When comparing this default cycle with default cycles past, once thing is certain: Today’s capital structures are a lot more complex.
For starters, no one knows who holds what. In the boom era of lending between 2005 and 2007, banks didn’t just write a check and wait for the interest to accrue-they syndicated it out through CLOs, which were purchased by hedge funds. When faced with a workout situation, these nontraditional holders are less likely to “take their medicine,” as one source put it, by taking a writedown on the company and right-sizing its debt load. They’d rather take control of the company through the bankruptcy courts (a scary practice for many of them which have never acted as operators), or “kick the can down the road,” a term that’s become popular in recent weeks.
Lenders have taken to “kicking the can down the road,” or extending debt maturities in exchange for more onerous terms on companies that are struggling to service their crippling debt loads. Some buyout pros believe these “amend and extend” policies are responsible for holding back the tidal wave of bankruptcies that bankruptcy professionals predicted at the beginning of this year. In the firm’s Q2 earnings call this month, Blackstone Group president Tony James said banks have been happy to “kick the can down the road,” because it is cutting back on the number of distressed situations that turn to bankruptcy.
Another development specific to the recent cycle is the prominence of second lien debt. Pre-buyout boom-era capital structures didn’t have a separate slice of debt at the top of the capital structure which is separate from the senior lenders but above the sub lenders. The presence of a third entity in workout negotiations has made inter-creditor agreements that much trickier.
Both of those factors contributed to the sticky situation facing U.S. Shipping Partners, a former portfolio company of Sterling Investment Partners. As we covered yesterday, the bankrupt company’s fate is not ending in a logical solution. Rather than retire some of its $450 million debt load and merge with strategic buyer Rand Logistics, the company has chosen to continue with 9.1x leverage and its lenders at the steering wheel. In Rand Logistics’ plan, 75% of the company’s debt would be retired, meaning debt holders would have to write down their holdings instead of seeing them to maturity. The decision was made by a steering committee made up of senior lenders Par IV Capital Management, Stone Tower Capital and Zimmer Lucas Capital.
But according to two sources close to the situation, the steering committee just isn’t looking out for the first lien senior lenders. The firms on the steering committee own second lien debt as well. Meanwhile CIBC, the first lien’s joint lead arranger, is not even on the committee. Third Avenue Funds, a distressed debt hedge fund which was also on the steering committee, exited the group and sold its position earlier this year, one source said.
By dominating the steering committee, the lenders have made it possible to “kick the can down the road,” thereby avoiding writedowns on their second lien debt or retiring it early. That may work out great for the lenders, except holding debt in a company that’s levered 9x is much riskier than the lenders “taking their medicine” now. If the the company buckles under its debt load and stumbles into Chapter 22, the outcome will be even less attractive.
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