4.5 Private credit & Distressed Debt Flashcards

Question

2 types of bankruptcy

Answer 1

1) liquidation (chapter 7) - not a going concern 2) restructuring (chapter 11)

Answer 2

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%

Answer 3

Reduction in amount owed as a result of bankruptcy proceedings

Answer 4

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.

Answer 5

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.

Answer 6

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.

Answer 7

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

Answer 8

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).

Answer 9

When the reorg plan categorizes claims in particular classes, equity last, senior debt first

Answer 10

Before any security holders are paid, employee salaries, taxes, and accounts payable typically need to be paid.

Answer 11

Additional credit provided by secured lenders to debtor companies striving to continue their business operations. Creditors grant DIP financing for a number of reasons. 1) It enables the debtor company to remain in operation and attempt to address debt issues. 2) DIP loans get priority over other debt incurred by the debtor before the Chapter 11 filing.

Answer 12

1) investment grade 2) Leveraged loans

Answer 13

1) The borrowing firm's debt is rated below BBB or Baa. 2) The loan has a coupon rate in excess of 125-200 basis points over LIBOR. 3) Second lien interest after senior secured loans. 4) Similar to high-yield/junk bonds in terms of credit ratings and corporate profile.

Answer 14

Because investors started buying these securities

Answer 15

40%. Borrowers may be unable to pay back loans if credit conditions tighten

Answer 16

80% by Collateralized loan obligations and open end mutual funds If demand for CLOs reduces then financing can become more limited

Answer 17

Senior loans with High priority in bankruptcy

Answer 18

*Lending directly from someone, not a bank* 1) Focus more on assets of company not on credit analysis 2) Mostly secured senior debt 3) unlikely to experience j curve effect (lower fees and higher yields) 4) most loans are to companies with revenues up to 100m, EBITDA of 10m, loan amount 20-50m Lender needs the skills to source the deals, restructuring, law, working with the borrower

Answer 19

Originating loan directly to customers Usually lower interest rates that consumer debt => reduces costs via refinancing Investors in P2P can earn higher yields than on similar risk credit 2/3 of P2P lending is done by institutional investors

Answer 20

*Unsecured intermediate note with a combination of debt and equity* 1) Each note is tailored 2) equity kickers are issued via WARRANTS (call options on stock with very low strike price) 3) equity component can be 5-20% of total equity 4) the higher the coupon the fewer warrants Total return: 15-20% (10-14% coupon, 5-10% equity kicker)

Answer 21

Corporate Debt = firm’s assets - Call option on firm’s assets

Answer 22

1) When the borrowing firm goes public or receives capital via a large equity issuance. 2) Borrowing firm being acquired or recapitalized Mezzanine debt investors receive the face value of the mezzanine debt and the sale of stock from the conversion rights or sale of warrants attached to the mezzanine debt.

Answer 23

They provide financing to middle cap companies, that use mezzanine financing in amount less than 400m

Answer 24

1) it is provided by PE Firms (mezzanine debt funds) => very specific, requires long negotiation to exit (usually sold at a deep discount) 2) medium term (5-7 yrs), fixed coupon 3) mezzanine debt investors focus on total return (debt + future equity participation) 4) often includes payment in kind toggle (PIK Toggle) = allows borrower to decide if coupon payments are made in cash or more mezzanine bonds 5) only interest payments until maturity 6) higher loan to EBITDA multiple. Ex: 4.5 multiple means that company with 10m EBITDA can borrow 45m, with 23m senior debt, 22m mezzanine debt

Answer 25

Lending to a company that is financially back by a PE or Buyout sponsor. In case the company becomes distressed the sponsor injects money into the business

Answer 26

1) management buyout (MBO) 2) growth and expansion 3) acquisition 4) recapitalization 5) CRE financing - gap between first mortgage financing (40-75% LTV) and contributed equity (10-15%) 6) LBO 7) Bridge financing

Answer 27

1) Mezzanine funds 2) Insurance companies 3) Traditional senior lenders (stretch financing) 4) Traditional VC firm

Answer 28

- Limited partnerships managed by GP - Investors are pension funds, foundations - repaid in 4-7 years - significantly smaller than LBO funds (which can be 20+b) - 1-2% management fee, 20% carry Differ in 2 ways: 1) returns are lower (15-20%) - higher for PE 2) team of Mostly financial engineers VS tech knowledge team in PE

Answer 29

Debt that exceeds collateral value. In return as for an equity kicker

Answer 30

1) mezzanine lenders can be on board of directors 2) borrower restrictions (on new debt, dividends, etc) 3) extremely flexible debt structure 4) INTERCREDITOR AGREEMENT (negotiation between senior and mezzanine creditors) 5) Subordination - **blanket subordination** - prevents any prepayment to mezzanine creditors until senior creditors have been paid off completely - **spring** - allows interest payment while senior debt is still outstanding, but prohibits payments in case of default/covenant brake on senior debt 6) Acceleration of payment - require debt to be repaid sooner 7) assignment - mezzanine creditors are not allowed to sell their interests to a third party without prior agreement with other creditors 8) take out provision - give mezzanine debt investors the right to purchase the senior debt after a certain portion of it has been repaid. As a result, they may become the firm's senior debtholders. They then usually convert the debt to equity, thus becoming the firm's largest shareholder. • This is one of the most important specifications in the intercreditor agreement.

Answer 31

1) debt with market price less than 1/2 of principal 2) yields 10% above risk free rate OR has a CCC (Caa) credit rating 3) buy debt from near or in default companies 4) in terms of risk - between LBO and VC

Answer 32

1) inefficient / stale management 2) failed LBOs

Answer 33

1) market is inefficient 2) deep discounts due to illiquidity 3) transform to equity or good returns on discounted debt if company corrects

Answer 34

Credit loss rate = Default rate x loss given default OR Default rate x (1- Recovery rate)

Answer 35

Credit spread = Credit loss rate + Required risk premium

Answer 36

both cyclical To have lower allocations to debt late in the credit cycle (when spreads are tight)

Answer 37

1) active control seeking (most risky and time intensive, 20-25% expected returns) 2) active not control seeking (target return 15-20%, ensure best return on debt) 3) Passive (buy from companies that cant hold distressed debt) 4) non performing loans - focus on collateral value

Answer 38

1) long term, illiquid 2) business risk (company does not recover) That the business is able to execute business plan, more resemble equity investors

Answer 39

1) vulture investors help clean up the market of bad companies 2) the credit cycle is a series of booms and busts 3) most important skill is identifying FULCRUM SECURITY 4) fulcrum security has changed from being subordinated debt to senior secured bank loan 5) negative perception is due to loan to own mentality

Answer 40

VC Backed: 1) failure rate 75% VS 90% 2) failure rate by yr5 19% VS 51% 3) Acquisition rate by yr 5: 4.1% VS 0.36% 4) IPO Rate by yr 5: 7.58% VS 0.02%

Answer 41

1) term 1-3 years 2) high interest rates 3) equity kickers (right to purchase share at the price of the latest round of financing). Warrant coverage 5-15%. 4) interest only period followed by scheduled amortization

Answer 42

Warrant coverage refers to the number of shares lenders receive through warrants (which is a percentage of the loan amount). For instance, a $1 million venture loan with a 5% warrant coverage gives the lender the option to buy $50,000 in equity at some future time at a given strike price.

Answer 43

1) VD Funds 2) Specialized banks

Answer 44

1) 78% US. In 2019 - 130b in start ups, 10-12b in VD 2) Europe 10% VD (uk, france, germany) 3) other regions 6% (1-2m deal size)

Answer 45

12-18% IRR, 3 components 1) fee income, 1-2% of capital 2) interest income 9-15% yield on capital 3) warrant gains, equity kicker

Answer 46

1) reduced equity dilution 2) debt financing is cheaper 3) flexible structure 4) delays the need for equity financing

Answer 47

VD Loss rate is around 3% Because start up failures outnumber loan defaults, as the VDs are paid at the next level of capital raising

Answer 48

1) Less liquid funds had lower price vol. (even after adjusting for smoothing effects of illiquidity). 2) Less liquid funds had lower return correlations (~0.2 vs. 0.8). 3) Distressed & DL (least liquid) outperformed more liquid fixed-income strategies (including MD). Despite results, due to illiquidity understating price vol., not accurate to compare these performances.

Answer 49

Identifying the fulcrum security This because vultures earn the largest profits from holding post-bankruptcy/recovery equity (not from the cash recovery values of debt senior to the fulcrum security).

Answer 50

With continuous compounding

Answer 51

Cash on cash investment, receives coupons twice a year. Not subject to J curve

Answer 52

1/2 number & 2/3 dollar amount of claims in each class of creditors vote in favor of plan

Answer 53

Based on invested capital

Answer 54

1990, 2001, 2008