Intro to Restructuring

Background:

  • For most bankruptcies, you won't even know it's happening as it's happening
  • In a sophisticated financial system, bankruptcy should not equal the end of the business because companies are generally worth more alive than dead. Instead, business is transferred from equity shareholders to the lenders
  • Restructuring: process where a new capital structure is determined
  • Restructuring Investment Bankers work with distressed companies and/or stakeholders to help them with M&A, financing, and restructuring negotiations
Basic Problem of Restructuring:
  • Basic Problem: a firm's financial value (assets value) is less than its debt component
  • Basic Question: what is the firm worth? 
    • In a bankruptcy scenario, equity is worth however much we think it's worth
    • Some distressed companies could be worth a lot but are just facing temporary debt issues
There are 2 sides in restructuring and distressed situations:
  • Debtors: companies, borrowers of debt
  • Creditors: different groups of lenders
There are also differences between stressed, distressed, and bankrupt:
  • Stressed: the company is still able to pay interest on its debt, but it may have trouble with an upcoming maturity (repayment of the debt principle), or it may be heading toward a cash crunch
  • Distressed: the company has already defaulted by missing an interest or principle payment or maturity, or it has violated a covenant
  • Bankrupt: the company has entered a Chapter 7 or Chapter 11 process and wants to achieve the best possible outcome
    • Chapter 7 liquidation: court-appointed trustee to reorganize debt
    • Chapter 11 reorganization: existing management to reorganize debt
Illiquid vs. Insolvent:
  • Illiquid: company does not have enough current assets to repay its current liabilities - often associated with cash flow and working capital management
  • Insolvent: assets cannot sufficiently repay liabilities

Absolute Priority Principle:
  • Value of a company should be liquidated to security holders based on their 1) seniority and 2) secured collaterals
  • As such, the capital structure determines the order of claims on a company's assets, and creditors are paid before shareholders

  • Companies use different tranches of debt because investors have different risk appetites
  • Broadly speaking, debt is divided into Senior Debt and Junior Debt, or "Bank Debt" and "High-Yield Debt" 

Types of Debt:
  1. Revolver: Secured debt
  2. Term Loans: Usually Secured
  3. Bonds: Secured or Unsecured or Subordinated
  4. Mezzanine (convertible debt, preferred stock): Unsecured
  5. Common Shares: Equity

1. Revolver:
  • Senior Debt
  • Corporate credit card
    • Set limit, can keep borrowing until limit is hit
    • Different from a loan which is a lump sum
  • Packaged alongside a Term Loan to the same investor base, secured with 1st lien, priced at LIBOR + spread. 
    • 1st lien: claim on specific collateral
  • Main Features:
    1. Always 1st lien
    2. Floating interest (LIBOR + spread)
2. Term Loans:
  • Senior Debt
  • Term Loan A:
    • Provided by bank
    • Usually 1st lien, 5-year term, packaged with revolver
    • Amortizing term loan: set schedule to pay down the principal over time
  • Term Loan B/C/D:
    • Riskier loans syndicated to institutional investors like hedge funds, CLOs, mutual funds, and insurance companies (and some banks)
    • More prevalent in LBOs than TL-A
    • Looser covenants, may be 2nd or 1st lien, and require less principal amortization rather than a large balloon payment at maturity
3. Mezzanine Debt:
  • Mix between debt and equity
  • E.g. Convertible debt, convertible preferred stock

Characteristics of Debt (summary):

As we move down the capital structure:
  • Interest and payments increase
  • Lower chance of collateral
  • Longer maturity period
  • Prepayment is not allowed - chance of call protection increases
  • Maintenance -> Incurrence covenants
  • Junior form of debt are usually issued by a non-bank issuer 



Covenants:
  • Set of restrictions that debtors must adhere to in order to be in compliance under contract
  • Covenant violations are events of default, giving lenders same default rights as a payment or interest rate default
  • Maintenance covenant: 
    • compliance checked on a scheduled basis
    • e.g. leverage ratio can't exceed 5x; interest coverage ratio must remain above 3x
  • Incurrence covenant:
    • compliance only checked upon incurrence of an event
    • e.g. company can't sell assets or issue dividends, or if it raises capital, it must use the funds to repay debt
PiK Interest:
  • allows interest to accrue to the loan principal instead of being paid out in cash
  • company still records the interest expense on the income statement, so pays lower taxes, but it adds back the PiK interest on the CFS as a non-cash expense

Comments

Post a Comment

Popular posts from this blog

Basic Financial Accounting: The 3 Financial Statements

Image
 Introduction: There are 3 financial statements to know:     Income Statement : details the taxes , revenues , and expenses a company incurs in a period of time     Cash Flow Statement : determines how a company manages its cash position and tracks changes over a period of time, divided into CFO (cash flows from operations), CFI (cash flows from investing), and CFF (cash flows from financing)     Balance Sheet : shows a company's assets and how it acquired them using equity and liabilities at a specific point in time
Read more

Discounted Cash Flow (DCF) Valuation + Questions

Image
Review: If you haven't yet, go back and read the article on WACC before starting this one Remember these formulas from the previous article: WACC = (% Equity * Cost of Equity) + (% Preferred Stock * Cost of Preferred Stock) + (% Debt * Cost of Debt * (1 - Tax Rate)) Cost of Equity = Risk-free Rate + Levered Beta * Market Risk Premium EV = EqV - Cash + Debt + Non-Controlling Interests + Preferred Stock EqV = EV + Cash - Debt - Non-Controlling Interests - Preferred Stock  Introduction to Valuation There are 2 main ways to value a company: Relative Valuation: using market historical data of similar companies or transactions to value a company Public Comps (Comparable Companies Analysis) Comparing the valuation multiples (such as PE ratio or EV/R ratio) of similar publicly traded companies to determine a valuation range Precedent Transaction Analysis Similar to Comps, but used more commonly in M&A scenarios. Also known as "M&A Comps" Analyzing recent transactions of
Read more

Intro to Private Credit

Intro: TLDR: private credit is any loan that isn't a bond (not publicly traded) and not issued by a bank The non-investment grade credit markets in the US and Europe have expanded threefold in size since the Global Financial Crisis (GFC), growing from $1.7 trillion to $5.1 trillion. Companies in need of debt financing can either turn to banks for a loan—which would then either hold the loan on its balance sheet or syndicate it to a group of similar investors—or they can turn to private credit.  Private Credit: loans provided by lenders other than banks. Private credit funds lend directly to companies, often without using investment banks as an intermediary. They hold the debt and collect interest, rather than sell it off in pieces to other investors like a bank would. While a PE firm buys all or some of a company, private credit firms lend money to a company directly. AKA: In private equity, you are the owner of the business, and when it comes to private credit, you should operate
Read more