In addition, Ms. Aalto will be speaking at the upcoming Global Forum on Investing in Distressed Debt in New York coming up in September - An event we are encouraging all readers to attend.
This interview has incredible amounts of information from someone on the ground, doing deals on a daily basis. Enjoy the read.
Tanja - Give us a little background on yourself
I started at Barclays Capital in the Restructuring & Finance group in October 2009 after more than 13 years in the restructuring group at Houlihan Lokey. In aggregate, I have worked on well over 50 large restructuring transactions, in addition to other smaller and/or shorter engagements, representing companies, secured creditors, unsecured creditors and even shareholders in Chapter 11 and out-of-court processes. While at Houlihan, I also did a meaningful amount of work in Europe and Brazil in the 2000 through 2005 time period as those markets were busy with “distressed” work. I joined Houlihan in 1997 out of business school, and was at the time fascinated by the idea of focusing on distressed situations to help companies and stakeholders maximize value (have remained hooked ever since). Prior to business school, I worked at a boutique consulting firm focused on competitive strategy and new market entry for Fortune 500 companies. I graduated from Princeton University with a B.A. in Economics in 1992, and subsequently graduated from the Darden School of Management with an M.B.A. in 1997.
You were an advisor to the bond holding steering committee in CIT's bankruptcy. Given the speed that CIT emerged from Chapter 11, combined with the 2005 changes to the bankruptcy code, it is your sense that negotiated pre-packs will be the norm going forward and what does that mean for various creditor constituencies "giving up" value to facilitate a quit bankruptcy exit?
Each situation is unique in that liquidity need, capital structure, regulatory influence, composition of stakeholders and other variables will inevitably influence a restructuring process. CIT was one of those unique situations where the structure of the transaction and the associated timing reflected the outcome of extensive negotiations between and among the company and the ad hoc committee of bondholders. The possibility of an out-of-court exchange offer was preserved in the dual path plan, which solicited votes for both the exchange offer and a pre-packaged Chapter 11 plan simultaneously to ensure certainty in a timely manner upon the expiry of the solicitation period. The exchange offer satisfied the company’s desire for an out-of-court alternative while the pre-packaged Chapter 11 plan provided the “back-stop” needed to ensure a successful transaction. Speed was perceived to be critical in the CIT situation given concerns regarding the potential dilutive effect on value of prolonged uncertainty on CIT Bank and the company’s vendor and trade finance businesses. The concept of “giving up” value is fairly complex as I suspect many stakeholders viewed the exchange/restructuring as one of exchanging the form of value (debt-for-equity conversion) to preserve and/or ultimately create opportunities for higher value with a deleveraged post-transaction CIT.
As you note, pre-packaged Chapter 11 processes have become more prevalent than at any other time in my own experience working on distressed situations. One reason pre-packs were often challenging was that companies did not have adequate liquidity to continue to fund operations through what was frequently a protracted time period of negotiations with stakeholders. Additionally, the presence of a “blocking” position in a key voting security can also complicate the success of a pre-pack restructuring to the extent that the larger holder(s) have an agenda that differs from the company and/or other stakeholders. Capital structure layering frequently complicates reaching a quick agreement with stakeholders as intercreditor issues often prove to be a distraction. Companies tend to prefer out-of-court exchange offers to the extent requisite deleveraging can be successfully negotiating with high enough participation levels. A pre-packaged Chapter 11 is the ‘middle ground’ where a company is concerned about the “holdout” risk inherent in most exchange offers, but has the requisite votes for a plan of reorganization pre-filing to satisfy confirmation standards. While it is true that pre-packs are less costly than the typical longer Chapter 11 process (thus preserving additional value), the implementation of a restructuring through a pre-packaged process is more frequently dictated by stakeholder negotiating dynamics and the company’s liquidity cushion rather than any “give up” of value. That said, there are businesses (such as CIT) for which the potential value loss related to a prolonged bankruptcy process is meaningful enough that stakeholders are motivated to reach a speedier agreement for a more expedited process.
Can you give us a sense of the state of the DIP market today? We know from cases like GGP that rate has come down dramatically, but are lenders still driving the process in negotiating terms or has the market overshot itself where debtors are really the one calling the shots?
The DIP market generally fluctuates in line with the overall financing markets as it relates to economics. Year-to-date leveraged loan and high yield volumes underscore the fact that we are currently in a very robust financing market. While competition for the fewer large DIPs and exit financings is certainly more intense now than it was when there were more opportunities in the market, banks still fundamentally base their proposals on prevailing market rates for comparable perceived risk. While a debtor/company may be more able to solicit a higher number of financing proposals in the current market environment, I have not myself seen situations where our fellow lending institutions are willing to propose below market terms to “win” the financing.
How have you found the transition to expand Barclays' restructuring group, where restructuring is one of many revenue drivers, versus Houlihan, where restructuring was THE business driver?
The two platforms are very different. While restructuring is certainly a key practice area for Houlihan, it is worth noting that Houlihan also has strong financial advisory and corporate finance practices that have historically served to support the firm’s steady growth through economic and market cycles. After more than 13 years at Houlihan, I was attracted by the broader array of strategic and financing services that the Barclays platform can offer stressed and distressed clients. The group I joined at Barclays has the ability to strategically deploy capital in distressed situations in addition to more traditional restructuring advisory services. Additionally, the ability to offer a client access to the resources of the full bank is something I find to be invaluable. Many over-leveraged and/or liquidity constrained companies have alternatives available to them that do not fall within the core expertise of boutique restructuring firms such as Houlihan (i.e., deleveraging equity offerings, refinancing, securitizations, etc.). The Barclays platform is premised on a “team” approach where the restructuring group is appreciated for its specific expertise by other product, coverage and industry groups. It is this “team” approach that creates a significant opportunity for my group to leverage its skill set in assisting a greater number of both existing and new clients.
Of all the bankruptcies you have been a part of (Globopar, Delphi, XO, Fruit of the Loom) which did you find most interesting and why?
While the Globopar restructuring process was fascinating due to its cross-border nature and the myriad large funds that accumulated enough debt to be influential in assisting or complicating the process, it admittedly was not an in-court process. Picking the most interesting bankruptcy process is very difficult as they are all very different, which hits on the crux of why I continue to remain excited about what could prove to be one of the largest distressed cycles within the next few years. I will focus here on the Chapter 11 restructuring of United Artists Theatre Company back in 2000 as it was the first transaction I worked on where investors leveraged ownership in the fulcrum security to gain control of the company post-emergence. As you may recall, Anschutz Corp. purchased stakes in both the bank and bond debt at a meaningful discount, which resulted in an implied purchase valuation for the company of ~4.0x. While hedge fund ownership strategies are more commonplace now across restructuring transactions, Anschutz’s strategy in United Artists was the first time I myself directly watched a smart and opportunistic outside investor map out a path to control through a Chapter 11 process. Anschutz subsequently applied a similar strategy in the Regal Cinemas bankruptcy process along with additional investors that were eager to replicate Anschutz’s success in the sector.
Given the amount of capital that has migrated to the distressed space, do you believe that recoveries will be substantially higher than previous cycles? How is this impacted by more intricate capital structures (1st lien loans, 1st lien bonds, 2nd lien bonds, etc)
Recoveries are ultimately dependent on valuation and, perhaps more importantly, on valuation relative to the blended average purchase price of the stakeholder. The elevated amount of capital parsing through Chapter 11 situations, over-leveraged securities and distressed industries in general appears to contribute to what I perceive to be somewhat of a “distressed asset bubble” in the current market place. What this means is that I am running across over-leveraged situations where securities continue to trade at higher implied valuation multiples than historical averages. While there is certainly some logic to pricing in a rebound for companies negatively impacted by the prevailing soft economy, I do see valuation multiples that continue to exceed what I would myself deem to be an appropriate inflation for recovery “option” value. The uptick in distressed company security valuations will have some impact on implied recoveries to the extent that higher valuation multiples are not sustained and/or company performance does not rebound from current reduced levels. Previous cycles had their own disaster scenarios where valuations fell far short of original expectations. It is unfortunately difficult for me to provide a definitive prospective perspective on how the next cycle will average out relative to history.
Capital structure layering is absolutely another variable that will impact recoveries in the next restructuring cycle. Second lien securities are more prevalent, and are often “silent second” positions relative to senior first lien debt. The existence of multiple tranches of debt adds to complexity in negotiating a consensual restructuring to the extent that there is debate regarding the “fulcrum” security. The impact on recoveries will be case specific, but there are scenarios where a senior security may try to crowd out junior securities in an effort to gain control of the company post-emergence. Additionally, we are now seeing cases where junior stakeholders step up with rights offerings to facilitate a repayment in full of senior claims. Recoveries in either scenario will ultimately depend on the company’s performance and prevailing sector valuation multiples relative to the timing of an investor’s sale of post-emergence ownership interests.
We do not know if you have an opinion - but what is your outlook for defaults over the next few years - will the maturity wall in 2013 and 2014 lead to a rapid increase in pre-packs and distressed exchange offers over the next two to three years?
Most seasoned restructuring professionals did not anticipate the resurgence in capital markets activity that pushed out what was originally anticipated to be a year of double-digit default rates in 2010. The significant amount of amend-to-extend volume during the first quarter of 2010 added to the already staggering wall of debt maturing in the 2012 through 2014 time period. My own expectation is that the restructuring market will remain quieter into 2011 as highly leveraged companies continue to manage through the economic downturn with existing balance sheet liquidity. Activity should pick up in 2012 and thereafter as companies seek to actively manage upcoming debt maturities through opportunistic exchange offers and/or refinancing efforts. However, I will caveat that all remains highly dependent on the state of the capital markets. I do not specifically expect a rapid increase in pre-packs in 2012 as an expedited solution for management of over-leveraged companies as any Chapter 11 process (pre-packaged, pre-arranged or free-fall) tends to carry some taint from the perspective of most management teams. The ability to implement a pre-packaged Chapter 11 plan is generally determined by a company’s liquidity profile and stakeholder dynamics rather than by prevailing and expected default rates.
If you were to recommend one book to an aspiring distressed debt investor, which would it be and why?
I would recommend Martin Whitman’s book on Distressed Investing. The book is a great primer that provides an introduction to how to think about anticipating distressed cycles and evaluate over-leveraged situations. Additionally, the overview of bankruptcy processes and associated case examples provide additional background context for someone who may be new to investing in distressed assets. Understanding valuation waterfalls, creditor rights and the overall process is critical (in addition to having a perspective on valuation) to having a solid framework to evaluate any distressed security.
Thank you so much for your time with Distressed Debt Investing Tanja!
if you had made an investment in CIT duing the restructuring, when it was still trading as cit in October 2009 at the bottom of their chart, would that investment be worthless when they emerged from chapter 11 in november 2009?
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