#16692 - Corporate And Capital Structures - Debt Restructuring

Corporate and Capital Structures:

• Balance Sheet:

• The restructuring generally occurs on the left hand side of the balance sheet.

  • E.g. Renegotiating interest payments on debt.

• It may also occur on the right hand side, although this is ancillary, and the principal focus is still on the left hand side.

  • E.g. Divestment of irrelevant assets.

• E.g. Single project financed by a loan of 200:

• This is because equity is subordinate to debt.

• Equity = Residual claim

• E.g. Single-project firm, to be liquidated after 1 year. Start-up costs = 10,000, of which 5,000 is debt.

  • 2,000 in a secured loan, with 5% interest rate.

  • 1,000 in senior unsecured subordinated notes, with 7.5% interest rate.

  • 2,000 in unsecured convertible debenture, with 3.5% interest rate.

  • 3 common shares.

  • Why the different interest rates?

    • Higher interest rate = Riskers; Lower interest rate = Safer.

    • Secured loan = Safest = 5% interest rate

    • Unsecured + Subordinated note = Riskiest = 7.5% interest rate

    • Convertible = Ability to share in the potential upsides by converting into equity if the company does well = Need to pay for this advantage = 3.5% interest rate

  • How much money will be owed to each class at the end of the year?

    • 2,000 x 105% = 2,100

    • 1,000 x 107.5% = 1,075

    • 2,000 x 103.5% = 2,070

  • How much cash flow does the firm need to generate in order to be solvent?

    • 2,100 + 1,075 + 2,070 = 5,245

    • Cash flow solvency = Ability to pay one’s debt as they fall due.

    • Balance sheet solvency = The nominal value of one’s assets must be equal or greater than the nominal value of one’s debts.

  • At what firm value does it become profitable to convert the debenture into equity?

    • After conversion = 3 + 1 = 4 shares

    • 4 x 2,070 per share = 8,280. This is because each share must be worth more than 2,070 in order for it to be profitable to convert

    • 8,280 + 2,100 + 1,075 = 11,455

PE-led LBOs:

• Re McCarthy & Stone plc:
  

  • They were in the business of retirement accommodation.

  • M&S plc was the entity that was publicly traded on the LSE. All outstanding shares in M&S plc was acquired by BidCo and delisted.

  • The assets of M&S plc are held by a subsidiary, M&S (D) Ltd.

  • M&S (D) Ltd holds the shares of the other subsidiaries further down in the corporate chain.

  • BidCo acted as the borrower in the acquisition financing.

    • Facilities A, B, and C: Senior term loans.
      First-ranking security over certain assets, second-ranking security over other assets. Guaranteed by other group companies.

    • Facility D: Senior property revolving credit facility.
      First-ranking security over assets over which ABC rank second, and second-ranking security over assets over which ABC rank first.

    • Facility E: Senior working capital revolving credit facility. Pro rata loss sharing agreement with ABC.

    • Facility F: Second lien facility.

    • Mezzanine facility.

    • Investor loan notes. These were structurally subordinated and held by an entity higher up in the corporate chain.

    • Numerous layers of debt, and complex interactions between different layers.

• IMO Car Wash:
  

  • They were the largest carwash company in the world.

  • Acquired by US-based PE fund, Carlyle, using leveraged financing.

  • Senior facility issued by Bluebrook.

  • Mezzanine facility issued by Spirecove.

  • Both facilities came with a first-priority security over all assets of Bluebrook, IMO (UK), and Spirecove.

    • They were linked through an intercreditor agreement.

    • Senior creditors to be paid first, and mezzanine second, only after full payment has been made to the senior creditors..

    • Mezzanine creditors had an option to purchase the senior facilities.

    • Waterfall clause: Proceeds deriving of enforcement to be paid first to senior creditors and then to mezzanine.

  • Mezzanine creditors argued that value broke at their level, and they therefore ought to have been entitled to participate in the scheme of arrangement.

  • But, if firm value really exceeded the nominal value of the senior facilities, they would have exercised their option to purchase the senior facilities.

• Re Countrywide plc:
  

  • Countrywide was in the business of making home mortgage loans.

  • Country wide was publicly traded.

  • The acquisition financing was injected into HoldCo 4.

    • Senior revolving credit facility (“SCRF”):
      Secured by first-priority fixed and floating charges over all assets of HoldCo 4, Countrywide, and guarantor subsidiaries. Priority in relation to proceeds of enforcement of floating rate notes (“FRNs”).

    • Senior secured floating rate notes (“Cash-pay FRNs”).

    • Senior secured floating rate election FRNs (“PIK election FRNs”):
      Both types of FRNs were secured by first-priority fixed and floating charges over all assets of HoldCo 4, Countrywide, and the guarantor subsidiaries. They were also subordinated to the RCF in relation to the proceeds of enforcement.

    • PIK = Payment in kind (i.e. additional debt) rather than cash, for tax purposes.

    • Senior notes:
      Secured by second-priority “pledges” of assets of HoldCo 4 and Countrywide.

    • RCF, FRNs, and senior notes secured by guarantees by Countrywide and the guarantor subsidiaries.

  • Note the comprehensive security interests that covered nearly all the group assets + comprehensive guarantees by the group subsidiaries.

• These are all leveraged buyouts.
  

  • Layered financing structures.

  • Series of NewCos that do not have any holdings; they are merely SPVs that issue the necessary deb instruments for acquisition financing.

  • The target essentially pays for its own acquisition. The debt is serviced using the cash flows generated by the target group, and the debt holders are given security over the target’s assets.

• The consolidated balance sheet of the target carries much more debt following the acquisition. This becomes an issue during economic downturns.

  • The target group must service a much higher level of debt with essentially the same cash flow generated by the same operating subsidiaries.

  • The “rescue culture” came hand in hand with the rise in PE transactions.

    • Economically unviable = Ought to liquidate.

    • But financially troubled because of the increased debt load and still economically viable = Ought to be rescued.

  • Note: The assets held by some of the entities are essentially the shares in the subsidiaries immediately below them.

• Senior Debt:

  • Term loan = For capital expenditure.

    • Repayable at a predetermined maturity date.

  • Revolving credit facility = For working capital.

    • Can be drawn down on by the borrower as and when needed.

  • Amortising VS Non-amortising (i.e. “bullet”) debt.

    • Amortising = Repaid in installments.

    • Bullet = Repaid all at one go.

  • Guaranteed by group companies.

  • Secured on the assets of group companies through fixed and floating charges.

  • Typically held by traditional banks or syndicates of banks.

    • Syndicated loans are arranged by an arranging bank.

    • Each participating bank makes a separate loan and are severally (and not jointly) liable.

    • The loan is administered by an agent bank.

    • A majority (by loan value) of the lending banks may decide on certain important matters.

• Second lien debt:

  • Typically a single, non-amortising term loan.

  • That is contractually or structurally subordinated to the senior debt.

  • And are secured on a second-ranking basis.

  • Held by hedge funds and other institutional investors.

    • Note the absence of traditional banks.

• Mezzanine debt:

  • Typically a single, non-amortising term loan.

  • May be syndicated

  • Contractually or structurally subordinated to the senior and second lien debt.

  • Carries a higher rate of interest than the senior debt.

  • May be combined with equity warrants.

  • Will typically be paid off through an issue of high-yield, junk bonds

  • May take the form of PIK notes (where interest is paid out in (further) debt rather than cash).

  • May be convertible.

• Debt securities:

  • Will typically feature at the mezzanine level (and further down the chain).

  • Bonds:

    • Negotiable instruments representing long-term debts (of more then 10 years).

    • May be secured (known in the US as bonds) or unsecured (known in the US as debentures). In the UK, both are called debentures.

  • Notes:

    • Bonds with maturity between 1 and 10 years.

  • Commercial papers:

    • Short-term: Maturity of less than a year, typically between 1 to 6 months.

    • Most actively traded.

  • Interest rate:

    • Fixed or floating (which is pegged to a benchmark rate such as LIBOR).

    • Floors, ceilings, collars, and reverse floaters.
      Floors = Minimum; Ceilings = Maximum; Collars = Combining floors and ceilings, so that interest is kept within a certain range; Reverse floater = Varies inversely.

    • Payable in intervals of 6 or 12 months, or upon maturity.

  • Maturity date:

    • May be short- or long-term.

    • The principal is repayable on the maturity date.

  • Subordination and security:

    • The debt securities are typically subordinated to the claims of other creditors.

    • Asset-backed securities = Secured on the issuer’s assets.

• Quasi-equity:

  • Loan notes:

    • Structurally subordinated.

    • Interest is tax deductible.

    • Possibly convertible.

  • Preference shares:...