Professional Documents
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Agenda
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Agenda
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Defining Distress
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Broad definition Below investment grade debt (CCC or lower) YTM > 1,000bps over risk-free Treasuries
Companies fall into distress for a number of reasons: Over-leveraged Liquidity issues Slipping credit Poor operating performance Accounting irregularities Inadequate cash flows Competition
Corrective Actions
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Corrective actions Asset restructuring Financial restructuring = private workout or Ch 11 If all else fails Ch 7 = Company shuts down & assets distributed to creditors. Ch 11 = Stabilization, reorganization & approval Creditors may include: Banks Utilities & other trade vendors Investors with bonds Interest Holders
Ch 7 Liquidation Priority
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1. Secured claims 2. Administrative expenses 3. Post-petition unsecured claims
Chapter 11 Process
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bankruptcy court supervises the reorganization of the companys contractual obligations. This process can be divided it into 13 steps, embedded in three primary phases: (1) Filing
(2) Negotiation (3) Approval
Filing P H A S E 1
PHASE 2
Two types of petitions can filed with a bankruptcy court: (1) a voluntary petition, filed by the debtor or, (2) (a less common) an involuntary petition, filed by creditors. Upon filing a petition the debtor automatically assumes the identity of a debtor-in-possession (DIP). A DIP refers to a debtor that keeps possession and control of its assets while undergoing reorganization under Chapter 11.
2. First day motions (FDMs) are then filed by the debtor, usually 1- 3 days following the petition filing
and are intended to ensure that the debtor can operate its business normally with regards to its employees, suppliers, customers and other stakeholders.
3. The court considers the FDMs at a first-day hearing that usually takes place on the first or second
day of a Chapter 11 case. The court then issues first-day orders (FDOs) approving the FDMs.
4. The debtor obtains DIP financing to fund its ongoing operations and operates in the normal course of
business as a DIP.
5.
Within the first two weeks of a case, a government agency, called the U.S. Trustee appoints the Official Committee of Unsecured Creditors (the Creditors Committee) to deal with restructuring related issues. The U.S. Trustee will usually try to include several types of creditors (trade creditors, bondholders, etc.) so that the creditors committee is a representative body.
PHASE 3
The Meeting of Ceditors (often referred to as the Section 341 Meeting), which is a joint meeting of the debtors representatives and the creditors, typically occurs approximately 30-65 days after a Chapter 11 filing. At this meeting the U.S. trustee and creditors may question the debtor under oath concerning matters regarding the nature and location of assets such as reporting its monthly income and operating expenses, establishing new bank accounts, and paying current employee withholding and other taxes. A notice is sent out to anyone who may have financial or other claims against the debtor requiring that they submit a proof of claim by a specific date or be barred from asserting that claim. This date is called the claims bar date. Once the court has gathered all of the claims that resulted from the bar date notice, hearings are held to determine the value of any claims that are disputed. The debtor finalizes its long-range strategic business plan and develops a plan of reorganization, which sets forth how the debtor plans to repay its creditors. The debtor has the exclusive right to propose and file such a plan of reorganization during the first 120 days of the Chapter 11 process (called the exclusivity period). If the debtor is proceeding in good faith, the exclusivity period may be extended (or in other cases reduced) by the bankruptcy court but may not exceed 18 months. After the exclusivity has expired, a party in interest or the U.S. Trustee may file a competing plan. The debtor must submit to the court a Disclosure Statement (DS) with its proposed plan of reorganization. The DS is a document presents information on: (a) the debtors current and projected financial conditions, (b) the debtors proposed plan for paying its creditors and (c) the business case for why the Plan should be approved. After this DS is filed, the court must hold a hearing to determine whether the DS is approved. acceptance of its plan. The court may extend (up to 20 months) or reduce this acceptance exclusive period.
7.
8.
9.
10. The debtor has 180 days after the petition date or entry of the order for relief (in the case of involuntary) to obtain
P H A S E 3
The debtor will then seek bankruptcy court approval, or confirmation of its plan of reorganization. The court holds hearings to consider whether the Plan of Reorganization complies with the requirements set forth in the Bankruptcy Code. If confirmed, the debtor may emerge from Chapter 11 as a reorganized company and operate its business as described in its plan of reorganization. A final decree closing the case must be entered after the estate has been fully administered. Local bankruptcy court policies generally determine when the final decree is entered and the case closed.
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If the court approves the plan of reorganization, it is confirmed and usually within a few days the plan becomes effective. At that point, the company emerges from Chapter 11 as a reorganized entity.
A companys securities may continue to trade after Ch11 filing. There is no federal law prohibiting securities trading of bankrupt firms.
However, trading can be limited due to trading orders from the court.
If company emerges, creditors and bondholders generally become the new Plan of reorganization usually cancels existing shares, because secured and
unsecured creditors are paid from the companys assets before common stock holders. So, if liabilities > assets = $0/share.
bankruptcy proceedings; Ticker Alone = Newly issued shares.
Note Ticker + Q = Bankruptcy filing; Ticker + V = Trading during Post-emergence, bond holders may receive new stock, warrants, new
U.S. Issuers Non-Financial Issuers (Excludes SICs 60-69) Issuers undergoing pending Chapter 11 proceedings Issuers that have not been acquired since the bankruptcy filing
Trade claims & receivables Common stock, preferred stock, PIPEs, rights &
warrants High yield bonds, corporate & municipal bonds Below par bank loans, DIP loans, bridge & mezzanine loans Collateralized debt, second lien notes, & real estate assets Futures, options, swaps, & indices
bonds As of 2008, approximately $200B of the $900B US high yield market can be considered distressed. Distressed securities markets are highly inefficient Securities often sell at deep discounts
Investors Skills
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Skill sets are highly specialized Legal backgrounds Restructuring expertise Strong negotiating skills Extensive networks Asset valuation skills
ACTIVE
PASSIVE Controlling Non-Controlling
Seek
Involvement
Horizon
Opportunity
2-3Y
Always
1-2Y
Always
Target Returns
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Investments made during economic downturns Profits realized during bull markets Targeted annual returns rest in 20-25% range On average = 12%
Distressed Portfolios
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assessment Investments based on market/trading dynamics, assessed position values, risk/return profiles, etc. Portfolios based on:
Standard risk management measures Arbitrage risk Sector diversification and position limits Leverage limits Credit information (past, present & future) Tail risk Cost & effectiveness of hedging instruments Liquidity analysis
Outright short Bearish views on companys credit fundamentals Often done through CDS purchases Long/short Assumes securities are undervalued (overvalued) and will depreciate (appreciate) Capital structure arbitrage Mispricing between securities of the same issuer Value trading Assumes securities undervalued; purchased before Reorganization Plan announced or immediately following restructuring Rescue financing Lending to companies prior to Ch 11 filing
Agenda
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Defaults
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Defaults
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12/8
11/26 11/10 10/31
3,299
3,325 3,400 2,913
2,947
2,840 2,323 1,842
0251
6361 5731 2869
9/26
9/15 9/5 8/4
309,731
13 2,178
283,645
484 1,941
6035
6211 6798 1531
693,000 613,000
4/10
2/5
1,250
894
1,098
1,149
4512
4213
Agenda
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FAS 157
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Previous fair value accounting standards Does not require any new fair value measurements Does require new and expanded disclosures Establishes a three level hierarchy Categorization primarily depends on observables inputs
Hierarchy
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Level 1:
Positions for which observable inputs used to
Hierarchy
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Level 2:
Observable inputs are quoted prices for: similar assets in active markets, Or, quoted prices for: identical or similar securities in inactive markets, or
Hierarchy
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Level 3:
When there are not enough observable market
inputs for the valuation to comply with the Level I or Level II requirements.
Level III valuations represent the most difficult path Additional disclosures are required for Level III assets.
Which Level?
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Distressed securities may fall into Level 2 or Level 3 High yield distressed debt securities may fall into
Level 2
Bankruptcy claims may fall into Level 2 or 3 Nonperforming assets may fall into Level 2 or 3
Reorganization value for fresh start Creditor or debtor committees Analyzing bankruptcy claims
Conclusions
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driven strategies Company-specifics often drive prices (not stock market) = Investors research critical Many valuation approaches but few KEY factors:
Fundamentals! Understand the law and the state of the economy Examine management quality and motivation Know the creditors involved and claim complexity Diversify distressed portfolios Patience during reorganization/workout process
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