4.5 Private credit & Distressed Debt Flashcards
Types of debt
1) leveraged loans & direct lending - private credit
2) mezzanine & distressed debt - referred to as PE due to equity like risks
3) Venture Debt - debt given to VC
Amount of dry powder? What can oversupply and under supply of it do?
200b of private debt investments
•Oversupply of dry powder may reduce credit spreads & weaken covenant protections.
• Undersupply may mean sufficient private credit may not be available when needed.
3 Private credit funds:
1) Interval funds - Semi-liquid, semi-illiquid closed-end funds; offer to repurchase from investors some of funds’ outstanding shares at regular time intervals (e.g., monthly); thus, do not trade in secondary market. 5-7 yrs
2) Drawdown funds - investors commitments are called as needed (e.g., to meet expenses or investments), providing partnership-like liquidity. May have indefinite term or fixed life. May purchase bank loans or bonds or underwrite new debt.
3) Funds with loan-to-own objective - Make loans with intention of converting them to ownership stake in debtors’ firms. Loan-to-own investment: investors focus on value of borrower’s assets that may be repossessed if borrower cannot service the loan
Fulcrum security
Senior-most debt security most likely to be repaid with equity in reorganized firm.
Reorganized firm’s equity may be substantially undervalued in its first year; then may increase.
PE funds involved in reorganizations may invest in fulcrum securities.
PE equity funds VS Hedge fund investment duration in distressed firms?
PE take longer positions
Hedge funds - shorter positions
Syndicated loans?
Loan to one borrower, multiple lenders
Bonds VS Loans
1) Liquidity:
Bonds - more liquid
Loans - less liquid, may have higher yields due to liquidity premiums
2) Default risk:
Bonds - junior to loans, usually unsecured
Loans - most senior, usually secured
3) Interest rate risk:
Bonds - higher risk, non callable, fixed rate
Loan - lower risk, callable, floating rate
Floating rate bonds that daily reset to short term market interest rates have the same interest rate risk as?
Cash
Change in bond price for an increase in interest rates is expressed as?
Bond price change = - Duration x Interest Rate increase
When is duration and when is modified duration used?
Duration - cont compounded rate
Modified duration - discrete compounded rate
Modified duration formula:
y - stated annual yield (no effects of comp interest)
m - number of compounding periods per year
y/m = period non annualized rate
Effective interest rate includes what? Formula?
Includes effects of compounding
Investment grade levels from Moody’s and SnP?
Moodys - Baa and above
SnP BBB and above
3% sovereign debt yield, credit spread for A rated bond is 1% and for B rates 2.8%. What is the yield of the debt in 2 scenarios?
3+1 = 4% a rated
3+2.8=5.8% b rated
Spread of yields in 2021 of treasuries and high yield bonds?
3.4%
Credit spread definition
Difference in vield between two debt instruments of similar maturities, one with credit risk and the other with little or no credit risk.
In other words, it is the excess yield on a credit risky debt instrument relative to the yield on a debt instrument of similar maturity with little or no credit risk.
Indenture definition?
Contract between a lender and a borrower that states the terms of the loan (e.g., interest rate, maturity, face value, payment schedule, and covenants).
Covenants definition
Promises made to the lender that certain activities will or will not be carried out
4 types of covenants
1) Affirmative - conditions with which borrowed must comply. Requires disclosure of financial information
2) Negative - prohibited activities (result in default)
3) Incurrence - require certain actions to be taken or not after a certain event occurs
4) Maintenance - standard is regularly met to avoid default
Covenant lite (cov-lite) loans are? Key stats? Recovery rate?
Loans will few covenants
They have been increasing, which results in higher distressed debt levels
75%+ of loans in US in 2018 were cov lite
50% of loans in Europe in 2016, and 5% in 2007
Recovery rate:
1) first lien - from 77% to 43%
2) second lien - from 43% to 14%
5 ways that covenants can control risk (Antezak, Lucas, and Fabozzi (2009)
1) preservation of collateral - lenders require 50% LTV for inventory, 60% PPE, 80% inventory
2) appropriation of excess cash flow - excess cash flow to go to paying down debt
3) control of business risk (limit risky activities)
4) performance requirements
5) reporting requirements
Problems with the LBO of Refinitiv (2018)
1) Borrower could prepay the unsecured debt before the secured debt (which is at the top of the capital structure and typically paid first).
2) The company could be sold without first having to pay off its debt.
3) No limit on dividend payments
6 levels of Capital stack from highest priority to lowest?
Unitranche loans definition? Effect on mezzanine lending?
Hybrid loan that combines senior and junior debt into one loan at one blended interest rate
Mezzanine is decreasing because of this and rise of direct lending
2 types of bankruptcy
1) liquidation (chapter 7) - not a going concern
2) restructuring (chapter 11)
Recovery rates for bankruptcy companies?
1) first lien / secured bonds 76% on first lien, 56% on secured bonds, 44% senior unsecured bonds
2) Subordinated debt 20-30%
3) equity: 0%
Haircut in lending
Reduction in amount owed as a result of bankruptcy proceedings
6 chronological steps in Chapter 11 bankruptcy
1) Debtor files a petition with the court for protection under Chapter 11.
2) The filing prompts an automatic stay by the bankruptcy court, which suspends actions by the debtor company’s creditors.
3) If the debtor company has a prepackaged reorganization plan, it can request court approval of the plan at the same time as filing for Chapter 11 protection.
4) If no prepackaged reorganization plan exists, the debtor in possession has 120 days after filing for protection to file a reorganization plan, and an additional 60 days to convince the creditors to accept the plan. The plan has to be accepted by the creditors and then confirmed by the bankruptcy court.
5) If half the number and two-thirds of the dollar amount of the claims in each class of creditors accept the plan, then bankruptcy court approval is sought. If the plan is not accepted, the debtor company must submit a new plan and renegotiate with creditors, or the bankruptcy court may cram down a plan on all parties.
6) After the 180-day exclusive period is over, any claimant may submit a reorganization plan to the court. If the debtor company accepts the plan, bankruptcy court approval may be sought.
Plan of reorganization definition, what does it include?
Business plan the debtor proposes for emerging from bankruptcy protection as a viable company.
It includes how creditors and shareholders will be paid.
Creditors are entitled to vote on the plan. If all impaired classes of security holders vote in favor of the plan, the bankruptcy court will conduct a confirmation hearing.
If the requirements of the bankruptcy code are met, the plan is confirmed and a newly reorganized company emerges from bankruptcy protection.
Prepackaged bankruptcy filing
Some debtor companies may agree on a reorganization plan with their creditors before filing for Chapter 11 protection, where creditors typically agree to compromise on the debt in return for equity in the reorganized company.
In this case, after filing with the bankruptcy court and submitting the previously negotiated reorganization plan, the company can quickly emerge with a new structure.
Cram-down definition? When can it occur?
Provision in the bankruptcy proceedings that enables the bankruptcy court judge to execute a reorganization plan over the objections of an impaired class of security holders
A reorganization plan may be confirmed over the objection of a class of security holders as long as the plan:
1) does not unfairly discriminate against members of that class
2) is fair and equitable with respect to members.
Usually option of last resort
Blocking position definition? Impact?
One or more creditors can block a reorganization plan if they hold more than 1/3 of the dollar amount of any claimant class.
A blocking position forces the debtor company and other parties to negotiate with the blocking creditors).
Since when is reorganization possible in EU?
2022
Mezzanine debt, High yield bonds and Leveraged loans compared on:
1) security type
2) credit rating requirement
3) level of loan covenants
4) term
5) amortization
6) coupon type
7) coupon rate
8) prepayment penalty
9) recovery if default
10) liquidity
Main categories of venture lenders
Key terms of VD
CAPM Formula?
