Introduction to troubled-debt restructuring Corporate Restructuring Tim Thompson

Download Introduction to troubled-debt restructuring Corporate Restructuring Tim Thompson

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<ul><li> Slide 1 </li> <li> Introduction to troubled-debt restructuring Corporate Restructuring Tim Thompson </li> <li> Slide 2 </li> <li> Distressed Firm Workout Chapter 11 (outside option) No Chapter 11 filing Prepackaged Ch. 11 Chapter 11 Reorganization Chapter 7 Liquidation (outside option) Auction or sale </li> <li> Slide 3 </li> <li> Focus of lecture Firm already in distress defined as not able to make debt payments as they come due Choices Renegotiate contracts with creditors out of court (workout) Renegotiate contracts with creditors in court (Chapter 11) Allow the firm to be liquidated by court appointed trustee (Ch 7) Chapter 11 court may order the company be sold to highest bidder Most focus will be on large firms, usually publicly held </li> <li> Slide 4 </li> <li> Insolvency Troubled debt restructuring methods needed because firm is insolvent I.e., it can not meet its obligations as they come due. This is not the legal definition </li> <li> Slide 5 </li> <li> Causes of insolvency Bad luck Economic conditions Competitive position eroded Firm specific factors Bad strategy Bad execution -- mismanagement Fraud Overlevered the company </li> <li> Slide 6 </li> <li> Effect of insolvency Have to recontract with creditors get parties to agree to reorganization liabilities, ownership, control or liquidate Recontracting can be settled out of court Workouts/private reorganizations Or, in court Chapter 11 (reorg) or Chapter 7 (liquidation) </li> <li> Slide 7 </li> <li> Main effect of reorganizations Restructure terms on debt reduce interest payments/principal amounts Extend maturity Substitute equity (or equiv.) for debt What if V is very large? Could be that have too little cash flow, but good value, could offer BH more value, but paid later Not the usual situation </li> <li> Slide 8 </li> <li> What is optimal choice if managers are value maximizing? Is the firm worth more as a going concern? with its own strategy bought out by another firm Or is it worth more liquidated? What is size of the pie and how is it to be sliced? Tough question on both counts! </li> <li> Slide 9 </li> <li> Watch out for incentives on all sides! Creditors Race to the top Dont want firm to go into Ch. 11 In Ch. 11, want you to liquidate inefficiently Shareholders Stay out of Ch 11 In Ch 11, want ongoing firm Managers Depends on what their position looks like </li> <li> Slide 10 </li> <li> Chapter 11 is not first choice Almost all large, publicly traded firms attempt to workout debt before entering Chapter 11 Why do firms attempt a workout? </li> <li> Slide 11 </li> <li> Workouts less expensive than Chapter 11 Gilson, John and Lang (GJL) studied NYSE AMEX firms doing workouts and Ch. 11s in 80s Legal and professional fees higher in Ch 11 Avg length of Ch 11 is longer, especially when workout included exchange offer In workout, only deal with claims in default* In Ch 11, all claims </li> <li> Slide 12 </li> <li> Problems with Ch. 11 Legal/professional fees have priority over other claims, so less incentive to get it done Management by judges Major decisions: file application with court, notify creditors -- file complaints Judges legal requirements claimholders must receive at least what theyd get in liquidation, company not in danger of going bankrupt again (near future) </li> <li> Slide 13 </li> <li> Why would bondholders or lenders agree to workout? Chapter 11 is a protection for the debtor (called the debtor in possession, or DIP) Chapter 11 can extract an even better (worse for the creditor) deal for the DIP than you might get in workout! </li> <li> Slide 14 </li> <li> Advantages to DIP of Chapter 11 New issued debt higher priority than pre-petition debt Interest on pre-petition unsecured debt stops accruing Automatic stay from creditors Easier to get reorg plan accepted because of voting rules </li> <li> Slide 15 </li> <li> Why does firm go to Chapter 11? Creditor holdouts (and advantages above) In workout, have to get all participating creditors to agree Bondholders have incentive to free ride on the settlement Try to trap the free riders by making the exchanged bonds higher priority, shorter maturity Problem worse with public debt, more complex debt </li> <li> Slide 16 </li> <li> LTV decision Judge Burton Lifland Bondholders who tendered in previous exchange offer were entitled to claim equal to market value of new bonds Non exchanging bondholders entitled to claim equal to face value of debt Makes holdout problem worse </li> <li> Slide 17 </li> <li> Rights of management in Ch 11 DIP (debtor in possession) has exclusive right to file first reorg plan for 120 days typically extended, sometimes for years Large management turnover in both workouts and Ch 11s Also, reputation issues </li> <li> Slide 18 </li> <li> Tax disadvantage to voluntary restructuring Tax Reform Act of 1986 More difficult to preserve NOL carryforwards Hard to avoid paying tax on income from forgiveness of debt Revenue Reconciliation Act of 1990 newly exchanged bonds trading at a discount to face value, the firm must book the difference as taxable income </li> <li> Slide 19 </li> <li> Prepackaged bankruptcy Hybrid of workouts and Chapter 11s Firm files Chapter 11 But files reorg plan at the same time (agreed to with secured creditors informally beforehand) Can hurry up the Ch 11 process Not a sure thing! Why do Ch 11 at all? </li> <li> Slide 20 </li> <li> Deviations from Absolute Priority in Troubled Debt Restructuring Corporate Restructuring Tim Thompson </li> <li> Slide 21 </li> <li> Absolute Priority In typical corporate finance treatments of default, assumed that claimants of the firm will be paid according to absolute priority First, secured claimants Administrative claims Employee claims Customer claims Tax claims Unsecured creditors, then equity </li> <li> Slide 22 </li> <li> Deviations from APR common Kaiser, Chap. 11, documents many papers describing deviations from APR Both in Chapter 11 and in workouts Typically, equity and unsecured debtholders receive more than should, more senior claims receive less than should Equity receives more in workouts than in Chapter 11 </li> <li> Slide 23 </li> <li> Do markets expect APR deviations? Generally, yes. Kaisers Chapter 11 suggests that debt markets do not seem to anticipate the eventual APR violations, but most of the literature suggests that markets do, in fact, incorporate these violations into pricing. </li> <li> Slide 24 </li> <li> Betker (1996) Show table </li> <li> Slide 25 </li> <li> If markets efficient, do deviations from APR matter? Still matter, because the noise in how much you would get/lose due to violations leads to inefficient investments in time to find out how large deviations will be in time and effort to limit/increase size of deviations in increases in rates/onerous covenants when you issue debt </li> <li> Slide 26 </li> <li> Why are there deviations? Management bargaining position Factors influencing amount Larger proportion of debt, less violations higher proportion of secured debt/bank debt, etc., less violations More equity percentage held by mgmt. especially if same mgmt. continues employment Manager position looks like shareholder, more! </li> <li> Slide 27 </li> <li> Lo Pucki and Whitford (1990) Managers act more in their own interests than in equity interests, so understanding the distinction is important on case by case basis. </li> <li> Slide 28 </li> <li> Recovery rates How much do bankers/bondholders get back of their original investment in Chapter 11 reorganizations? What is relation between recovery rates and seniority/security? What is relation between recovery rates and public/private/banks? </li> <li> Slide 29 </li> <li> Altman evidence Average recovery rate approx. 40% Recovery rate defined as the price one month after default occurred divided by par value 199136.0% 199023.4% 198938.3% 198843.6% 198775.9% 198634.5% 198545.9% </li> <li> Slide 30 </li> <li> Altman: rec. rates by priority 1985-1991 Averages Type of debtRecovery rate Secured60.51% Senior52.28% Senior subordinated30.70% Subordinated(cash pay)27.96% Subordinated (PIK)19.51% </li> <li> Slide 31 </li> <li> Recovery rates in Eastern Airlines Secured debt with sufficient collateral100% Secured debt, insufficient collateral 11.75% First equip cert100% 12.75% Second equip cert60% 13.75% Third equip cert6% Accrued interest on secured debt57% Capital lease obligations100% Unsecured debt PBGC pension claims15% Manufacturers sub notes11% Conv Sub Debs6% Healthcare claims8% Stock0% </li> <li> Slide 32 </li> <li> Kaiser notes, Franks and Torous Table 12.2 Percentage recovery rates by creditor class exchanges, Chap. 11, and prepacks Conclusions: Recovery rates higher in workouts than Chapter 11s Prepacks more like workouts Pre-solicited somewhat higher than pre- negotiated </li> <li> Slide 33 </li> <li> Kaiser notes, Franks and Torous Table 12.5, form of compensation workouts v. Chapter 11s Conclusions: Cash larger part of distribution in Ch. 11 Bank debt reduced in chapter 11, becomes senior debt Junior debt and preferred receive equity, both methods Equity is larger part of distribution in Ch. 11 </li> <li> Slide 34 </li> <li> Loss in value at Eastern Weiss and Wruck Table 2 Total recover by fixed claimants and equity at resolution of bankruptcy, $2,005.5 million. At filing of Chapter 11, total estimated market value of equity plus different measures of debt, around $4 billion Loss of approx. $2 billion in value in Chap 11 argue was not due to industry conditions Direct costs were $114 million only. </li> <li> Slide 35 </li> <li> What was problem? Uncertainty about going concern v. liquidate Judge allowed managers to use proceeds of asset sales to fund continued operations (at substantial op losses) Some venue shopping? </li> </ul>