Chap 22 Private Credit and Distressed Debt Flashcards
What is a fulcrum security in PF fund strategy?
Senior-most debt security in a reorganization process that is not paid in full with cash but rather is the security that is most likely to be repaid with equity in the reorganized firm
Why an increase in the portion of loans that are covenant-lite will affect default rates and magnitude of losses given default
Covenants protect the creditor’s interests by requiring the borrower to comply with certain requirements (e.g. debt service coverage ratio) or prohibit them from certain actions (e.g. increasing debt load or issuing higher seniority debt). Covenant-lite means the borrower can get over-leveraged. If they default, and likely they will, creditor risk increases
Define mezzanine financing
Mezzanine debt - between the ceiling of senior secured debt and floor of equity. Mezzanine finance defies generalization, it’s highly customized and focused on equity appreciation while maintaining the characteristics of high yield debt (principal & interest payments)
Does mezzanine debt with an equity kicker exhibit the J-curve return pattern of private equity?
Nope, mezzanine fund, not J-curve effect is not a factor.
Advantage of mezzanine - immediate cash-on-cash return, bears a coupon that requires twice-yearly interest payment to investor.
Hence, mezzanine financing funds can avoid early negative accounting returns associated with VC & LBO funds
How mezzanine financing can lower a firm’s weighted average cost of capital?
For the size of companies that tend to utilize mezzanine financing, there are inefficiencies and imperfection in the open capital markets
Difference between mezzanine debt and high-yield bonds and leveraged loans
Seniority: from high to low
Leveraged loans, high yield bonds, mezzanine
Term: from long to short
high yield bonds > mezzanine debt (4-6yrs) = leveraged loans
Liquidity: from high to low
Leveraged loans, high yield bonds, mezzanine
Define distressed debt
Debt that has deteriorated in quality since issues and the market price is less than half its principal value, yields 1,000 or more basis points (10% or more) over riskless rate or has a credit rating of CCC or lower
Two sources of distressed debt
Company with deteriorated financial condition
Debt issued by PE or LBO firms
Difference between Chap 7 and 11 of bankruptcy in US
7 - company is no longer viewed as a viable buisness and assets are liquidated
11 - attempts to maintain operations of a distressed firm that may be viable
Who’s the initial investor in debtor-in-possession financing
Senior and subordinated creditors
