Sunday, January 25, 2009

Chapter 7 Cases Poised To Surge

The liquidations of Circuit City and Linens 'N Things are just the beginning. As we discussed recently, the dea(r)th of distressed financing will crimp the plans of any companies who plan to brave the current crisis through traditional Chapter 11 bankruptcies. The FT ($$$ link) seems to agree. Conventional sources of debtor in possession funding are gone, GE Capital and CIT which had provided over 50% of DIPs in recent years are themselves considering financing "alternatives", and the hedge fund community which was always a last resort for rescue financing... well... it ain't doing that hot either.

What are the implications:

1) Debtor/creditor negotiations will become that much more acrimonious. Companies will need to agree to more exorbitant terms from their assorted creditor groups in order to achieve consensual out-of-bankruptcy restructurings. Because unless secured prepetition lenders agree to priming DIPs, a company threatening creditors with Chapter 11 as a negotiation "out" (a strategy that had been used widely in the past when financing was freely available, and a reason why Trump managed to avoid bankruptcy so many times) will be a moot point, since virtually all Chapter 11 cases will end in liquidation, resulting in much lower recoveries for all stakeholders.

2) Investors who have been buying the stock of Lazard, Evercore and other restructuring focused investment banks, which are probably the only companies on Wall Street currently making any money, should think twice. As the biggest source of revenue for restructuring companies is providing financings (2-4% fees on the amount arranged), and of course, monthly retainers and success fees for lengthy, 1.5-2 year-long Chapter 11 cases, its is possible that the income stream for these advisory shops will be drastically altered. As liquidations become prevalent the only remaining way to make some cash will be to push very hard for prepack debt-for-equity swaps. Additionally, creditors will think twice before allowing several sets of financial or legal advisors to leech off an unviable going concern candidate (which is surprising, considering the lawyers in the Lehman bankruptcy case likely need to rent out Giants stadium for an all hands meeting ).

3) Private equity firms who have been slow in acknowledging reality and are slow in marking down their equity in Linens type LBO-to-liquidation specials, will be forced to bite the bullet faster, and likely post very deplorable results sooner than hoped for, resulting in another Hedge Fund type exodus of capital, this time from the PE guys (although Apollo is vehemently fighting this tide)

4) Who knows? The game theory parameters are changing on a daily basis... But if on top of everything bankrtupcy courts are soon entitled to change contract terms on an ad hoc basis, we fully expect all hell to break loose soon enough. Sphere: Related Content
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