes on the DDIC [Distressed Debt Investors Club]

2012 Wharton Restructuring Conference

noreply@blogger.com (Hunter) — Thu, 02 Feb 2012 05:43:00 +0000

In the past few years, we have promoted a number of fantastic events at U Penn's Wharton School. This year is no exception: On February 17th, Wharton is hosting their 2012 Wharton Restructuring and Turnaround Conference. The title of this year's conference is particularly relevant: "The Great Deleveraging - Dealing with Debt on a Global Scale." Panelists include players from all facets of the distressed debt and restructuring world; firms speaking include: PIMCO, Bayside, FTI, DB, Monarch, Centerview, Alix, Alvarez, all the top bankruptcy law firms, and many others. One panelist I am particularly interested in hearing from is the Honorable Kevin Gross: Chief Judge of the US Bankruptcy Court of Delaware, who has been a fixture in the distressed debt world presiding over cases like Nortel, Newpage, and the LA Dodgers just to name a few. The event will also feature a keynote from Marc Lasry, Co-Founder and CEO of Avenue Capital, which should be fantastic.

Fore more information about the conference, please visit the event page here: "2012 Wharton Restructuring and Turnaround Conference." Distressed Debt Investing will be in attendance and we hope to see you there.

What Hedge Funds Are Playing Eastman Kodak's Bankruptcy (Hint: One of them is Greenlight Capital)

noreply@blogger.com (Hunter) — Wed, 01 Feb 2012 03:53:00 +0000

Last night, Akin Gump, as attorneys for the ad hoc group of second lien note holders of Eastman Kodak, filed the ownership of Eastman Kodak securities for its members under Bankruptcy Rule 2019. I have written about Rule 2019 in the past and I expect a more detailed post coming from one of our guest contributors later in the week. The quick and dirty summary: The new Rule 2019 requires affiliated groups of stakeholders (read: ad hoc groups) to disclose their economic interests in a debtor.

The link to the document (Docket #153) can be found here: Eastman Kodak Ad Hoc Holdings. I have also embedded the document below.

As expected (I believe this is the first large case that the new Rule 2019 is applicable), the ad hoc members disclosed both their physical and synthetic positions. These disclosures will change with time as members and holdings change but at this point in time, one can get a look at the holders of Eastman Kodak's securities.

Here is the list of funds / entities represented in the Rule 2019:

Alden Global
Archview L.P
Avenue Capital
Barclays Capital
Bennett Management
Brevan Howard
Capital Ventures
CS Global Credit Products
DE Shaw
DB
Greenlight Capital
GSO / Blackstone
JP Morgan
JP Morgan Investment Management
Knighthead
KS Management
Linden
Litespeed
Morgan Stanley
RBS
River Birch Capital
UBS

For detailed on each of the holder's economic interests, see below. 2nd lien notes have rallied dramatically from the lows and received a nice pop on the bankruptcy filing (due to less leakage to subordinated creditors). At some point in the next week, I'll provide an analysis of the EK capital structure, specifically the 2nd liens.

EK 2019

Understanding Incentives: An Often Overlooked Part of the Investment Decision Making Process

noreply@blogger.com (Hunter) — Tue, 31 Jan 2012 03:56:00 +0000

Before I begin, I'd like to thank CNBC for recognizing Distressed Debt Investing as one of today's best alternative financial blogs. For those interested, you can view the entire list here: CNBC's Best Alternative Financial Blogs

On a number of posts in the past, I have tried to discuss how I weigh incentives and motivations of major players in the investment situations I am analyzing. In essence, if you had to boil down a key determinant of how I view incentives, it goes something like this: People want what best for them, and that often means getting paid. Whether that be management teams, board of directors, FAs, shareholders, etc, in the end, and as shallow as it sounds: follow the dollars (specifically the ones that can be earned 100% ethically), and you can more often than not, come out with the solution that inevitable plays out.

The example I often point to is that of management team's sizable equity incentive plans granted during the bankruptcy process. More often than not, a management team will have a SCANT equity holding of the debtor prior to entering Chapter 11. Then, out of seemingly thin air, management is granted 4, 6, 8, or 10% of the company via options that generally trigger when the company emerges from bankruptcy or hits some makeshift financial goal negotiated with creditors that are driving the process (read: distressed funds / distressed private equity) and the financial advisers. And because the debtor has the sole right to file its own plan of reorganization, management's incentives are to broker the best deal for themselves financially...i.e. "Well the unsecured creditors are offering us 5% of the equity - if the subs can up that to 10%, we'd be more inclined to support them." Bankruptcy judges are many times loathe to confirm a plan that is not the debtors own creation, it stands to reason that the management team has just scored an amazing pay day for themselves.

In my opinion, the annual proxy is the most important, yet the least read of companies' SEC filings. While the entire document is a treasure trove of information (management bio, board bio, shareholder makeup, board makeup, board compensation, etc), the most important nugget of information to me is the report of the compensation committee. This, in no uncertain terms, will tell you what guideposts and targets a board (almost always directed by a consultant hired by the management team) has set up for its executive management team to maximize their financial compensation. Not only that, but it lays out items like acceleration of benefits on a change of control which can lend a clue whether a company is preparing itself to be sold to the highest bidder.

Let me take an example. A specialty metals manufacturer recently changed the make-up of their management compensation to eliminate leverage metrics. Historically, the compensation committee targeted a conservative Debt / EBITDA ratio, management hit that ratio (like clockwork), and got paid. Last year, after a few more aggressive board members joined the board, that leverage target was removed from the compensation structure. Since then, the company has added over a full turn of leverage moving spreads out considerably. No credit analyst reported on this. No one even talked about it or mentioned it in an 8k or a transcript. It was subtly removed from the one year's proxy to the next. And if you had caught it, you may have been out of the bonds before their prices fell.

In addition, I think board compensation and make up is something that is often overlooked by the analyst community. Let's talk about the economics of being a board member: I'd say the average S&P 500 board member is making between 100k-200k/year for attending 5-8 meetings a year where all their expenses are paid, they are put up in a 5-star, and are wined and dined by management teams that they either have a related business with, or have been friends for a number of years. These board members have the clout of being on a big-name company board of directors. They can brag to their friends about that. People DO NOT give that up easily. If there is a hostile offer for a company and the target's board will be replaced, AND that same board will not make a windfall on acceleration of stock options, then I doubt that hostile will work out. Tender offers can work, but a highly incentivized board of directors will pay a highly incentivized law firm to work out defenses that will keep the pay checks coming.

There are other most esoteric incentive structures that analysts need to be cognizant of that are often overlooked. In a bankruptcy for instance, a financial adviser's terms of agreement with the company / equity committee / unsecured committee is often filed publicly with the court. FAs will take a monthly fee but the real dollars come from incentive fees for selling the company. These incentive fees are often structured at various tier levels. Believe me when I tell you that FAs are not setting ultra lofty goals for themselves as to not receive their incentive kickers: They will set reasonable goals that can be used as a base line for valuation work in terms of recoveries to various constituents.

In the beginning of January, I wrote up, as a long idea, the AMR 2001-1 As and Bs EETC (as a strip) on the Distressed Debt Investors Club. This past Friday, AMR elected to 1110A the collateral backing that deal sending the bonds soaring today. My thesis rested not only on the large deficiency claim that rejecting these aircraft would bring about, but also on some more qualitative work. Despite the MD-80 status as uneconomic fuel hog, AMR needs a number of these legacy planes to continue operations in certain routes. And as the planes backing the 2001-1 deal were some of the newest MD-80s, it'd stand to reason they'd accept these. But for me, an important intangible: Boeing owned the equity of the planes backing the deal. (AMR was leasing them from Boeing). If you haven't heard, AMR has purchase commitments for nearly $3 billion of Boeing new build planes over the next five years. I think it was in AMR's best interest to keep things running smoothly on the new order side with Boeing and as an act of good faith, accepted this collateral, despite the economics that say rejection was the correct choice for AMR. The leases will probably be re-worked, but in the end, the catalyst, the incentives, and the mis-pricing was there for an fantastic investment opportunity.

Peter Lupoff, founder of Tiburon Capital Management, advocates something called the Rational Actor's Assessment:

Rational Actor’s Assessment is a game theory approach where we identify every rational financial actor and consider their anticipated behaviors if pursuing their own rational self-interest. Rational Actor’s are Management, Bond Holders (perhaps a new, activist bondholder), Bank Debt Holders, Private Equity, Competitors, the Trade, Unions, Biggest Shareholder, etc. Any constituent group whose behaviors can influence outcomes

You lay out what is best for each stakeholder, and then play the game. I've recommended it in the past: Bruce Bueno de Mesquita's The Predictioner's Game is simply the best book on the topic. The book uses game theory in the lens of international politics. I think though it is just as relevant to evaluating whether a merger is going to go through, if a company is going to overspend on capex to meet sales incentive targets, if the unions will play ball in a bankruptcy etc. You will never be able to play out every situation in your head (or an Excel spreadsheet - points to self with two thumbs) with 100% accuracy, but you can improve your ability to gauge how situations will play out and by doing that should vastly improve your investment success.

Reminder: Global Distressed Debt Investing Summit

noreply@blogger.com (Hunter) — Mon, 30 Jan 2012 05:27:00 +0000

I wanted to give readers a quick reminder about the Global Distressed Debt Investing Summit coming up on February 8th here in New York City. I also wanted to announce that Distressed Debt Investing contributor, Josh Nahas of Wolf Capital Advisors will be speaking on the panel "Current Trends in Distressed Debt Investing." Josh, along with three other panelists, will share their views on the current trends and prospects for the asset class in the coming months and years. We hope to see you there.

For those interested, you can find the event agenda here: Global Distressed Debt Investing Summit Agenda

Happenings in the Credit Markets - January 2012

noreply@blogger.com (Hunter) — Fri, 27 Jan 2012 18:45:00 +0000

So, things change fast apparently. A little over a week ago I wrote that: "On the credit side, things feel pretty customary on the new issue front. High yield and bank debt deals are not 3-5x oversubscribed like they are in "go-go" markets. There has been a pretty good amount of supply but these deals are not flying off the shelves"

Well, I take that back: Deals (some of them quite suspect) are flying off the shelves. Many of deals priced this week in high yield land were 5x+ oversubscribed. Some marginal issuers, brought by marginal dealers / agents, were also getting done but more akin to 1-2x oversubscribed. One of the hottest deals in the market, which I particularly liked at both original and (less so, but still interesting) final pricing was the Eastman Kodak DIP. The final pricing was L+750, 1% floor, issued at 98. Originally it was talked in the 96-97 range at L+850 with a 1.5% floor. The deal was nearly 10x oversubscribed and probably right so at that initial pricing. The deal is now trading at 100.5-101 with good 2-way markets

What concerns me though, is the feeling of rumbling of risk taking percolating in the market. We're no where near "All hands on deck: sell everything" in terms of where I feel risk is priced. But initial deal pricing is tightening in dramatically, bankers are increasing the size of deals (always to the detriment of creditors), and cuspier and cuspier borrowers are coming to the market. It feels like many marginal issuers have been waiting on the sidelines for their window to issue into a hot market: This is feeling like that sort of market.

In early December, I wrote

"But with everyone painting a doomsday scenario, I'm not quite sure that will happen. The market is NOT ready for a sustained bullish rally - too many investors are flat or are running with a low gross exposure. The only thing that I've known to be true in macro prognosticating: The market will move in a way that hurts the most people at anyone time. If everyone is long, it will go lower. The pain trade today, surprisingly, is up. "

Since then everything is up except: Credit, distressed, equities, Italian bonds, etc. As I am oft to do, I point to Howard Marks' view of the risk spectrum as a pendulum. I visualize this as 5 points on a pendulum:

When the world is extremely bearish and you can buy most things indiscriminately for a sizable gain. At these times, your friends call you a lunatic / maniac and are one of the few buyers out there (November 2008 is the prime example)
When the world is bearish, there are more buyers, and risk assets will still produce a better than commiserate return for the risk underwritten
When markets are fairly valued and the bulls and bears are equally on the side of the fence. At this point, investors are taking return for the exact amount of risk
When markets and the world are bullish, assets are becoming fully valued, and really the best strategy to employ here are event driven ones like merger arbitrage or liquidations (LBHI) that remove market risk from the equation. Here you start to see short squeezes
When markets are fully valued, everyone is a buyers (except for you hopefully), and you are playing with fire by buying any risk asset

We moved very quickly from point 2 which I felt represented a lot of the 3rd /4th quarter of 2010 to point 4 (or maybe a 3.75 if I was exact) which I would characterize now. We're no where close to 5 - there are still too many bearish people out there but we are at a point where I am definitely a better seller of risk assets and am instead focusing 100% of my time on special situations (I would characterize the EK DIP as such, as well as a few other distressed situations).

The high yield market, as measured by the CS HY Index, is up 2.62% YTD. CCC/Split CCC is up 5.75% year to date(!). Yesterday was one of the stronger days I can remember in high yield with buyers of everything and very few cash sellers. It felt like a panic really to be long risk, especially down the credit spectrum. High yield recorded $1.9b of inflows last week which I am sure will push prices up higher. As inflows push bids up, the HY market shows higher returns, which makes retail investors (read: dumb money) chase returns further propagating the cycle. With the Fed on hold until 2014, the appetite for yield seems insatiable right now.

I am generally early (like most value investors) so do not take this post to mean I am sitting on my hands waiting for the market to turn. I continue to do work on special situations (in and out of bankruptcy), and see value in certain structures (I am still working through Petroplus). In fact, one of my largest positions (at least in my personal account) is a bankrupt equity that I plan to post on the DDIC sometime in the next few weeks with a possible 5-10x return with minimal downside.

The one word to describe my sentiment: Cautious.

Bankruptcy Concept: Credit Bidding and the Supreme Court

noreply@blogger.com (Hunter) — Tue, 24 Jan 2012 03:06:00 +0000

A few months ago, I asked volunteers for writers for the blog as we expand our coverage of all things distressed. We have three writers that have volunteered - one that will focus on structured finance concepts and two that will focus on legal concepts. In addition, I am looking for two other writers - one to cover European situations and one to cover domestic distressed situations.

With that out of the way, I want to introduce George Mesires, partner in the Finance and Restructuring Practice at Ungaretti & Harris LLP, who will be contributing an article once a month for the blog. I asked George a few weeks ago to delve further into the Supreme Court's decision to look at the ability of secured creditors to bid their claims in a bankruptcy auction as it has been topical on a number of case in the past 18 months. Enjoy!

U.S. Supreme Court to Provide Guidance on Credit Bidding Rights

On December 12, 2011, about six months after the Seventh Circuit issued its decision in the River Road Hotel bankruptcy case and split from its brethren in the influential Third Circuit (home to the Delaware bankruptcy court) and the Fifth Circuit, the U.S. Supreme Court agreed to hear whether a secured creditor has an absolute right to credit bid its debt under a plan of reorganization whereby a debtor proposes to sell the lender’s collateral free and clear of the lender’s liens. The Supreme Court’s decision, expected near the end of the Supreme Court’s term in June 2012, should provide needed guidance to lenders. Although the Seventh Circuit’s River Road decision provided some comfort to secured lenders (at least to those in Illinois, Indiana, and Wisconsin!) that they may exercise their right to credit bid under an auction sale proposed under a plan of reorganization–– the unsettled state of the law has added uncertainty and risk in these credit bid situations, resulting in a higher cost of capital.

What is credit bidding?

Credit bidding is the ability of a secured lender to bid at the sale of the lender’s collateral using the lender’s outstanding loan balance as credit against the purchase price of the collateral. By using the amount of the outstanding claim as currency, the secured lender does not have to come out of pocket with cash, which eliminates the costs – administrative and financing – associated with making a cash bid. Credit bidding protects the secured lender against an attempt by a debtor to sell the collateral too cheaply. If the secured creditor thinks the collateral is worth more than the sale price, the lender may credit bid its debt, and if the lender’s bid prevails, it will have preserved its ability to participate in any appreciation of the value of its collateral in the future.

Credit bidding in bankruptcy.

Generally, a debtor in bankruptcy may sell its assets in two ways: (i) under section 363 of the United States Bankruptcy Code the (“Bankruptcy Code”); or (ii) pursuant to a plan of reorganization under section 1123 of the Bankruptcy Code.

Under Section 363, it is not disputed that a secured creditor may credit bid its debt (unless the court in very limited circumstances finds that “cause” exists to deny the secured lender the right to do so).

Alternatively, a debtor can sell its assets pursuant to a plan of reorganization. In certain circumstances, a debtor can “cramdown” a plan of reorganization over the objection of creditors, including a secured creditor. To cramdown a secured creditor, among other things, the reorganization plan must be “fair and equitable” to the secured creditor. The “fair and equitable” standard may be satisfied by showing that the plan provides: (1) that the holders of such claims retain the liens securing such claims and receive deferred cash payments having a present value equal to the value of their collateral; (2) for the sale of the collateral free and clear of liens (with such lien attaching to the sale proceeds of the sale) but subject to the secured creditor’s right to credit bid; or (3) for the realization of the secured creditor’s claim by some means which provides the secured creditor with the “indubitable equivalent” of its claim.

Thus, the plain language of section (2) above states that a secured creditor shall have the right to credit bid in a sale of its collateral pursuant to a plan of reorganization. Indeed, historically, there has been little dispute that a secured lender had the right to credit bid its debt in such cases. Recently, however, several creative debtors (see e.g., debtors in the Pacific Lumber and Philadelphia Newspapers cases) have sold a secured creditor’s collateral pursuant to a plan of reorganization without allowing the creditor to credit bid. And such arrangements have been upheld by two federal circuit courts.

In the River Road bankruptcy case, the debtors proposed selling substantially all of their assets, consisting mainly of the InterContinental Hotel Chicago O’Hare, pursuant to a plan of reorganization. As part of its plan, the debtors sought to deny the lenders the ability to credit bid their debt.

But rejecting the rationale of the Third and Fifth Circuits, the Bankruptcy Court for the Northern District of Illinois denied the debtors’ attempt to bar the secured lenders from credit bidding, which was immediately appealed by the debtors. In June 2011, the Seventh Circuit upheld the bankruptcy court’s decision. Not only did the Seventh Circuit find support for its decision in the plan language of the cramdown provision of the Bankruptcy Code, but the court also was influenced by the way auctions are recognized and the way secured creditors are treated elsewhere in the Bankruptcy Code. The Seventh Circuit recognized that under both section 363 and the plan cramdown provision, a secured creditor is permitted to credit bid, which “promises lenders that their liens will not be extinguished for less than face value without their consent … Because the Debtors’ proposed auction would deny secured lenders the ability to credit bid, they lack a crucial check against undervaluation. Consequently, there is an increased risk that the winning bids in these auctions would not provide the Lenders with the current market value of the encumbered assets.”

With its decision, the Seventh Circuit split from the Third Circuit’s decision in 2010 in Philadelphia Newspapers and the Fifth Circuit’s decision in 2009 in Pacific Lumber, setting up a clear dispute among the circuit and bankruptcy courts, which made this issue ripe for consideration by the Supreme Court.

Why it Matters.

The Supreme Court’s ruling will be important for at least two reasons. First, in recent years, most chapter 11 bankruptcy cases have resulted in asset sales – not reorganizations. Thus, resolution of this issue is critically important to the administration of bankruptcy cases and to providing secured lenders clarity as to whether they can credit bid their bid in both 363 and plan sales under the Bankruptcy Code. Continued uncertainty and disagreement among the circuits will lead to disparate results, higher risk, and increased costs of capital.

Second, without clarification by the Supreme Court that a secured creditor has an absolute right to credit bid, over 100 years of bankruptcy jurisprudence stands to be undermined. Generally, bankruptcy law has not permitted a secured creditor to lose its lien in bankruptcy without the lender’s consent, payment in full, or surrender of the collateral to the lender. The continued ability by debtors to block secured creditors from credit bidding will shake the lending community’s faith in the bankruptcy system, and be reflected in higher costs of capital at a time when the economy is still on fragile footing.

Bankruptcy practitioners are following this case closely. Briefing on the case should be completed by early March 2012, with oral arguments to follow. A decision will likely be issued near the end of the Court’s term in June 2012. We will report on this case as soon as a decision is issued.

Advanced Distressed Debt Lesson: Election Forms and DIMEQ

noreply@blogger.com (Hunter) — Mon, 23 Jan 2012 04:17:00 +0000

A few weeks ago, contributing author Rodney McFadden introduced readers to the DIMEQ security (Dime Litigation Tracking Warrants). He ended his post with this:

"The max upside in this case for DIMEQ that would result from being classified as a Class 12 GUC claimant or an equitable lienholder is about $3.00 per LTW (versus today ~ 65 cents) before post-petition interest if the full $337 million reserve goes to the LTW Holders. If the federal judgment rate is applied to that award for 3.5 years it moves the recovery up to about $3.20. On the downside, if DIMEQ is deemed to be Equity and if the Debtor prevails in applying the improper conversion rate then the worst scenario based on Plan value would put the DIMEQ security between $0.07 and $0.10."

As those following the case now know, Judge Walrath opined that the litigation tracking warrants were more equity like and the stock collapsed. The risk factors posed by judges ruling against you (in one shape or the other) is ever present in bankruptcy and investors need to use caution when approaching situations with such binary outcomes. For full disclosure, I purchased DIMEQ AFTER the decision was released. I have since sold my position on the settlement which we will get to shortly.

Rodney McFadden is back tonight with another post: This one digging into the DIMEQ election form. Buying and selling a security is only part of the equation as it relates distressed debt investing. Many forms and agreements are needed to be filed to insure that a creditor (or in some cases, equity holders) receive what is owed to them. Warning: This is a highly technical post. With that said, I think you'll definitely learn a lot from it. Enjoy!

Parsing the DIME Litigation Tracking Warrant (DIMEQ) Class 21 Election Form

Anyone who has followed the DIMEQ situation within the Washington Mutual Inc., (WMI) Bankruptcy for the last year and a half would probably be willing to concede that the Dime LTW’s are one of the most esoteric securities ever created. Indeed, many millions of dollars were spent by the LTW Plaintiffs and the WMI estate to determine what the Holders of these securities were entitled to. Ultimately the Court determined that these were equity securities that were entitled only to whatever treatment was afforded to other Common Equity Interest Holders. Following the Court’s ruling, there was a subsequent Settlement entered into, by and between the LTW Plaintiffs and WMI, which provided that the LTW Holders would be entitled to receive a $9 million General Unsecured Claim in Class 12 (less up to $3.2 million for the legal expenses of the LTW Plaintiffs); a $10 million “out of the money” Subordinated Claim in Class 18 and 8.77% of the 30% portion of Reorganized WMI going to all Common Equity Interest Holders.

The Settlement seems fairly straightforward, right? Well at first blush, perhaps, but a closer look reveals a much more complex situation which primarily results from the trifurcated treatment of the Class 21 LTWs under the Settlement. When looking at the treatment under the Plan, and the Capitalized terms and definitions therein, in combination with the respective Ballots for Class 12 Claims and the Class 22 Interests, a Class 21 Election Form cannot, (and perhaps more precisely) will not be drafted to provide for the fairest or simplest of treatment for the LTW Holders. Before we go forward, and in the interest of clarity, the Class 21 LTW Holders are not entitled to vote under the plan because, despite the settlement, they remain “disputed” thus they receive “Election Forms” not Ballots. A link to a non-executable version of the LTW Election Form is provided below. The version that is currently available, for viewing only, urges Holders to “PLEASE CONTACT YOUR NOMINEE TO RECEIVE A VALID ELECTION FORM” which has me wondering if they ever intend to distribute executable versions, absent an overt request. The LTWs have always been the red headed stepchild of this Bankruptcy Estate, so I guess there’s no point in stopping that now.

It is only fitting that a security as esoteric as DIMEQ would be difficult to parse, all the way to the bitter end, and the Election Form for Class 21 does not disappoint. In fact, it presents some interesting decisions for an LTW Holder. Understand that in order to even find out what the options are, it requires a bit of reading and cross referencing. In order to receive anything under the Plan, you apparently have to take action because as I read the Class 21 Election Form, it appears that if you do nothing, you get nothing. So, in order to find out what you get as an LTW Holder, you need to avail yourself of a copy of the Reorganization Plan and Disclosure Statement, paying close attention to the deadlines and Capitalized Terms therein, and read them in combination with the Class 21 Election Form. In light of a reading and cross referencing of these, I understand the following to be correct for LTW Holders:

Provide the releases by February 29, 2012 and receive:

Pro Rata share of 8.77% of whatever percentage (if any) that Common Equity Interests get under the Plan. Common Equity Interests are currently slated to share 30% of Newco but this is subject to Court approval;
Pro Rata share of ($9.0 million less approximately $3.2 million) on account of the allowed Class 12 Claim; and
Pro Rata share of a Class 18 Subordinated Claim, up to $10 million, which is currently viewed to be out of the money.

Provide the releases after February 29, 2012 and receive:

None of the Newco Stock going to Common Equity Interest Holders (if any). My understanding is that there either cannot or will not be any Newco Stock escrowed for the Common Equity Interest Holders.
The recovery on account of the Class 12 Claim and Class 18 Claim if you turn in your paperwork within 12 months following the Effective Date.

So, given the above, exactly what are the risks, going forward, for an LTW Holder and what is the potential value of these LTWs?

According to the liquidation analysis within the Disclosure Statement accompanying the 7th Amended Plan of Reorganization for WMI, the value attributable to “Equity Interests” is approximately $145 million. This amount is comprised of the $70 million value of Reorganized Common Stock as valued under the Plan plus the $75 million cash “Release Consideration” paid over from the Senior Noteholders. At a $145 million Plan value for all Equity Interests collectively, the theoretical value in the hands of LTW Holders, assuming nothing changes, would be calculated as (0.0877*.30*145,000,000/113,000,000) which yields a value of $0.034 per LTW on account of the Newco portion of the LTW Settlement. The $9 million Class 12 GUC claim, less up to $3.2 million in fees paid to LTW counsel, would yield a value of $0.051 per LTW on account of the allowed General Unsecured Claim portion of the LTW Settlement. The total theoretical value for DIMEQ would seem to be $0.085 per each LTW based on Plan value. And realize that this is discounting entirely the Class 18 claim of $10 million for now because it is “out of the money”. It also assumes that an LTW Holder tenders the releases so as to be received by February 29, 2012 and that the Common Equity Interests actually receive a recovery under the Plan.

However, the discussion doesn’t end there because there apparently is some risk that the Court will apply the Absolute Priority Rule (APR) and rule that Common Equity Interest Holders (Class 22 – WAMUQ & PFG Claimants and Class 21 - DIMEQ) can’t be paid until the Preferred Holders in Class 19 are paid in full and that would present a $7.5 Billion hurdle based on Par value. The TPS Group, representing the Cayman REIT Preferred Holders, has been lobbying for the application of the APR, and they are not alone. Near the end of the hearing on Wednesday, January 11, 2012, the Judge even opined that the Debtors’ assumption that it could violate the APR was “Optimistic”, which signals that she is giving some consideration to instituting the APR. Absent that, the Court has the discretion, and the blessing of the Debtors and the Equity Committee, to adjust the proposed distribution of 30% of Newco to Common Equity Interest Holders. The institution of the APR or any downward adjustment of the Newco allocation by the Court would necessarily mean that the currently proposed recovery for all Common Equity Interests would be decreased if not entirely eviscerated. Accordingly, there is risk that the Newco portion of the recent LTW Settlement may have no value in the hands of the LTW Holders.

So it begs the question, if the APR is instituted, why would the Preferred classes receive all of the Newco when senior classes of subordinated claims in Class 18 are projected to receive no recovery under the plan? The answer there would seem to be that, since the Court bestowed upon the Equity Committee the opportunity to pursue “Colorable Claims” for the purported insider trading of certain Settlement Noteholders, the EC would obviously not agree to give up the opportunity to pursue those claims (via the current settlement embodied within the Plan) if none of their constituency would receive any benefit. So my guess is that if the Absolute Priority Rule is applied, and that is still a big if, it would only be imposed amongst the equity classes. It remains to be seen what will happen there but it bears noting that, according to the Ballot Instructions, votes for the Common Equity Interest Holders (except for DIMEQ) and the Preferred Holders in Class 19 would have to be submitted and received no later than February 9th for the votes to count and the Releases would have to be tendered by February 29th in order for the equity classes to be eligible to receive a recovery under the Plan. The big downside is that by the time that the Releases are provided, Equity Interest Holders won’t know what the final treatment will be.

The resultant problem here for LTW Holders is that they also have until February 29th to tender their securities and give the Releases. In reality, to be safe, one would need to turn in the paperwork a few days in advance of the deadline to be certain it is timely received. Once again, based on a reading of the Class 21 Election Form, it would appear that if the Releases and the LTW securities are not tendered by the deadline, one would not be eligible to receive any Newco but could apparently still get the recovery on account of the allowed Class 12 Claim and the recovery from the Class 18 Claim (if any) if the Releases are provided within 12 months after confirmation. However, it appears that you have to request a special form from the Liquidation Trustee in order to affirmatively provide the releases on a post-confirmation basis if you miss the Feb. 29th deadline. Since the Confirmation hearing is on February 29th you have to tender the LTWs and releases before you know whether the APR will be applied so you are just flying blind at that point and can do nothing about it. Accordingly, heading into the February 29th Confirmation Hearing, the only guaranteed recovery for LTW Holders would be the Allowed Class 12 Claim of $9 million, less up to $3.2 million in legal fees for LTW Plaintiff Counsel, shared amongst approximately 113 million LTWs.

One final item that LTW Holders should be aware of is that once the Election Forms are turned in, if the Holder makes the choice to provide the requisite Releases in order to accept the treatment under the Plan, the securities themselves will also be tendered. As such, the LTWs would no longer be tradeable and likely a contra cusip would be issued within the Holder’s account to freeze the securities.

Link to non-executable LTW Election Form:

http://www.kccllc.net/documents/0812229/0812229120116000000000001.pdf

The main case In re Washington Mutual, Inc., Case No. 08-12229 (MFW)

The Adversary case is: Nantahala Capital Partners, LP, et al. v. Washington Mutual Inc., et al., Adv. Proc. No. 10-50911 (MFW)

Sahm Adrangi's Kerrisdale Capital 4Q 2011 Letter

noreply@blogger.com (Hunter) — Sat, 21 Jan 2012 01:16:00 +0000

A few years ago, I introduced readers to Sahm Adrangi who, in 2009, launched Kerrisdale Capital. Sahm found an incredibly lucrative niche: being one of the first fund investors to aggressively short Chinese frauds, a strategy that has produced a whopping 588% net return to investors since inception, at a time when the S&P is only up 44%. In 2011, he generated ~200% return for investors - definitely the highest number I've seen printed in 2011 among funds. He has grown his asset base to $60M, and rightly so given his ability to identify alpha opportunities that are market agnostic. If the Eurozone breaks down, China has a hard landing, or the U.S. finds itself in a double-dip recession, I believe Sahm will find a way to generate positive returns for his investor.

I've provided his letter below that he sends to interested parties. For more information, their website can be found at http://www.kerrisdalecap.com/. Enjoy!

Kerrisdale Quarterly Letter 12-31-11

Buffets Restaurants Files Prepackages Bankruptcy

noreply@blogger.com (Hunter) — Thu, 19 Jan 2012 04:25:00 +0000

As expected, Buffets ("the Company") filed a prepackaged plan of bankruptcy earlier today with support of 83% of its senior lenders. Buffets operates the Old Country Buffet, HomeTown Buffet, Ryan's, and Fire Mountain restaurant brands with approximately 500 restaurants across the country. For those interested in following along, you can find the bankruptcy docket here:

Buffets Bankruptcy Docket

For reference, Banc of America had a 39-41 quote on the Buffets TL this afternoon, with a few other dealers making markets slightly wider than that (GS was 37.5-42.5 earlier today).

Here is a price chart of the term loan over the past year:

In the press release announcing the restructuring agreement, the Company noted that existing lenders would be providing a $50M DIP loan and that 81 under-performing restaurants would be closed during the restructuring process. The plan contemplates that the entire $245M of outstanding debt will be eliminated and that existing lenders will receive 100% of common stock upon emergence (subject to dilution of the Management Incentive Plan at 8%).

Buffets, Inc.'s legal advisors are Paul, Weiss, Rifkind, Wharton & Garrison LLP and Young, Conaway, Stargatt & Taylor, LLP. The Company's financial advisor is Moelis, Inc.

In his Declaration of Support for the Chapter 11 petition and first-day motions, A. Keith Wall, the company's EVP and CFO noted that this would be the second filing of the company in 5 years as the company filed in January 2008 after the disastrous acquisition of Ryan's Restaurant Group confounded by a weak economy. At that time the company was in bankruptcy for 16 months, with a confirmation in April 2009.

What was FASCINATING about the previous bankruptcy was fact that a great majority of Buffets' leases were structured as a master lease. In bankruptcy, one can reject leases on a discreet basis. If a number of leases are rolled into a master lease, the company must reject all or none of those leases. Buffets were unable to reject their above market leases in that bankruptcy and were burdened with a difficult cost structure on top of rising food and labor costs. With that said, in this declaration, Wall states:

"Now, however, many of the former unitary leases have been broken up by means of numerous property sales to individual landlords. Consequently, the Debtors believe the legal impediments that restrained the Debtors' ability to reject such above-market leases in their prior chapter 11 cases have been eliminated, and the Debtors intend to file a motion to reject many such leases"

The affidavit also notes that an ad-hoc committee of prepetition lenders have worked with the company over the last few months on restructuring Buffets into a more streamlined and profitable operation. (Editor Note: I would be curious if the new rule 2019 will apply here.)

In the Motion to Approve Use of Cash Collateral (Docket #18), terms of the DIP Credit Agreement are laid out: $20M synthetic LC facility with a $29M DIP term loan. This is split up into three tranches: A/B/C with sizes of $30, $10, and $10M respectively. The TLA and TLB tranches will pay L+900 with a 1.5% floor with the TLC paying 250 basis points more than that. We do not know what the OID (upfronts) or backstop fees will be as the Company has requested an order to file fees under seal.

In addition, in that same Motion, a document is filed (5 of 6) that amends the existing credit facility that will be converted to equity. This document is signed by the following lenders:

Credit Suisse Loan Funding, LLC
Eaton Vance (across a variety of funds)
Boston Management and Research as various Investment Advisor
Rimrock (across a variety of funds)
Twin Haven Capital Partners

No projections were filed with the disclosure statement so its hard to get a sense for what sort of value the term loan offers at 40 cents on the dollar. The DIP is interesting but that's probably already spoken for by one of the aforementioned lenders.

We will continue to monitor the situation as more information is released.

My favorite chart from Greenlight's 4Q Letter (and their top 5 positions)

noreply@blogger.com (Hunter) — Thu, 19 Jan 2012 00:55:00 +0000

Today, Zerohedge posted Greenlight's 2011 4Q letter which I've embedded below. For those wanting the juicy details, Greenlight's 5 largest long positions were: Apple, General Motors, gold, Market Vectors Gold Miners, and Microsoft. The two new positions he invested in during the quarter were Dell and Xerox (Editor Note: I am long MSFT, DELL, and GM).

Greenlight

My favorite chart from the entire letter is below:

The last 6 weeks of bullishness has been driven by a combination of bettering of sentiment out of Europe, driven largely in my opinion by the ECB's simply enormous LTRO program, as well as improved economic indicators in the United States. It remains to be seen if Europe can break the cycle laid out above (i.e. we are right now in the 'champagne party').

On the credit side, things feel pretty customary on the new issue front. High yield and bank debt deals are not 3-5x oversubscribed like they are in "go-go" markets. There has been a pretty good amount of supply but these deals are not flying off the shelves. IG books are filling quickly with deals going subject very quickly after launch. To me this is a function of more the lack of supply of paper that came to market in parts of the 4Q.

So to me, the appetite for risk is fairly customary and credit markets are not in either of the extremes of extreme bullishness (i.e. you should sell) or extreme bearishness (i.e. you should buy). Fair value to slightly overbought as investors reach down for yield seems a fair characterization on the current credit markets.

Distressed Debt Weekly Links of Interest

noreply@blogger.com (Hunter) — Sun, 15 Jan 2012 14:08:00 +0000

Here are some of the things we are reading over the long weekend here at Distressed Debt Investing. Enjoy!

Pivot Capital Management's Presentation on China [via Frankly Speaking]

A post from December on Jeffrey Gundlach's DBLTX [Economic Musings Blog]

Weil Gotshal Looks Back at 2011 [via WSJ Bankruptcy Blog]

Glenn Hubbard's white paper on how the mortgage mess should be fixed [Glenn Hubbard's Blog]

Notes from the Washington Mutual Disclosure Hearing [QNews Blog]

Global Distressed Debt Investing Summit

noreply@blogger.com (Hunter) — Thu, 12 Jan 2012 00:44:00 +0000

On February 8th, the 3rd Global Distressed Debt Investing Summit will take place here in New York City. There looks to be a very strong group of presenters from buy side shops such as Littlejohn & Co., Octagon, Versa Capital, Karsch Global Credit, and Avenue Capital. The panels look fantastic covering issues that are currently facing investors including the state of the capital markets, the issues in the leverage loan and CLO markets, global distressed debt investing (topical because of Europe), and many others. Here is a note from the conference organizers:

iGlobal Forum is pleased to announce the 3rd Global Distressed Debt Investing Summit due to take place on February 8th, 2012 in New York City. As the distressed debt market navigates through the evolving changes in the economy, new types of deals and opportunities are opening up for prospective investors. Now more than ever, the expanding distressed debt field is of a great interest on a global stage as Europe’s debt market continues growing and outperforming the US. With the recent European credit crisis strongly affecting worldwide markets, it also provides a new outlook and opportunities in a number of different sectors. The upcoming Summit will provide attendees the chance to explore opportunities in the major sectors such as real estate, structured credit investing, the wavering Maturity Wall, and more.

For those looking for more information on the conference, please visit the conference website: Global Distressed Debt Investing Summit. Distressed Debt Investing will be in attendance and we will be sure to bring you coverage of the issues and topics presented. Hope to see you there.

Distressed Debt: Petroplus and Guarantor Structures

noreply@blogger.com (Hunter) — Wed, 11 Jan 2012 05:02:00 +0000

(Update: Wrote this last night. 3 people emailed me after saying I was missing a great short term trade. They were right. Bonds up 8 points on news that Company reached a temporary agreement with lenders for liquidity and a possible agreement with a third party for supply of crude for Croyton and Ingolstadt)

Yesterday, I mentioned that one of the ways I find distressed debt ideas to research is via the price action. Here is a chart of Petroplus' 7% bond due 2017:

In the painfully slow, last week of the 2011, Petroplus ("the Company") announced that its revolving credit lenders froze approximately $1 billion of uncommitted lines under its revolving credit facility. Bonds dropped 10 points from 60 to 50 on the news. News started to trickle out that the company would need to shut down some of its refineries as the lack of liquidity would make it impossible to source crude for its refining operations. The company was downgraded by both S&P and Moody's, with both rating agencies citing near-term liquidity risks at Petroplus.

The Company announced that it was continuing negotiations with its revolver lenders, and that it would commence a temporary shutdown at three of its five oil refineries. Then, on January 5th stated this in a press release:

"The Company also announced that access to all of its credit lines under the Revolving Credit Facility has been suspended and access to its pledged bank accounts with its Revolving Credit Facility lenders has been restricted, pending the outcome of the negotiations with the RCF lenders."

Bonds dropped another ten points on the news. Press reports indicate that since then, Petroplus has hired four financial advisors (including Rothschild), and bank lenders have also hired counsel and an FA to assist in the ongoing issues at the Company.

Stepping back just a bit, Petroplus is one of the largest refiners in Europe. They own 5 refineries:

Coryton Refinery in the UK
Antwerp Refinery in Belgium
Petit Couronne Refinery in France
Ingolstadt Refinery in Germany
Cressier Refinery in Switzerland

According to the Company, these refineries have a combined capacity of approximately 667,000 barrels of crude per day. In its announcement stating that all its credit lines have been suspended, the Company noted that two of the five refineries are being shut down, one is expected to run out of crude in the next week, and that the two remaining (Ingolstadt and Coryton) are running at lower than normal capacities. Without liquidity, Petroplus cannot purchase its raw material (crude) to process into refined products.

Complicating this situation further are three salient points:

If the company does indeed file for bankruptcy, it may be quite messy given the multi-jurisdictional issues related to a European restructuring
Europe is almost certainly going to be in a recession meaning the demand for refined products will be lower, pushing prices down, while the price of crude may continue to move higher pushing the crack spread to very low and possibly negative levels
The guarantor structure, while on the surface looks reasonable, is actually very questionable

Let's take point #3 and examine it a little closer. For reference, you can find the documentation for the four publicly traded bonds here: Petroplus Bond Documentation. The Company issues its 4 bonds out of a finco "Petroplus Finance Limited." Here is the org chart according to the 9.375% OM:

According to the 9.375% Indenture, the Guarantors are defined as:

the Company (Petroplus Holding AG)
PRML (Petroplus Refining and Marketed Limited which owns the Coryton facility)
PPI (Petroplus International BV)
Petroplus France (Petroplus Holdings France SAS which owns the Petit Couronne and Reichstett refineries, but through subsidiaries)
Petroplus Bermuda (or Petroplus Finance 2 Limited)

This is where things get very tricky. Reading further in the OM, you get this:

As of the Completion Date, the Senior Guarantors will consist of the Company, PRML, PPI, Petroplus France and Petroplus Bermuda.

The Company is the parent company of the Petroplus group and holds, directly or indirectly, the Capital Stock of all of its Restricted Subsidiaries and does not conduct any revenue-generating operations.
PPI is a first-tier intermediate holding company.
PRML directly owns and operates the Coryton refinery; directly owns the Capital Stock of Petroplus Refining Teesside Limited, which own and operates the Teeside refinery; directly owns the Capital Stock of Petroplus Marketing Limited, which engages in commercial activities with respect to the Coryton and Teesside refineries.
Petroplus France directly owns the Capital Stock of (a) Petroplus Raffinage Reichstett SAS, which owns and operates the Reichstett refinery, (b) Petroplus Raffinage Petit-Couronne, which owns and operates the Petit-Couronne refinery and (c) Petroplus Marketing France SAS, which engages in commercial activities for the Reichstett and Petit-Couronne refineries.
Petroplus Bermuda is a finance company and does not engage in, or generate any revenues from, refinery operations.

My emphasis added. While Petroplus France (more specifically Petroplus Holdings France SAS) is a holding company owning the stock of the Reichestett refinery and the Petit-Couronne refinery (via Petroplus Raffinage Reichstett SAS and Petroplus Raffinage Petit-Couronne, respectively) , the liabilities at those entities would come ahead of you in a recovery. You would be left with the residual value (asset - liabilities) which would then flow up to through the recovery waterfall. From my estimation, the only refinery in this structure in which you have a real hand in the recovery is the Coryton refinery. I have yet to find a good break out of liabilities and am still working on building that from the ground up. Here is an asset / revenue breakdown from the 2010 annual report:

And here is a break-down of the currency break-down of trade payables (not sure how helpful this is):

In addition, the 9.375% OM states:

"Following the assumption of the obligations under the Notes by Petroplus Finance Limited and the release of the proceeds of the Offering from escrow, the Notes, the New Convertible Bonds and the Existing Senior Notes will be secured (equally and ratably) by the following collateral: (a) intercompany loans made by Petroplus Finance Limited to Petroplus International B.V. and Petroplus Holdings France SAS in an aggregate amount equal to (i) the aggregate principal amount of the New Convertible Bonds ($150 million) and (ii) the aggregate principal amount of the Notes, (b) an intercompany loan made by Petroplus Finance Limited to Petroplus International B.V. in the amount of $1.2 billion, (c) intercompany loans outstanding to Petroplus Marketing AG of no less than $1.0 billion and (d) a pledge of all the shares of the Petroplus Finance Limited."

This disclosure brings up all sorts of "double dip" issues that frankly, I have yet to wrap my arms around yet.

This is the first of probably many posts on Petroplus that I will share with you as the situation unfolds. Right now my initial inclination is stay on the sidelines despite my belief that an asset like Coryton is a pretty darn good one. To me, the company is going to need a lot of capital to restart its operations (or convert its operations to storage) and purchase crude (i.e. priming risk), the situation in Europe is not conducive to expanding crack spreads (though the closing of the Petroplus refineries will surely help their competitors), and the suspect guarantor structure, among other things. I am still sharpening my pencil on this one and would love to hear if you are working on it.

Where to look for ideas in Distressed Investing?

noreply@blogger.com (Hunter) — Tue, 10 Jan 2012 05:34:00 +0000

Over the weekend, a reader sent me a question on how I go about finding this to look at in distressed debt land. I may have covered this on the blog tangentially over the past few years, so I thought I would take a stab at it with a summary post.

More often than not, and maybe I am alone in this, ideas kind of fall into my lap. Thinking over the past few months I've spent an inordinate amount of time on MF Global, American Airlines, Jefferies, etc. More specifically, in the past week, all I've really been working on is Petroplus (I have no position one way or the other at this point and will do a post on it later this week). So here is essentially how it went:

Petroplus bonds down 35% to the high 30s
Start looking at the bonds

That might sound amazing simple, but really, that is exactly how it happened. I know about 4 or 5 analysts that started looking at the bonds when they dropped in November. I never got a chance to so now I am playing catch up.

With that said, when times are more sanguine than they have been in the past few months, I will use that time to sharpen my pencil on names that had little sponsorship or no hard catalyst but was trading at a juicy yield. I've been looking at Ahern for over a year now flying in the dark as they had not released financials for some time (we got our first glimpse from the bankruptcy filing). I've looked at ATPG for nearly a year now. I've looked at Eastman Kodak (and still really don't have much opinion) for three years now.

In that, I want to know who the players are in a particular situation. On both the investing side and the financial advisor side. If a group of investors are getting together to provide a DIP for XYZ debtor, and I have a position in the name, I want to be part of that group to protect my original investment. "FAs" take a ton of calls from the buyside trying to better understand the dynamics of a situation.

One of the greatest aspects of distressed debt investing is that complexity creates opportunity. Lehman Brother and American Airlines have such rich capital structures, with so many avenues to allocate capital, that an analyst could spend an entire year working on one or the other. Seth Klarman once noted in a speak to Columbia Business School students that Baupost had an "Enron Analyst" - the analyst's sole job was to understand everything Enron and help Baupost make money anywhere in that structure. Because of this dynamic, capital structures themselves present opportunities for me. While this is more than likely in more complex bankruptcies, the fact remains that capital structures are indeed getting more complex with 1st / 2nd lien structure, varying guarantors, etc.

I talk to a lot of other investors. One of the reasons for me starting the Distressed Debt Investors Club is so I could have an avenue to write to other investors during the day (I have about 500 posts on the member's message board). This inevitable creates a two-way conversation offline where me and another intelligent investor can compare notes not just on a specific bond or equity, but also shares ideas or what we are spending our time on. In addition, I read my "competitors" SumZero and VIC for ideas on the equity side that I may have missed. I also read notes and presentations from the sell side's distressed desk analysts to see what is topical to investors and what the market is pricing in.

I read a ton of bankruptcy filings. Too many probably. It's a guilty pleasure. All those references to 363s, lease rejections, cram-downs...Is it getting hot in here? In all seriousness, I try to keep a calendar of all major bankruptcy proceedings coming up and either listen in via CourtCall or know someone attending the proceeding to see if any news comes out that isn't fully reflected in the price at the time. From a post re-org perspective, I want to know the first day the stock trades (when issued) and want to have an opinion on valuation before that so I can act accordingly.

In addition, and some will call me crazy, but I take a cursory glance at every publicly traded bankruptcy filing that has a listed ticker. Many times the equity in these are zero. With that said, one out of every twenty-five in my estimation is a hidden goldmine. Last year, at one point in time, I had 30% of my personal account allocated to the equity of a company in bankruptcy. The downside was diminimus (there was a stalking horse bid already at above the equity trading price) with substantial upside (someone came in well above the stalking horse resulting in a nice gain). For those interested, you can run the function BNKF in Bloomberg for all bankruptcy filings (Note: This is not for the faint of heart).

Moving back real quickly to post re-org equities, I have a Bloomberg monitor with every reasonably liquid company that has emerged in the last five years showing me all time lows, 52-week lows, emergence price. If something is really ticking down hard, I'll refresh on the situation (I probably covered it in bankruptcy so shouldn't be that hard to get up to speed) and see if I have a reasonable idea on valuation.

I think a way to describe my search process is "pain." Where is the most pain for investors? Where is it hurting the most? Some call it "blood in the water" ... I simply think of it as opportunity. Pain usually is synonymous with forced selling, Taking advantages of forced selling is where money is made for the enterprising investor and that's where you should be looking. Nearly two years ago on the DDIC, I made a quick list of a few these opportunities:

Distressed

- Post-Re org equities - Many investors (i.e. CLOs) can't hold equity and are forced to sell

- CCC downgrade effect (certain accounts can't hold CCC assets or are penalized holding CCCs and are forced to sell)

- Default or hiring financial adviser effect (certain accounts need to sell bankrupt companies)

On-the-run Credit

- CLO "80" effect - CLOs mark purchases above 80 at par. If bought below par, bad issues arise

- Cross-over effect (certain accounts can't buy sub IG credit. When upgraded, natural tightening of spreads)

- Primary versus Secondary Trades: If a deal comes tight in the primary, secondary spreads should also tighten

Equity

- Merger Arbitrage

- Index additions and deletions

- Tax loss harvesting causes irrational selling in the 4th quarter (see Mike Burry)

- New lows cause irrational selling

- Spin offs selling effect

- Dual class A/B arbitrages

- SPAC investing (warrants, arbitrage)

- Closed End Fund Discounts

- Super micro-cap / illiquid stocks
- Thrift conversions
- Busted MLPs

Where else are investors finding market inefficiencies created by forced selling? Would love to hear about them in the comments.

Non-Agency RMBS: Private Label MBS - Quick Commentary and Valuation Overview

noreply@blogger.com (Hunter) — Thu, 05 Jan 2012 02:51:00 +0000

A few months ago I wrote an introductory post on Maiden Lane and Non-Agency RMBS. Since then, I've wanted to bring on someone to help write posts on the various flavors of structured/securitized finance. If you remember, in November, I reached out to readers to see if people would like to contribute. Luckily, I got a perfect match on the structured finance front. In 2012, we will try to do at least one post a month discussing everything from CMBS to Prime-X to CLO liabilities. As we add new writers throughout the next few months, I will add them to a contributor section in the right side-bar so you can see all of the relevant posts to a topic.

With all that said, here is an introductory post on the valuation on private label / non-agency RMBS. We will be doing a few posts explaining some of the introductory materials in the coming weeks. Enjoy!

Private Label MBS - Quick Commentary and Valuation Overview

As a subset of the structured products world, non-agency RMBS are essentially claims to cashflows from pools of non-agency guaranteed mortgages. These securities are backed by mortgages that were not qualified to be securitized by the GSEs due to their large balances, lack of full documentation, low credit scores or non-standard terms such as negative amortization schedules. As a result, non-agencies are very sensitive to the credit performance of their underlying collateral.

Current Landscape - 2011 performance:

Non-agencies experienced continuous price appreciation throughout 2010 and into March of 2011, driven primarily by supply constraints and relative cheapness of the sector. Since then excess supply from Maiden Lane II and European Banks, rally of the forward curve and heightened macro-economic volatility have brought the sector down 30% from their March peak. Nomura Securities has recently published that the spread between the ABX 06-2 AAA and CDX HY 5yr is trading at 1 year wides – the relative value is further highlighted by the fact that spreads in the ABX are loss adjusted. In light of the opportunities provided by this sector, I have provided an overview of the valuation process of non-agency bonds below.

Valuation Overview

1) Identifying Characteristics of the Bond

Collateral type- borrower type (SP, AA, OA, Jumbo), Fixed vs ARM, loan count, geographic concentration
Structure- seniority, credit enhancement (OC/XS), sequential vs pro rata, delinquency and loss triggers

This information is readily available on both Intex and Bloomberg. The classification is useful as different collateral types/seniorities will result in drastically different cashflow projections and discount rates.

2) Projecting Cash Flows

The 3 primary drivers of non-agency RMBS cashflows are CPR (voluntary prepayments), CDR (defaults) and SEV (severities). These assumptions take the form of time denominated vectors and should reflect both the current collateral performance and the investor's macroeconomic views. Close to the entire universe of non-agency RMBS waterfalls is modeled on Intex. Intex can take in the user's assumed cpr/cdr/sev vectors and output the expected cashflow profile of the bond (which will vary depending on its position in the deal's capital structure). Thus, producing an accurate cash flow profile is dependent on the investor's cpr/cdr/sev assumptions. (Dealers will often aid investors in running the bonds based on their assumptions of the collateral.)

In general, non-agency collateral types have exhibited the following lifetime cpr/cdr/sev:

While these numbers can be used as general guidance, cashflows must be projected at the deal level. Below are some more general points on cpr/cdr/sev to use for further guidance:

Historic 1-month, 3-month, 6-month, and 1-year cpr/cdr/sev data for a deal can be found on Bloomberg by typing “SEV”. This can also be found on Intex by expanding the history in the collateral section. In absence of special situations that can cause drastic spikes in immediate prepay, default or severities (ie. servicer takeover or resolution of servicing lawsuits), the most recent 1-month or 3-month numbers can be used to proxy for the deals’ near term cpr/cdr/sev’s.

Longer term prepayments will generally experience burnout and trend downwards as borrowers with the means to prepay will have already done so during 2010-2011, when refi rates hit historic lows.

Medium term default levels will likely exceed those of short term as cdr’s have been relatively muted in 2011 due to servicer lawsuits from improper foreclosures and modification initiatives. Cdr’s are expected to pick up again in the upcoming year as the foreclosure moratorium continues to lift and as servicers run out of loan mod options. Long term defaults will likely also exhibit a slight drop as the collateral pool will also experience credit burnout. Note that differences in cdr curves can be seen across servicers (Countrywide serviced bonds have muted cdrs while Carrington bonds have recently been liquidating above 20 cdr)

2 main ways to project long term default:

Collateral multiplier: Look through Bloomberg, Intex or LP’s collateral stratifications and identifying the % size of the 1 year current and 60+ (inclusive of BK, Foreclosure and REO) buckets. One can then run various default vectors on intex until they reach remaining liquidations to around 1.5-2x size of 60+ delinquency bucket and/or 100 minus 1-1.25x size of the 1-year current bucket.
PD by Collateral Bucket: Assign a probability of default to every permutation of CLTV, FICO, and Loan Balance bucket within the remaining collateral and take a sumproduct of the probability with the relative size of each bucket to arrive at the remaining liquidations number.

Given a large portion of cashflows for distressed non-agency sectors come from liquidation proceeds, projecting severities is perhaps the most important part of RMBS investing/trading. Base adjustments to cohort level severities are made based on loan size, where smaller loans generally receive lower recoveries, geographic distribution of loans, where higher concentrations of loans in judicial states imply longer liquidation timelines and higher severities, general timeline for liquidations of delinquent loans and HPA adjusted for LTV. In general, dealers are expecting a slight increase in medium term severities due to 2011’s extended liquidation timeline. Long term severity will likely decrease below current levels due to generally better collateral composition (LTV of current collateral is low from a historical perspective), increased concentrations of modified loans (modified loans exhibit 7-8% lower severities) and will also incorporate the investor’s view on hpa (higher hpa implies lower severity).

Additional considerations: For subprime front pay bonds, investors pay very close attention to servicing trends. Recent consolidation of the servicing industry (acquisition of Litton, HomeEq and Saxon by Ocwen) has resulted in significant servicer recaptures and disruptions to cashflows to front pay subprime bonds (Ocwen is known to be one of the most aggressive servicers in terms of recaps). One can sanity check payments streams for these bonds by looking at projected interest versus actual interest received in recent periods.

3) Discounting/Valuation

Finally, one must discount the obtained cashflows with an appropriate risk adjusted yield/oas to arrive at an intrinsic price (yields are most commonly used). These yields generally vary with macroeconomic fluctuations, housing price uncertainty and housing policy developments. Given the uncertainty of the collaterals’ cashflows, investors/dealers will generally run yields of non-agencies at different cashflow scenarios (stress/optimistic) and arrive at a narrow range of potential prices.

From recent BWIC’s, the range of non-agency collateral types have exhibited the yields presented below:

Distressed Debt Investing: Returns and Defaults for 2011

noreply@blogger.com (Hunter) — Wed, 04 Jan 2012 04:53:00 +0000

According to CSFB's High Yield Index, the high yield market returned 5.47% in 2011. It felt mighty worse for most investors as spreads widened approximately 150 basis points during the year (many total return investors hedge interest rates which tightened dramatically throughout the year). In addition, it was simply a very bumpy ride throughout the course of the year. Here is a chart of the YTD Total Return of the CS HY Index:

Source: Credit Suisse

As you can see, throughout the first half of the year it was a steady grind for investors with spreads hitting a low in the beginning of April fueled by sanguine default outlooks, healthy inflows, and robust appetite of new issues. We all know what happened next (debt ceiling, increased fears over Europe and double dip, etc).

Credit Suisse's "Distressed Securities" category which captures CC, C, and default securities was down 5.46% for the year which is in the range of where I am hearing distressed debt funds performed during the year.

On an individual bond basis, there were a lot of big losers during the years. Here is a quick snapshot of some of the more liquid names:

Stressed / Distressed Losers of 2011

General Maritime Senior Notes (Down 92% on the year...ouch)
Harry & David (Depending on where you have it marked, down ~90%)
VeraSun Senior Notes (Down 82%)
NorskeSkog Senior Notes (Down 80%)
Sino-Forest, all flavors that weren't repaid (Down ~80%)
NewPage 2nds (Down 80%)
AMR [certain flavors including the 6.25%] (Down ~75%)
PMI Senior Notes (Down 75%)
MF Global various flavors (Down 70%)
Foxwoods 8.5% (Down 65%)
EK 7.25% (Down ~65%)
William Lyon Homes Senior Notes (Down 65%)
Hawker Subs (Down 63%)
DirectBuy 2nd Liens (Down 63%)
Nebraska Book Sub Notes (Down 60%)
Ahern 9.25% (Down ~55%)
Aquilex 11.125% (Down ~55%)
Travelport 11.875% (Down ~55%)

And remember, this is just bonds. We saw many 2nd lien loans drop precipitously during the year (Quiznos for instance).

Sources: CSFB, JPM, TRACE, Bloomberg

As mentioned above, the default environment for the first half of the year was relatively benign. Throughout the 2nd half of the year, the number of issuers defaulted ticked up with a number of big name bankruptcies including AMR, Dynegy, and MF Global. Here is the list of names that defaulted during the year (in alphabetical order):

AES Eastern Energy LP
Ahern
Aquilex (missed payment)
American Airlines
Borders Group
Catalyst Paper (missed payment)
Constar International
DEB Shops
Delta Petroleum
Dynegy
Friendly Ice Cream
General Maritime
Graceway Pharmaceuticals
Harry & David
Nebraska Book
NewPage
OPTI Canada
Perkins & Marie Callender's
PMI Group
Real Mex Restaurants
River Rock Entertainment
Sbarro
Summit Business Media
Trailer Bridge
William Lyon

According to JPM, the par-weighted default rate for bonds and loan during 2011 was 1.8% and 0.4% respectively, in line with forecasts of a muted default rate for the year.

This coming year analysts across the street are generally predicting a higher default rate for high yield credit relative to 2011. Depending on who you talk to, estimates range from the low of 1.5% (JP Morgan) to a high of 4.8% (Goldman Sachs). On the whole though, it seems that default assumptions for 2012 are higher now than they were a year ago reflecting credit strategists increased pessimistic view on the investment environment.

Distressed Debt Themes for 2012

noreply@blogger.com (Hunter) — Thu, 22 Dec 2011 02:16:00 +0000

I think the one word to describe this year's distressed debt market was "unexpected." Whether it be the tragedies in Japan, Congress pushing us to a near technical default, the subsequent U.S. government downgrade, heightened and unforeseen issues with Europe, and a number of surprising bankruptcy filings (MF, AMR, etc), this has been a tough year to price risk for a distressed debt investor. According to HSBC's most recent "Hedge Fund Weekly", hedge funds classified as "Distressed Security, Global", excluding Paulson & Co affiliated funds, have seen year-to-date returns ranging from -9.5% to 7.4% with a number of funds hugging right around zero.

While I will save my post discussing the expectations for high yield returns for 2012 (I know, a fool's errand) for next week, I would like to talk about some issues and themes that distressed debt investors may possibly encounter through 2012. But first, let us look at my favorite chart: The number of distressed debt issuers traded over the course of the year:

(Note: I've cut the graph off as of two days ago to account for the dearth of trading around the holidays)

As this chart shows, the distressed opportunity set has increased precipitously over the past 12 months. Many of the new opportunities comes from junior capital (TRUPS, preferred, unsecured bonds, etc) of European banks. In addition, as the definition of distressed according to Bloomberg is a spread of over 1000 basis points along with a much tighter treasury curve, the bar is set a tad lower this year. With that said, I think any investor you speak to participating in the distressed debt market would tell you there is a lot more to do at this time time year than last year.

In terms of themes, I might as well get the elephant in the room out as quickly as possible: Europe. I have read every major investment bank's credit outlook for 2012 and everyone's projections for next year's returns are based on possibly scenarios in Europe. If you were to compare the two issues that rocked the equity markets over the past 12 years (the "Tech Bubble" and the "Mortgage Crisis"), issues in Europe are so heavily portended that I'm starting to wonder how much is already discounted in. I mean, were people talking about the Tech Bubble in 1999, like they are talking about Europe today? Were (informed) people talking about the mortgage crisis in 2007, like they are talking about Europe today?

I have no idea what is going to happen in Europe. I am not a macro analyst and find myself much more comfortable (and at an information advantage) discussing various bottoms-up situations than trying to guess which European Summit, if any will fix the problem. With that said, you can't ignore the situation because that is what is driving monthly returns (in fact, an interesting data point: many funds have put on hold hiring fundamental analysts for the mere fact that the added value is muted by macroeconomic / Europe factors).

One way that I like to think about situations is determining, where on a bell curve, the situation is priced. Here is the standard bell curve we all learn taking the CFA exam or intro stat:

Where the entire European debacle began to unfold, the +1/-1 standard deviation events were not priced in. I'd say, with everyone focused on Europe, the +2/-2 standard deviation events are probably pretty closed to being priced in and the thing you have to worry about as a portfolio manager are the very far tails, for instance, and Italian default. 12 months ago if you told people you were pretty confident that Greece was going to default, they'd say, "You know, its a possibility...but probably not." CDS on Greece has gone from 1000 basis points to 10,000 basis points (I don't have the points up front data in front of me) just this year. Everyone expects some sort of Greek default.

The question I then fall back on is this: Will Europe suffer a mild recession or a very bad recession? The problem with a very bad recession is the domino effects it has on the rest of the world. Here is the scenario:

Europe falls into a bad recession
Europeans purchase less due to austerity measures (wage cuts, higher taxes, etc)
China's economy, which benefits from Europeans purchasing their goods, slows down on lower exports
Australia, Singapore, Korea - all major exporters to China, slow down because China has slowed down because Europe has slowed down
Global commodity prices (and definitely Australian real estate) drop because China has slowed down
Major commodity producers, other than China, including Brazil, Canada, and Russia slow down because exports are lower due to lower prices and lower demand from everyone above
Pain

Do I think this will all happen? I am probably more likely to tell you these events will unfold than the average person on Wall Street. But that's why there is something called "tail hedging" (Up until June, Australia CDS was one of the cheapest tail hedges out there).

With that said, lets turn our focus to more structural / technical / non-European issues distressed debt investors will deal with in the coming year:

Lack of Liquidity and the Implications for Portfolio Management

I have discussed previously about the current abysmally low dealer inventories of corporate bonds. This has been driven by adoption of (absurd) regulation and de-risking of dealer desks across the Street. What concerns me is that as absolute yields in the high yield / leveraged loan marketplace has decreased while at the same time the relative yield offered by high yield / lev loans relative to other fixed income has increased, the amount of retail money that has flown into the space has increased precipitously. More retail money means more needs for cash and daily liquidity. This has a dramatic effect on how a PM will manage a book.

First, it means that the relative spread between illiquid and liquid issuers should increase. As more daily liquidity is needed, the demand for larger / on-the run bonds increases relative to smaller issues. This should cause stressed high yield, which is generally illiquid, to gap out even further when bad news hits the tape. The additional volatility will cause distressed debt investors to demand a higher discount rate when purchasing small issues meaning lower prices. If you extend this to the point of financial distress, companies should be pushed into bankruptcy more frequently as the need for higher IRRs for distressed suppliers of capital becomes impossible to bear for the marginal issuer.

Secondly, inflows and outflows are inherently volatile and streaky (returns -> more inflows -> higher returns -> further inflows). And because cash management will be focused on the most liquid issuers, these issuers will experience a whole different sort of volatility. Now, you may not think this is important until you look at the top holdings of many of the well-known high yield mutual funds: TXU, Sprint, Clear Channel, First Data, HCA, Harrah's / Caesars, etc. Most of the issuers have rich capital structures with every sort of layer imaginable. And as spreads widen due to the aforementioned volatility in the senior parts of these capital structures, the junior parts of the capital structure will widen out precipitously. This is a sort of minefield for investors that will have to be reckoned with next year.

Third, and sort of a byproduct of our second effect, is that cash balances, should in theory be hire. This concerns me because when cash balances are high, the propensity for rallies to extend past economical sense increases. If I am a mutual fund manager sitting of 5% cash position and the asset class grinds in every single week, at some point, I am going to lower my cash balance and spread more gasoline on the fire.

Fourth, and possibly a stretch, private equity will target larger companies next year and the years beyond. To me, it's a lot easier to finance a $5 billion entity that is levered 4.0x versus a $500M entity levered 3.0x, all else being equal. And with the amount of capital sitting on the sidelines of private equity, just waiting to be deployed, I think you'll see some big game being taken down next year.

Lower Recovery Rates

Many high yield strategists use a fairly simple formula to calculate projected high yield spreads and as a result, total return over a projected period:

[100% less Estimated Recovery Rates] * Default Rate Forecast + Excess Spread = Spread Estimates

The problem with this equation is pretty simple: Excess Spread changes with market volatility. In a very volatile markets, excess spread, or the spread an investor requires to be paid above what he expects to lose in a default scenario, increases dramatically. Hence, you have a circular equation.

More important to our discussion is my estimation that we will see lower recovery rates in the future, more specifically in the lower parts of the capital structure. Whether it be bank debt or secured bonds, more senior leverage is being put on capital structures, leaving junior note holders in a more levered position. Furthermore, the extremely weak covenant packages put into credit agreements and indentures between 4Q 2009 and 2Q 2011 means while the chance of an actual default is less (less likely to trip covenants if they don't exist), the companies that do default will already have been burned to the ground.

Higher Default Rates but still Relatively Benign

Despite my concerns in Europe, I cannot dismiss the data that suggests high yield issuers in the United States have the strongest balance sheets, collectively than in anytime in the modern history of high yield. And the maturity wall is really just a hill now:

We always see a few surprises each year. This year, other than MF, we saw AMR file. Of every analyst covering AMR on the equity and debt side, very few, if any, thought AMR would file in 2011. Dynegy is a similar story given the pricing of the various HY indices. Jump risk is something we all have to contend with in the distressed market and 2012 will be no different. I would expect default rates to increase into the latter half of the year as CFOs and investors alike begin to look out 12-18 months when lots of bonds and bank debt are maturing while at the same time the amount of firepower of CLO purchasing power dwindles due to the closing of their reinvestment windows.

With lower recovery rates in the junior tranches, I'd expect distressed investors to make an even more pronounced move into 1st lien paper (akin to Oaktree's strategy). Something like a Travelport 1st lien comes to mind.

More Cash to Invest due to Distributions from Liquidations

Lehman. Nortel. Washington Mutual. To the innocent by-standers eye, simply three companies that filed for bankruptcy. To me, and many other distressed investors: An oasis or bastion of safety. Nortel has been one of the best performing distressed bonds all year. WAMU, whichever flavor you choose, has been a solid performer the past few weeks. And Lehman: Lehman has let you allocate billions of dollars of capital in just a few trades allowing you to show your investors your are more allocated than you really are while at the same time grinding out returns. I have a recovery price in the low 30s for LBHI. Every day I suspect my bonds will grind their way there with little no volatility.

Unfortunately, this party is about to end. Lehman should start paying out distributions soon, and its just a matter of time for WAMU and Nortel once all the arbitration gets settled and the plan is confirmed, respectively. Distressed debt investors will find a bunch of cash from these distributions in their fund, looking for similar places to put the capital. But really, there aren't a lot of situations like that right now. MF could turn into such a situation, but we are far from that will over a billion dollars still missing. Maybe this capital will move into something like merger arbitrage (remember our point above about private equity taking down larger targets). I'd expect to see DIPs massively oversubscribed next year on the bankruptcies we see. Maybe the capital will move into Europe as European banks trickle out assets despite new collateral rules letting them pledge anything under the sun. Or maybe investors start taking bold position in deeply distressed situations looking for control while at the same time exposing their investors to more volatility. My dark horse candidate: A healthy push into sub-prime and other non-agency RMBS and CMBS.

Activism (in and out of the bankruptcy court) to Increase

In my opinion, and as mentioned above, the financing market for good and sizable companies is healthy right now. A healthy financing market fuels activists as they can push for a hostile offer more reasonably with committed financing. And even if they really do not want to take the company private, the white knight will also find himself with many options to finance a purchase. For investors in credit, I think the combination of a healthy financing market AND lower recoveries for junior tranches will push distressed investors to write large equity / rights offering checks to give them a chance to recover their investment less they hand the keys over to senior creditors. We saw this with Great Atlantic.

As capital structures get more fragmented / layered, and intercreditor agreements become more friendly to revolving lenders, junior creditors are in a unique spot to "create their own recovery" as it were. One of the most successful endeavors of this sort was Six Flags, where originally bank debt was going to retain the equity. Then it was the opco noteholders. Then finally, after a large equity check, the holdco noteholders took over the company and we know what happened there:

And to answer your next question: Doesn't this contradict with what you said about lower recovery rates? No. In fact, it worries me because smaller investors that cannot participate in rights offerings will see a much lower ULTIMATE recovery than their peers that have the chance to participate in an equity check.

This strategy is bound to be profitable, assuming a low enough purchase price, as EVENTUALLY, Europe will correct itself, and valuations across industries will increase If you can purchase a company in distressed with cheap financing, delever the structure, and fix operations, I think you'll have yourself a home run.

Conclusion

Everyone is calling for 2012 to be a volatile year. I hope just the opposite: I hope everything goes lower and assets across the board get cheaper. But with everyone painting a doomsday scenario, I'm not quite sure that will happen. The market is NOT ready for a sustained bullish rally - too many investors are flat or are running with a low gross exposure. The only thing that I've known to be true in macro prognosticating: The market will move in a way that hurts the most people at anyone time. If everyone is long, it will go lower. The pain trade today, surprisingly, is up. It's going to be a hell of an interesting year. Good luck.

Distressed Debt Weekly Links of Interest AND a few Updates to Recent Posts

noreply@blogger.com (Hunter) — Sun, 18 Dec 2011 23:55:00 +0000

This week I am going to try something new. Because there was a litany of news from the docket of a number of the bankruptcies we have followed in the past, I thought it would be beneficial to the reader to get a summary on some of the proceedings. First the updates, then the weekly links of interest:

Great Atlantic settles with Secured Note Holders: We have discussed the Great Atlantic & Pacific Company's bankruptcy in a number of posts. Most recently we discussed the calculation of the claim value of the company's Second Lien Senior Secured Note Holders. This week it was announced that the company has entered into a plan support agreement (PSA) settling the amount of the claim at $304M with per-diem adjustments of $108,000 if the company exits bankruptcy before or after the assumed March 1, 2012 date. This works out to an approximately 119 price on the bond. I have to assume the company, under the direction of the junior note holders who are funding the rights offering, wanted to avoid any sort of delay in the bankruptcy confirmation (which may have been held up if the Second Liens litigated for the make whole).

Dynegy and PSEG reach agreement on Roseton / Danskhammer leases: Importantly, this does not settle the amount of the lease rejection claim in the bankruptcy court. As first discussed in this post: Dynegy's Bankruptcy, Dynegy filed for bankruptcy in November to restructure its capital structure and reject the leases on the Roseton and Danskhammer power plants. What this agreement does though is leaves the pass-through notes as the only really opponent to the rejection of these leases and the associated damage claims. Under the agreement, PSEG would receive an allowable claim of $110M against Dynegy and would receive $7.5M in cash from Dynegy, among other things. From a valuation perspective, this means that the unsecured bond holders will receive slightly less as claims have increased marginally at the debtor.

And now the "Weekly Links of Interest"

An amazing insider look at manager's capital allocation decisions [hat tip Joe Koster's Value Investing World]

Another one from Joe: A series of lectures from Bruce Greenwald's Value Investing classes at Columbia Business School [Value Investing World]

Zero Hedge's Chronicle of the Last Days at MF Global [Zero Hedge]

Latham Watkins with a detailed look on the amended Bankruptcy Rule 2019 [Latham Watkins]

Sardar Biglari's 2011 Annual Letter to Shareholders [Biglari Holdings]

Kyle Bass at AmeriCatalyst 2011 (amazing video!)

New Items in the Right Sidebar of Distressed Debt Investing

noreply@blogger.com (Hunter) — Thu, 15 Dec 2011 05:06:00 +0000

First off, I'd like to thank everyone that has volunteered to write for the site. I would say we have 3 of our 5 spots definitively filled, and you soon will see their names / affiliations / links to all the articles they write in the right sidebar in the coming months. If you are interested, please contact me via email.

Importantly though, I received about 20-25 emails for people wanting to write about a specific situation here or there, but not with a firm commitment. I always find myself (and I am sure many others do as well) with too little time to cover and analyze every situation. With that said, I thought I would try an experiment: On the right sidebar, you will see a section entitled "Want to help out?" Whenever a situation comes up that either (1) I haven't followed and someone who knows the situation well would be better suited to write it up or (2) Many readers request a post on a particular topic of discussion and I don't have time, I will update that box.

So currently it read: "I am looking for someone to analyze PMI and determine the value of its unsecured bonds" PMI filed for bankruptcy a few weeks ago and bonds have drifted lower (even more so recently with the CDS auction). If you have looked at the situation, and would like to help out, all I ask is you email a few paragraphs to one/two pages explaining the situation and stamping a reasonable set of parameters / assumptions to get to a valuation.

When I get a sufficient response, I will use the work in question and develop a more comprehensive post incorporating elements from the author. And to get in front of a few questions I will get asked: Anything you send to me is 100% private / anonymous. If you would like me to post your name / affiliation, I will do that, but privacy is of the utmost importance around these parts.

Once the new post is up, I will change the "Want to Help Out Request" to a new situation and hopefully get more responses. I think this system will benefit all because (in theory) I will be able to cover more situations, more efficiently, and you as the reader, will be able to see more analysis of the many bankruptcies that seem to crop up more and more each day. Contributors will be granted a 6 months membership to the DDIC, access to me for resume/case study services/job search help for free, and will be invited to be a trial / beta user for our new project to be announced in 2012.

Here's to hoping we have a few PMI analysts out there! If you have any questions / thoughts, always feel free to email me at hunter [at] distressed-debt-investing [dot] com

Washington Mutual and DIMEQ

noreply@blogger.com (Hunter) — Thu, 15 Dec 2011 04:21:00 +0000

One security that has fascinated me and many investors for a number of months is the Dime litigation tracking warrants (DIMEQ). Without getting into the nitty gritty details and history of litigation participation certificates (If you are interested, read this document: POST-TRIAL MEMORANDUM OF LAW OF DIMEQ), the issue regarding DIMEQ in the Washington Mutual bankruptcy is whether the security should be considered equity of pre-bankrupt Washington Mutual, which for all intents and purposes is worth very very little, or something else entirely.

On one side of the table you had desk analysts arguing that DIMEQ will be considered equity and hence WAMU Holdco bonds would get a pop because they will receive a larger slice of pie (recovery). On the other side, you have one of the most focused legion of vested independent investors I have seen, discussing a very complicated issue, at the DIMEQ InvestorHub Message Board.

Earlier this week, Washington Mutual filed its 7th bankruptcy plan and disclosure statement. For those interested, here are the documents: WAMU's 7th Amended Plan and Disclosure Statement.

One investor that has been following the situation religiously is DDIC member Madclown, who writes a wonderful little blog entitled The Diligent Investor, which focuses on bankruptcy situations that most retail investors can participate. He contacted me last night with a post on the WAMU Plan and Disclosure Statement, which I've copied and pasted below. Enjoy!

Assessing the Impact of WAMU’s Reorganization Plan on the Dime Litigation Tracking Warrants (DIMEQ)

On December 12, 2011 Washington Mutual released the Seventh version of its Plan and Disclosure Statement. Woven within the Plan is a settlement agreement that provides for a recovery to equity holders in the form of Newco stock while dismissing charges levied by the Equity Committee against certain creditors for Insider Trading; charges that the Court found to be “colorable claims”. The recovery to equity represents a significant departure from the 6th Amended version of the Plan which did not provide for any recovery to equity.

These changes effectively put a floor of value underneath the litigation tracking warrants ("LTW") in a worst-case scenario if the Court rules against the LTW Holders in the Adversary Proceeding because the Plan provides that, in the event that the Court finds that the LTWs represent equity interests as opposed to either Class 12 General Unsecured claims or equitable lien claims, the LTWs will share a 30% stake in the Reorganized Company pari passu with common equity. In order to find that floor of value one must first determine what the reorganized Company is worth and then determine the proper conversion rate of LTWs into common equity to find the relative ownership percentage of this 30% stake for DIMEQ and WAMUQ. For simplicity’s sake we will assume that the Newco is worth $210 million which is the value assigned by the Court for the purposes of deciding “who gets what” under the Plan. As to the issue of the conversion rate, the Plan provides that the relative value of DIMEQ will be determined to be the lesser of:

The amount estimated by the Bankruptcy Court as the maximum amount in which the Disputed Claims relating to the Dime Warrants may ultimately become Allowed Claims times the per share price of Common Equity Interests on a date established by the Bankruptcy Court bears to the market capitalization of all other Common Equity Interests (as determined by the Bankruptcy Court using such same per share price)
The liquidated amount determined, pursuant to an order of the Bankruptcy Court, as the amount in which the Disputed Claims relating to the Dime Warrants are Allowed Claims times the per share price of Common Equity Interests on a date established by the Bankruptcy Court bears to the market capitalization of all other Common Equity Interests (as determined by the Bankruptcy Court using such same per share price)
The amount established by the United States Court of Federal Claims in the Anchor Litigation, pursuant to a Final Order, as applied in connection with the Dime Warrant Litigation, times the per share price of Common Equity Interests on a date established by the Bankruptcy Court bears to the market capitalization of all other Common Equity Interests (as determined by the Bankruptcy Court using such same per share price)
Such other amount as may be agreed upon by the plaintiffs in the Dime Warrant Litigation and the Liquidating Trustee; provided, however, the recovery in connection with the Dime Warrant Litigation will not exceed the lesser of (1), (2), (3) and (4) above,

I contend that this conversion rate is patently improper because it basically converts one share of DIMEQ into one share of WAMUQ and then adds the relative market caps and divides the total back into the improperly constructed DIMEQ market cap. The Debtor’s conversion method inexplicably ignores the conversion rate provided for by the LTW Agreement and further memorialized in an 8-k filed on March 13, 2003. Under the proper conversion method the “Adjusted Litigation Recovery” is divided by the “Merger Adjusted Stock Price” and then further divided by the number of outstanding LTWs. See calculation below.

So what exactly am I saying is the proper conversion rate? To simplify, we basically have to add the relative value of the LTW claims to the market capitalization of WAMUQ (1.7 Billion shares times the market share price of WAMUQ at a date to be determined) and then divide that total back into the value of the LTW claims. Now there are 4 possible amounts to assign as the value of the LTW claims which includes the lesser of the Estimated Claims ($337 million), the final allowed claims determined by the Bankruptcy Court (TBD), the final allowed claims determined by the U.S. Court of Federal Claims (TBD) and any stipulated amount agreed upon by and between the Liquidating Trustee and the LTW Plaintiffs (TBD or N/A).

We know what the highest possible claim amount is for DIMEQ and that would be the estimated Disputed Claims Reserve amount of $337 million. If one assumes that the LTW Plaintiffs don’t agree to less in a stipulated settlement, then the lowest amount that could be assigned to the LTWs would appear to be in the $228 million context. One can arrive at that value by taking the $356 million “pre-grossup” award from the Federal Claims Court (assuming the additional $63 million award is not awarded) plus the $104 million grossup less estimated litigation and issuance expenses of $22 million and that total then multiplied by a 38.757% tax rate (JPM’s estimate) and then reduced by 15% for the 85/15 split with WMI.

This whole exercise is, of course, a moot point if the Court finds that the LTWs constitute Unsubordinated General Unsecured Claims. The Court may also find that the LTW Claims are secured claims in the event that the Plaintiffs prevail on their Equitable Lien via Constructive Trust theory. In any event, whether the LTWs represent Unsubordinated Claims or Equity Interests and whether the Debtors prevail in their use of an improper conversion rate, it is now clear that the LTWs have value. What is also implicit in all of this is that barring any stipulated settlement between the Debtors and the LTW Plaintiffs, the Court will still have to conduct a final claims estimation hearing for the LTWs.

One final point I will make here is that the Plan currently provides that if the LTWs are deemed to be Equity Interests then they are an impaired Class and are not entitled to vote. Under this Plan construct it would apparently foreclose an LTW Holder from appealing the Judge’s decision to the District Court. Since there are many issues involved in the LTW Adversary Proceeding that are appealable and in the event that the Court finds the LTWs to represent Equity Interests, the LTW Holders should be given an election to either accept the treatment provided for under the Plan and to grant the applicable releases or in the alternative should be given an election to reject the treatment under the Plan, grant no releases, and take up any adverse ruling on appeal.

Conclusion - And most importantly, bottom-lining it:

The max upside in this case for DIMEQ that would result from being classified as a Class 12 GUC claimant or an equitable lienholder is about $3.00 per LTW (versus today ~ 65 cents) before post-petition interest if the full $337 million reserve goes to the LTW Holders. If the federal judgment rate is applied to that award for 3.5 years it moves the recovery up to about $3.20. On the downside, if DIMEQ is deemed to be Equity and if the Debtor prevails in applying the improper conversion rate then the worst scenario based on Plan value would put the DIMEQ security between $0.07 and $0.10.

Distressed Debt News: Lee Bankruptcy Filing

noreply@blogger.com (Hunter) — Tue, 13 Dec 2011 03:24:00 +0000

Today, Lee Enterprises ("Lee" or "the Company") filed for Chapter 11 bankruptcy protection in Delaware. This was anticipated per an 8K filed last week by the Company that stated:

"Pursuant to the Lee Support Agreement and the Pulitzer Support Agreement, the News Release announced, among other things, that Lee and its majority-owned subsidiaries expect to file voluntary petitions for relief under Chapter 11 of Title 11 of the United States Bankruptcy Code on or about December 12, 2011. Lee’s interests in Tucson, AZ, and Madison, WI, are not included in the filing. The Chapter 11 filings will be made pursuant to a “prepackaged” restructuring plan with the support of Lee’s Supporting Lenders (who represent approximately 94% of the total outstanding loans) and the Supporting Noteholders (who have provided unanimous support).

For those interested, the Lee Bankruptcy docket can be found here: Lee Bankruptcy Docket and the main claims agent page can be found here: Lee Claims Agent Page. As usual, we've added the docket to our bankruptcy docket page which can be found here: Distressed Debt Investing collection of bankruptcy dockets.

For reference, as of this evening, Lee Enterprises's term loan as well as its revolver, traded in the 66-68 context. As of the petition date, there was $548M of Term Loan outstanding and and $308M of outstanding borrowings under its revolver.

Negotiations for this pre-pack have been going on for sometime. For those in the market, you may remember Lee attempting to market a refinancing package earlier this year in the April/May time period for its debt maturing in 2012. When that didn't work out, negotiations began and eventually entered into a support agreement in August of this year with votes on the pre-pack being solicited in November.

The essence of the plans is as follows:

$40M DIP via Deutsche Bank will roll into new revolving credit facility
Existing holders of pre-petition credit facility will receive their $689.5M of a new first lien term loan facility and $175M of a new second lien facility (that has been backstopped by Goldman Sachs, Mutual Quest [Franklin Templeton], Monarch, Mudrick, and Blackwell Partners. The first lien facility is set to mature in December 2015, with the second lien maturing in April 2017. The pricing is L+625, with a 1.5% floor and 15% respectively (with a 5 point OID on the second lien)
Second lien lenders will also receive 15% of the outstanding stock on a PF basis
The "Pulitzer" noteholders will increase their coupon to 10.55% (that increase with time) and extend the maturity to 2015 and will see some debt paydown
Existing shareholders will retain their interests (holding 85% of the company before management incentive plans).

I will not that the 8K had slightly different figures for equity retention versus the disclosure statement (87% vs 85%).

Financial Projections from the Disclosure Statement (Exhibit F), are as follows:

Income Statement

Balance Sheet

Cash Flows

LTM EBITDA at Lee is around $170M. This versus the anticipated $990M of debt leads to leverage of 5.8x. This seems awfully high when you consider McClatchy trades at 5.5x today, but this seems to be already reflected in the market given the current trading price of Lee's credit facilities. I.E. With ~$860M of pre-petition credit facilities trading at 67, the market is implying a value of about $575M for the entity. This implies the new first and second lien paper will trade at a steep discount when they begin to trade. With that said, the company is projected to generate free cash flow of about $55M each year in the projection periods which will be used to de-lever the balance sheet.

First day hearings are scheduled for noon tomorrow in Wilmington with standard first day motions for a company putting forward a pre-pack. Lee is expected to exit bankruptcy within 60 days. We will keep readers updated if trading levels get to a price that interests us.

Quick Administrative Post

noreply@blogger.com (Hunter) — Thu, 08 Dec 2011 04:05:00 +0000

Three quick items of business:

1) If you have not, please head on over to our recent poll on what you would like to see on Distressed Debt Investing and let me know your thoughts. Remember, for those filling in a suggestion that I may have missed, I will choose the best suggestion and take that person + a guest out for dinner in New York City in 2012. Just remember to include your email address in the answer box (don't worry - only I will be able to see your suggestion + email addy).

2) Next year, I plan on adding four or five writers to this site that will contribute 1-2 articles/month. I have spoken with a number of interested parties, but particularly I am looking for people that want to have a voice and enjoy discussing / teaching concepts to a broader audience as a whole. For reference, last month had over 125,000 visits to the site from nearly 50,000 unique visitors and RSS subscribers. Whether you are out of work and looking to get your name out there, or established at a firm and just want to talk about investing, or possibly a lawyer that wants to promote business to his firm by discussing a topical issue on bankruptcy, we would love to have you. For those wanting to rename anonymous, I am obviously comfortable with such a move. If you are interested, please contact me at hunter [at] distressed-debt-investing [dot] com.

Update: For those asking what I am looking for in terms of writers, here is what I am thinking:

2 distressed buy side analysts or restructuring professionals focused in the US
1 distressed buy side analyst from Europe
2 bankruptcy lawyers / attorneys that want to write about topical subjects as it relates to distressed debt investing

3) Speaking of the traffic stats above, starting in 2012 and to fund certain projects I will be working on across the sites, I plan on selling advertising on this site specifically. I would like to partner up with a company that not only can advertise here, but can also contribute meaningfully to our readers via a sponsored post that adds value to the community. If you or your firm are interested, please email me.

Thanks!