Restructuring Flashcards
What are the two sides an RX banker can advise on and which tends to be more time-consuming?
Debtor: Company faces adverse financial situation; urgency of situation can vary widely; if debtor is insolvent, that means it does not have adequate value to satisfy debt obligations (usually more hands-on and requiring more work)
Creditor: Includes stakeholders who hold claims to debtors (debt lenders or equity holders); external stakeholders including suppliers
What is the most common reason for a company becoming distressed and requiring RX?
Unmet contractual obligation as catalyst. Most frequent reason is shortage of liquidity, usually due to deterioration of financial performance.
What is the difference between a Chapter 11 and Chapter 7 bankruptcy?
Chapter 7: Pure liquidation of distressed company; all assets liquidated and disbursed to stakeholders following waterfall.
Chapter 11: Company reorganization overseen by court with objective to emerge from bankruptcy with reasonable chance to return to state of normalcy; involves plan or reorganization
What does out-of-court-restructuring involve and why do many RX bankers consider it to be the ideal option for a distressed company?
Mostly based on modifying debt terms for near-term preservation of cash to prevent liquidity shortages. Usually preferred because quicker and less costly. Other common arrangements with creditors:
- Extending Maturity
- Changing Interest Expense Schedule (Cash to PIK Interest)
- Debt-for-Debt Swap (Offer debt of higher seniority for more borrower-friendly terms)
- Debt-for-Equity Swap
- Equity Interest (Warrants, Conversion Optionality)
Out-of-court RX has historically been known for being expensive and time-consuming. Which development has helped lessen these concerns?
Traditional Chapter 11 starts process from scratch and can take >1 year to complete (“free-fall” because of hectic nature). Plan of reorganization (POR) helps key stakeholders understand problems and preliminary voting can be done that ensures majority support.
What is the absolute priority rule (APR), and what would be an example when it is not followed?
APR serves as basis for waterfall structure pecking order in which recoveries are paid out. APR states no lower-priority class is entitled to be repaid until higher-priority classes have been paid. In reality there are often marginal deviations, as unsecured creditors and equity holders can be given small payments called “tips”.
What is the difference between the “going concern” and liquidation analysis valuation?
“Going Concern” Approach: Traditional valuation methodologies (DCF, Comps) with higher WACC assumptions to reflect added risk; assumption of operating further
Liquidation Analysis: Total value of liquidated assets; floor valuation; assumption of not operating any longer; if liq. Analysis is higher than “going concern” than company should be liquidated.
What is the purpose of the “feasibility test” under Chapter 11 bankruptcies?
Long-term goal of Chapter 11 is long-term sustainability and revert to “going concern”. In feasibility test, debtor’s financials are projected and examined to ensure financial solvency under current POR.
One of the main benefits of Chapter 11 is access to DIP financing. Why is this considered to be of such high importance?
DIP (debtor in possession) is important because most distressed companies suffer from lack of liquidity. Once distressed, financing becomes virtually impossible but court can provide protections for incentivization of lenders. Some companies solely file for Chapter 11 because of inability to raise capital and need urgent financing.
What does it mean when a DIP loan is “priming” senior secured claims?
Means new claim through DIP is superseding more senior lender (“super priority”) and added to top of capital structure. Court approves of priming lien only if doing so is deemed to be beneficial to all claim holders and necessary for debtor to continue operating.
What is the “fulcrum security” in RX?
Most senior security that does not receive full recovery. Therefore, the holder is in a position of leverage when it comes to negotiating the POR.
You have a leverage ratio of 5 and a coverage ratio of 5. What is the interest rate?
Leverage ratio = Debt / EBITDA = 5
Coverage ratio = EBITDA / Interest Expense = 5
Interest rate = Interest Expense / Debt = 1 / (LR * CR) = 1 / 25 = 4%
If we have EBITDA of $40m, EV/EBITDA of 5x, senior debt of $150m and unsecured debt of $100m, what is the value of equity and the value of debt if a chapter 11 is imminent? Where would the unsecured debt trade?
EV = $40m * 5 = $200m -> covers senior debt and 50% of unsecured debt (200 – 150). Unsecured debt will be impaired in Chapter 11. They are therefore the party that can vote on a plan of reorganization (POR) and will get reorganized equity as compensation. Therefore, you would not necessarily expect unsecured debt to trade at 50 but rather some amount above it, reflecting the reorganized equity they will portenitally get.
Why RX?
- Breath of industries as junior
- Unique nature of RX deals
- Confluence of finance, law, psychology
- Very high responsibility early on
Unsecured bonds due in one year. They’re $50m and company has $70m in liquidity. Nothing else matures before these bonds. Yet the unsecured bonds are trading at 60 cents on the dollar. What’s going on?
Capital structure dynamics come to play here. You are looking for “springers” or “springin maturities”, which means that if some liability is not repaid up to a certain amount at some point, another liability’s maturity will “spring forward” and will have to be paid sooner. Additionally, liquidity doesn’t have to be cash but can be revolver (that would increase interest payments or can not be drawn up to a certain amount).
