distressed securities primer

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7th Annual Distressed Investing Forum (Feb. 2008)

TRANSCRIPT

  • 1. BY:RICK MARTIN & ELPIDA TZILIANOS Valuation Considerations for Distressed Securities

2. Agenda

  • Overview of distressed securities
  • Defaults and availability of distressed debt
  • Fair value and distressed securities

3. Agenda

  • Overview of distressed securities

4. Defining Distress

  • Broad definition
  • Below investment grade debt (CCC or lower)
  • YTM > 1,000bps over risk-free Treasuries
  • Priced at or below 80 cents on the dollar
  • Highly concentrated in debt securities of companies in headed toward restructuring, bankruptcy, or liquidation
  • Market primarily consists of debt securities caught up in
    • Ch 11 Reorganization
    • Ch 7 Liquidation
    • Other extraordinary transactions (e.g.,out of court restructuring)

5. What Causes Distress?

  • Companies fall into distress for a number of reasons:
    • Over-leveraged
    • Liquidity issues
    • Slipping credit
    • Poor operating performance
    • Accounting irregularities
    • Inadequate cash flows
    • Competition

6. Corrective Actions

  • 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

7. Ch 7 Liquidation Priority 8. Chapter 11 Process

  • Under Ch 11, a company attempts to stay in business while a 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

9.

  • A case filed under Chapter 11 of the United States Bankruptcy Code is typically used to reorganize a business, i.e., a corporation, sole proprietorship, or a partnership. The Chapter 11 processes can be divided it into twelve steps, embedded in three primary phases: (1) Filing, (2) Negotiation, and (3) Approval.
  • It is important to note that stock and commodity brokers are not eligible for Chapter 11 filings and may only file Chapter 7 petitions.

Ch 11 Filing Process Phase I PHASE2 First Day Motions(1-3 days) First Day Orders(1-3 days) Creation of Creditors Committee(2 weeks) DIP Financing(2-3 weeks) Filing Avoidable Transfers(90 days - 2yearsPriorto Filing) 10. Phase I: Steps 1-5

  • 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 adebtor-in-possession(DIP). A DIP refers to a debtor that keeps possession and control of its assets while undergoing reorganization under Chapter 11.
  • First day motions(FDMs) are then filed by the debtor, usually1- 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.
  • The court considers the FDMs at a first-day hearing that usually takes place on thefirst or second dayof a Chapter 11 case. The court then issues first-day orders (FDOs) approving the FDMs.
  • The debtor obtainsDIP financingto fund its ongoing operations and operates in the normal course of business as a DIP.
  • Within the first two weeksof a case, a government agency, called theU.S. Trusteeappoints 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.

11. Ch 11 Filing Process Phase II Section 341 Meeting(Approx. 30-60 days) Disclosure Statement(Timing Varies) Voting on & Acceptance of the Plan(Timing Varies) Claims Bar Date(4-6 months) Plan of Reorganization(Timing Varies) PHASE 3 PHASE 1 12. Phase II: Steps 6-10

  • 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 occursapproximately 30-65 daysafter 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 aproof of claimby a specific date or be barred from asserting that claim. This date is called theclaims 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 aplan of reorganization , which sets forth how the debtor plans to repay its creditors. The debtor has theexclusive rightto propose and file such a plan of reorganization during the first120 daysof the Chapter 11 process (called theexclusivity period ). If the debtor is proceeding in good faith, the exclusivity period may be extended (or in other cases reduced) by the bankruptcy court butmay 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 aDisclosure 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 theDS is approved .
  • The debtor has180 daysafter the petition date or entry of the order for relief (in the case of involuntary) to obtainacceptance of its plan.The court may extend ( up to 20 months ) or reduce this acceptance exclusive period.

13. Ch 11 Filing Process Phase III Post-Confirmation: Modification/Administration(Timing Varies) The Final Decree(Timing Varies) Emerging from Chapter 11(Timing Varies) Revocation of Confirmation(At Most, 180 daysPostConfirmation) Plan Confirmation(Timing Varies) PHASE 2 14. Phase III: Steps 11-12

  • 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.
  • If the court approves the plan of reorganization, it is confirmed and usuallywithin a few days the plan becomes effective . At that point, thecompany emerges from Chapter 11as a reorganized entity.

15. Chapter 11 Trading Securities

  • A companys securities may continue to trade after Ch11 filing.
  • There is no federal law prohibiting securitiestrading of bankrupt firms. However, trading can be limited due to trading orders from the court.
  • These investments are very risky.
  • During bankruptcy bondholders stop receiving interest and principal payments and stockholders stop receiving dividends.
  • If company emerges, creditors and bondholders generally become the new equity holders.
  • 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.
  • Note Ticker + Q = Bankruptcy filing; Ticker + V = Trading during bankruptcy proceedings; TickerAlone=Newly issued shares.
  • Post-emergence ,bond holders may receive new stock, warrants, new bonds, cash, or a combination in exchange for their bonds.

16. Pluris Chapter 11 Bond Index

  • Bonds in the Pluris Chapter 11 Bond Index include secured and unsecured, senior and subordinate notes.
  • Generally, inclusion criteria for the Pluris Chapter 11 Bond Index are:
        • U.S. Issuers