The credit crisis isn’t the only crunch distressed companies face. As corporate restructuring timelines accelerate, debtors, along with their professionals and service providers, tackle a time crunch to accomplish in weeks what normally takes place over several months, or even years, in a traditional Chapter 11 corporate restructuring.

Corporate restructuring timelines have been accelerated due to factors such as tight credit and lending conditions, as well as by reduced time frames imposed by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Bankruptcy professionals must approach the Chapter 11 process even more strategically to keep pace with condensed timelines and to maximize the recovery for stakeholders. As a result, debtors find themselves saving significant time and costs associated with the bankruptcy process.

It was once not unusual to see the Chapter 11 process unfold over many years, reaching key milestones along the process until a company emerged from Chapter 11. Today we see more accelerated bankruptcies. Recently, we’ve seen examples such as a debtor who filed and emerged from Chapter 11 within a record 32 hours and a debtor who executed an equity-sponsored rights offering within months. We’ve also seen quick asset sales just days after a Chapter 11 filing as well as a rising number of prepackaged bankruptcies. According to BankruptyData.com, 12 prepacks have been filed in 2008; only four filed in all of 2007.

While debtors can benefit strategically from an accelerated bankruptcy, they also face increased procedural challenges. As an example, in the case of Bally Total Fitness Holding Corp., which filed a prepack and emerged in 51 days, the professionals and claims agent closely collaborated throughout this expedited time frame to ensure timely notice within the prepack requirements. Movie Gallery Inc., another example of a fast-paced case, quickly organized the team to assess nonperforming lease agreements with more than 4,000 retail locations, achieving an executed reorganization plan within seven months.

In addition, tight credit and lending conditions have made it much more difficult for companies today to secure debtor-in-possession financing and have encouraged debtors to move swiftly through the process. Furthermore, the bankuptcy measure of 2005 has also brought on even greater procedural challenges such as information dissemination to official committees as well as a reduced time frame to accept or reject lease agreements.

Accelerated bankruptcy timelines require sophisticated planning and coordination to ensure success. Companies and their professionals should follow some general principles to more easily navigate through increasingly compressed time frames:

Be smart. Corporate restructuring is both an art and a science. Make sure you enlist help from experienced restructuring specialists. From the lawyers to the claims agent, these specialists should have experience in handling the complexities of accelerated bankruptcy timelines.

Be quick. From preplanning to emergence, companies can achieve their goals fairly quickly with adequate strategy and agile execution.

Be prepared. Key company information should be accessible to help expedite the process and easily locate required records. Data needed during the process can include financial statements, vendor listings, employee-retiree listings, contracts and other valuable information.

Be transparent. Develop a strategic communications strategy to disclose progress to relevant constituencies during the restructuring process–from employees and vendors to financial institutions and the media. It is critical you know what to say, when and how to say it.

Be sensitive. When dealing with financial matters of this scale, emotions run rampant. Be sensitive to the needs of stakeholders, and provide reassurance that their matter is one of significance and is being addressed.

Companies, professionals and their service providers are under much scrutiny to accelerate the corporate restructuring process to maximize stakeholder recoveries and reduce the cost of bankruptcy. Now more than ever, they must approach Chapter 11 with as much advance planning as possible to ensure a successful emergence.

Jonathan A. Carson is a former restructuring attorney and president and co-founder of Kurtzman Carson Consultants LLC.

http://www.thedeal.com/newsweekly/community/beating-the-clock.php

The news from leveraged-loan land has been particularly dismal of late: Prices in the secondary market have plunged to record lows, and expectations of a severe recession are spurring worries of record corporate defaults. Fear is rising that the collateralized loan obligation funds that fueled the surge in leveraged lending before the credit crunch could soon be in trouble.

“We’ve left the zone of rationality,” says one leveraged finance banker. “There’s an utter lack of demand, and there’s no playbook here.” The banker is referring to the record low of 66.05% of par value hit on Oct. 17 by the most liquid loans as measured by Standard & Poor’s Leveraged Commentary & Data. These are senior, secured loans, meaning they sit atop the borrowers’ capital structure and are the first to be paid in the event of default. In more normal times, it’s rare for such loans to trade much under par.

But the market said goodbye to “normal” some time ago. S&P asserts that current prices imply unheard-of default rates of these securities. If that’s true, it could mean trouble — more trouble — for banks that have invested a combined $250 billion in loan investment vehicles.

Banker bashing
How much trouble is the big question. For now, loan markets are being depressed by a surge in forced sales of portfolios by struggling hedge funds and CLOs. According to LCD, the amount of such sales this month, referred to as “bids wanted in competition,” or BWICs, hit $2.31 billion as of Oct. 20. That’s already the highest monthly total since S&P began tracking the data last year. For the year so far, BWIC volume totals $9.04 billion, up from $8.9 billion for 2007.

“The spike in BWIC activity is both a symptom and a cause of the loan market’s woes,” wrote LCD in a report, comparing the forced selling with the overhang of unsyndicated loan commitments on banks’ books that choked the market last year. That overhang was once as high as $300 billion but has now dwindled through a combination of fire sales and busted deals to less than $50 billion. “The ongoing sales have kept prices under pressure. What’s more, concerns that BWICs will continue to flood the market with supply are keeping bargain hunters at bay,” LCD adds.

Sales of loan portfolios are coming from firms such as Highland Capital Management LP, GoldenTree Asset Management LP and Citadel Investment Group LLC. Those funds have been losing money as the value of loans has tumbled. The Wall Street Journal reported on Oct. 23, for example, that Bain Capital LLC’s Sankaty Advisors LLC credit affiliate has lost fully half its value from loan price declines. A similar dynamic, sources say, is playing out with market-value CLOs, which are beginning to unload loans as falling prices set off market-value triggers.

Market-value CLOs and hedge funds — both mark-to-market vehicles — hold about $50 billion in loan volume. That number represents just over 10% of the total $475 billion held by all investment funds in the market, according to J.P. Morgan Chase & Co. research.

But short-term market gyrations won’t hurt the majority of investors in leveraged loans. That’s because the bulk of the investment vehicles in the sector are so-called cash flow CLOs, which do not mark their portfolios to market and consequently aren’t as vulnerable to market volatility. Instead, they hold the loans at par value and continue to pay their investors as long as defaults don’t disrupt the flow of interest payments that generate returns as they cascade down through the various CLO tranches.

“No one has ever lost money in a triple-A CLO investment,” argues one banker.

However, the prospect of rising defaults could become a real worry for these funds.

For now, default rates remain low compared with the historical average of 4.35%, but the trend is unmistakably bad: According to S&P data, global default rates for the 12 months ended in September hit 2.04%, up from 1.84% in August. In the U.S., speculative-grade defaults ran at 2.68% in September, up from 2.44% in August. That figure is almost triple the record low 0.95% default rate at the end of 2007.

And, of course, the outlook is much worse. S&P says it expects defaults to jump to 7.6% in the next 12 months and, “under a pessimistic scenario,” could reach 9.6%. That number is still below the historic high of 12.5% hit during the 1991-1992 recession, when the high-yield market virtually shut down. But the market is reacting much more pessimistically than S&P. Indeed, the default rate implied by current loan market prices is 23.4%, according to LCD. In other words, the market is suggesting that almost a quarter of current leveraged borrowers could default before their debt matures.

If that happens, it could present problems for investors in the vehicles, particularly for banks, which are the largest buyers of the most secure triple-A tranches of CLOs. J.P. Morgan estimates that commercial banks, mostly from Europe, hold about $250 billion of investments in the most senior, and presumably most secure, tranches. The banks were active investors in the structures during the credit boom. They also inherited large triple-A CLO investments from the formerly off-balance-sheet structured investment vehicles that banks largely took back on their balance sheets when the credit crisis began last year. Those SIVs were by far the largest investors in triple-A CLO tranches, at one point representing some 50% of senior investments in the loan vehicles.

Consequently, any large-scale rise in default rates that cuts off the flow of funds to the vehicles, resulting in losses, will presumably hurt bank balance sheets at a time of extreme vulnerability.

However, loan market participants caution that such an outcome, though not impossible, is still highly unlikely. The reason: CLOs were structured to avoid massive default risk.

First, the vehicles are overcollateralized, meaning the value of bonds backing the CLO is higher than the CLO’s value, allowing for some cushion to protect investors. Second, senior loans are backed by hard assets, which will allow for some recovery if companies begin to fail in a recession. Third, investors feel protected because, unlike the pool of mortgages backing the infamous CDOs that started the crisis, loans are spread out among industries, creating protection through sectoral diversification.

“At some point, this stuff does have intrinsic value,” says one investor.

Of course, cash flow CLOs have never been tested in a market environment as gruesome as this. How well they handle things from here on out remains the $250 billion question.

Tags

• Bain
• BWICs
• Citadel
• CLOs
• GoldenTree Asset Management
• hedge funds
• Highland Capital Management
• S&P
• Sankaty Advisors

 http://calculatedrisk.blogspot.com/

Tuesday, February 19, 2008

LBO Deals were Losers for Wall Street

The WSJ Deal Journal has an interesting analysis today: Leveraged Loans: The Hangover Wasn’t Worth the Buzz

Investment banks now face around $197 billion in exposure to leveraged loans used to back big buyouts in 2007, adding inestimable stress to their efforts to extricate themselves from the credit crunch. Was it worth it?

Not really, no.

The WSJ’s Heidi Moore provides some analysis for several banks. As an example, for Citigroup she writes:

Citigroup … earned only $856 million in fees from private-equity firms in 2007, even though the bank underwrote leveraged loans totaling $114.3 billion and still holds $43 billion in exposure. Oppenheimer analyst Meredith Whitney estimates Citigroup’s leveraged loan write-downs would be about $2.5 billion …

And this doesn’t count the opportunity costs.

 http://www.ft.com/cms/s/1/daf6090e-d978-11dc-bd4d-0000779fd2ac.html

Leveraged loans

Published: February 12 2008 14:43 | Last updated: February 12 2008 20:41

The markets have been so transfixed by the horror show unfolding through subprime and collateralised debt obligations, they have not been focused on the banks’ other crisis: leveraged loans. Optimists thought that once the loan pipeline slipped below $150bn, debt investors would be cheered by hopes of a logjam clearing and would pile in again. Wrong.

It has been a terrible period for leveraged loan prices – worse than for high-yield bonds despite the unsecured nature of the latter. Some of the reasons may be “technical”, but somehow, that tag no longer has the comforting ring of a short-term blip. “Technical” factors can hang around long enough to inflict more damage on Wall Street through further write-downs – which in some cases could apply to lending commitments still off-balance sheet. 

Among these factors is a steeper yield curve, which has rendered floating debt such as leveraged loans, priced off short term Libor interest rates, less competitive in yield terms. Then there are the pressures faced by many of the traditional “go-to” investors for this paper: hedge funds and leveraged buyers. Some of the popular trading programmes that have supported the secondary market are facing margin calls. And credit vehicles, such as so-called CLOs, risk hitting triggers that require asset sales because their underlying collateral is falling in value.

Then of course, there is the economy and the outsized credit risk the banks run if they have to hold onto the leveraged loans they have committed to, as opposed to flogging them to others. Still, as Standard & Poor’s LCD research points out, there is quite a lot of default risk already priced into US current prices which are heading towards 85 cents on the dollar. S&P LCD estimate that default rates would have to rise to roughly 10 per cent to wipe out the excess risk premium priced into current US loans. That is a lot given the 2000 high of 8.2 per cent. But with corporate profits looking toppier than then, and gearing higher, loans may not recover soon. Banks hoping for a respite from their nightmare could face more writedowns yet.

Post and read comments on this Lex

Copyright The Financial Times Limited 2008

Doubts about planned leveraged buyouts could remake the rules that have guided deal making during an unprecedented boom.  11:38 p.m.

• Home Depot May Get Less for Supply Unit

• Banks Begin to Retreat From Financing Offers

Investment Banks Pull
Deal-Financing Offers

Slew of Retreats Strains
Once Healthy Relations
With Private Equity

By DANA CIMILLUCA and DENNIS K. BERMAN
August 10, 2007; Page C2

Choking on a massive backlog of pending private-equity financings and a choppy credit market, investment banks are rapidly retreating from offers to finance other deals in the works.

In a slew of recent auctions, investment banks have yanked back so-called stapled-financing packages used by sellers’ banks to attract private-equity bidders.

The seller-financing is called “staple” financing because it is often physically “stapled” to offering documents. The deals number at least five and include Morgan Stanley’s sale of cable company Insight Communications Co. and Goldman Sachs Group Inc.’s sale of Goodman Global Inc., a Houston-based maker of heating products that is part owned by private-equity firm Apollo Management LP.

Staples have long been touted as a way to provide a “floor” price for potential buyers, in the absence of other financing sources. But the recently pulled offers show how ephemeral such offers truly are. And that is straining the relations between private-equity firms and investment banks that serve them. Those relations had been harmoniously profitable when the volume of deals surged to record highs earlier this year.

In the case of New York-based Insight, Morgan Stanley’s refusal to fund the deal on the terms it originally offered has caused tension between the firm and Insight owner Carlyle Group, people involved in the auction said.

Morgan Stanley originally offered a financing package of 9.25 times Insight’s annual cash flow. After demand in the high-yield market evaporated this summer, it reduced that to 7.5 times before pulling the offering altogether.

Morgan Stanley or another bank could still end up financing the deal, one person familiar with the matter said. Final bids for Insight, which was expected to fetch as much as $2.5 billion, were due Wednesday. It is unclear whether Morgan Stanley will be able to find a buyer without the financing package. Time Warner Cable Inc. could still put in a winning bid for Insight.

Banks are pulling the financing because of larger problems in the market. Wall Street has committed to funding some $225 billion or more of pending leveraged buyouts, meaning the banks will be on the hook to finance them if debt investors pass. Kohlberg Kravis Roberts & Co., which has agreed to more deals that any other buyout firm this year, is taking a particularly hard line. It is forcing banks to honor their commitments on loans and bonds whose terms investors have begun to find nearly impossible to stomach.

Faced with the possibility of having to use their own money to finance a big chunk of those deals, the banks are turning their backs on new commitments.

Already, the market turmoil has claimed other auctions as victims, including the sales of Virgin Media Inc., Cadbury Schweppes PLC’s U.S. drinks business and Nexstar Broadcasting Group Inc. They have been shelved pending a more hospitable financing market.

Representatives of Carlyle, Morgan Stanley and Goldman declined to comment.

Write to Dana Cimilluca at dana.cimilluca@wsj.com and Dennis K. Berman at dennis.berman@wsj.com

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