Distressed Debt Panel at the Bloomberg Dealmakers Summit

On Wednesday, Bloomberg hosted their Dealmakers Summit here in New York City. If you have access to Bloomberg, via the terminal or online videos, I suggest you watch a number of the panels: they are very good. One of those panels focused on the distressed debt market and restructurings. The panelists included:

• Jeffrey Aronson, co-founder and managing principal of Centerbridge Partners (JA)
• Timothy Coleman, Senior MD and head of Restructuring at Blackstone (TC)
• William Derrough, Managing Director and Co-Head of Restructuring at Moelis (WD)

Needless to say, that's a bit of an all star panel. Here are my notes from the panel. Enjoy!

Question: How are you each spending your time? How does that compare to 6 months ago? What industries are you focused on?

(WD): Spending a lot of time in Europe. What is going on in the sovereign crisis is having impacts on financial institutions and portfolio companies in those nations. Unlike the United States, Europe never saw a bounce back in credit. Financing is hard to get done in Europe. Activity in the United States has picked up with a lot of new names being talked about relative to the 3-4 people had always talked about before. Shipping and power are actionable things now versus something that was just talked about a few months ago. Infrastructure as well.

(TC): Similar to what WD said. The market has been busier than anyone would have admitted last year. We expected a slow year and its been a very busy year. Names that are bubbling up are the ones that everyone had thought would refinance their debt but that's not happening - especially over the last few months. The markets are very expensive right now and that leads to borrowers and debtors moving towards privately negotiated transactions whose cost might not be as onerous as a public market restructuring.

(JA): We've seen a marked change in the opportunity set over the last 2 months. 6 months ago all the focus was on Europe. In the past 2 months, with all the uncertainty in the world and spread widening dramatically, there are a lot of things to look at in the U.S. He cautions to note that this doesn't immediately mean these situations turn into restructurings. Prices have come down and that might mean an adequate return on investment but that doesn't mean the company is going to file. Usually, when markets turn quickly, bankers might get more phone calls, but unless there is an impending catalyst (maturity, covie breach), it's not necessarily a transaction at that moment but it can still be a good investment for Centerbridge b/c the price is cheap.

Europe is a big opportunity for Centerbridge (they opened up a London office last year). Forever, people have talked about Europe/London being a battleground for restructuring transactions, but it never really happened. 20 Years ago, if you did a deal in London, you'd deal with the "London Rules" - essentially unspoken rules in a default where money center banks wouldn't take a haircut, they would extend principal and make the interest virtually zero. Because of this, there were very few attractive investments. Lenders rarely sold, which is must different than the U.S. But now, for the first time, we are seeing lenders starting to sell. We are seeing banks selling individual positions which JA had never seen before to a large extent in Europe. It is accounting driven. Banks will not take a book loss.

Question: Are you guys seeing a shift in your European business? (referencing Aronson's comments about flows in Europe)

(WD): I think a lot of sales out of Europe is being driven by Basel and cap requirements. Its not 25 years ago where they could hope to hide it. Was in the peripheral countries, banks are selling U.S. stuff first, and will end of selling Euro stuff last. With all the changes, banks are going to streamline to a core operation.

(TC): The loans are really trading at 40 - banks have it on their balance sheet at 80. Banks are writing down their loans slowly.

Question: High yield issuance has dropped 90% in the last few months, since August 1st, versus last year. Can you explain that?

(TC): Last year was sitting on top of a mountain. Last year was record record numbers. So tough comps. Really has to do with inflow and outflow of capital. High yield had lot of outflows and inflows are starting to come back. Leverage loan market lagging high yield market - loan market kept lending longer and they are still in an outflow position. I think whats going on is that there are a lot of nervous people out there. A lot of people are sitting in the high yield market because there are not better alternative but these people aren't comfortable there. At the first sign of trouble, people will pull money out.

Question: Because of that dynamic, are we in a situation of "Have and Have Nots" in terms of access to credit in the high yield market?

(TC): If you are in the distressed space, no one can access the market. The only people accessing the market are in Double - B land. Or maybe frequent issuers where investors know the story. You are still paying up big in terms of spread to Treasuries. 2 deals a week now versus 20 a few months ago. This is an aberration - this is just a moment. The market will come back; there are a lot of pent - up demand. The question is when. BB will slide into B issuers, and then into the weaker issuers. You'll see the market return. The question is how fast.

(JA): I will say the markets are extremely fickle. High yield is a quasi-debt, quasi-equity instrument. High yield really tracks the equity market. I have a different view than TC on fund flows. High yield market is maybe a trillion dollars. The fact that $2 billion comes out of the market in any weak may make the headlines - in the real world its diminimus. And really what the market is driven by is fear and greed. And when people get afraid and are concerned, people pull back. This is a moment of time, markets will go up and down.

(WD): Feels like these cycles of peaks and valleys are coming faster than they used to. You wouldn't have a credit bounce back like you saw from 2009-2010.

(JA): News flow and information is driving the shortening of those cycles.

(TC): We had 10 year cycles in the 70s, 80s, 90s, etc. I think with information that is shortening the cycle. The fact that we had a near depression in our country and the fact that was over in a year from a market standpoint is unheard of. If you had told people in prior cycles they would have laughed at you. To be honest, everyone projected that restructuring would have continued for quite some time - no one predicted it would come back as quickly as it did, then get bad so quickly, etc.

Question: And what about the severity of the trough we are in now? Are we going to see an uptick in default?

(JA): If you have a maturity tomorrow you are in trouble. It really depends on the state of the market. Some of it is just luck. Investors that own highly levered companies attacked the capital structure last year and did things proactively to address maturities. That was the smart thing to do. The major jumbo deals did the smart thing. And today they are breathing a sigh of relief.

I think people use the expression kick the can. And that's what people did (large LBOs). If you fundamentally overpay for a business, and if you put too much leverage on it, you will ultimately have to deal with that. If you own that business, the longer you can extend that debt, the better it is (you can eventually take company public in roaring markets). Eventually this debt matures.

(TC): If you look at a trend line, if we get past this current snag, economists are projecting a long-term 2% growth trend. This is down from the beginning of the year. Its hard to earn yourself out of 2% growth relative to 5% growth. These companies will get it trouble. It may not be tomorrow because few, if any of these deals have covenants and long maturities. And maybe if the market comes back, they'll push another maturity out, and continue the process.

Question: Interesting to see how many firms like Centerbridge are out there looking for distressed opportunities. What do you see when working with distressed companies, what do you make of the distressed investing environment chasing these deals?

(WD): As compared to twenty years ago, there is a lot more money allocated to distressed. There seems to be a consolidation of the number of firms out there relative to 2007. LPs are trying to figure out who the long term players in the market - meaning its hard for small firms to grow / grow their asset base. From the advisory side, if you are thinking to introduce someone to a situation, you want to make sure that investor is going to be their tomorrow. You want stability in the organization when making these introductions - you want them 6-12 months down the line when you are closing the deal.

(TC): There is A LOT of money chasing deals. Money was raised in 2007 and never deployed. If you are skillful (like Centerbridge), you know how to make money in this sort of market. But net/net, there is definitely money to be made in the distressed market right now.

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High Yield CDX Rolls

Tomorrow morning (September 27th), the HY CDX 17 will begin trading and will replace the HY CDX 16 as the on-the-run high yield synthetic index. Many hedge funds and other investment advisers will establish new positions in this index (as an outright call on credit spreads from a long/short/hedging perspective or index arbitrageurs) and will reduce or eliminate position in the HY CDX 16 as the index becomes more illiquid relative to the on-the-run index.

This "CDX roll" happens two times a year. In effect, certain credits are added to the 100 member index while others are removed from the index. This year, the methodology for additions / deletions was dramatically overhauled. Previously, a dealer poll was conducted to add / remove credits. The new methodology utilizes a system whereas the existing index is "screened" through three filters, and depending on the outcome, credits are dropped and others are added. Dealer input is still involved during the process to accommodate certain technical aspects that may not get captured by the more quantitative screening process.

Similar to the old methodology, the first screen is to determine whether a credit is even eligible for inclusion in a high yield index. This can happen for a few reasons:

• The company has been upgraded
• Two high yield companies have merged making inclusion redundant
• A takeover / takeout
• A default
• An orphaned credit (i.e. there are no obligations to deliver into a CDS contract).

For this roll specifically, 5 credits are being removed from the HY16 for one of the above reasons:

• Qwest
• Macy's
• Temple Inland
• Domtar
• Nalco

For credits that are removed in Step #1, replacements must be the most liquid names (Using a 6 month analysis of records at DTCC to determine liquidity) in the least represented (i.e. most underweight) sectors. We start with the MOST underweight sector and add until we replace credits from Step #1. For this roll in particular, the credits to be added (and the Markit specific industry) are:

• Health Management Associates (Healthcare)
• Seagate (Technology)
• Bausch & Lomb (Healthcare)
• Sunoco (Oil & Gas)
• R.R Donnelley (Industrial)

After Step #1 in completed, the second step / filter revolves around removing illiquid credits from sectors that are "overweight" relative to the iBoxx USD Liquid High Yield Index. If the current HY CDX (i.e. CDX 16) has a sector that is overweight by more than 300 basis points, the least liquid credit in that index will be removed. Like the first step, the replacements from here are the most liquid credits from the most underweight sectors (pro forma for the additions / deletions up to this point). In this particular roll, Georgia Pacific and Mediacom will be removed and will be replaced by Vulcan Materials and SRAC (Sears Roebuck Acceptance Corp). SRAC, despite being affiliated with Sears (i.e. retail) is classified as a financial - color me surprised.

The third step in the addition / deletion methodology looks at ratings of the existing index relative to the aforementioned iBoxx USD Liquid High Yield Index on an issuer weighed basis. There are three buckets: BB, B, CCC. Again if there is a 300 basis point discrepancy, the least liquid credit in the most overweight rating category is removed and the most liquid name from the most underweight rating category is added. In this step, Univision, a CCC credit, was removed and Springleaf Finance Corp, a single B credit, was added. Initially, Liz Claiborne was to be removed (according to the September 14th provisional changes released by Markit). Dealers apparently voted this down as Liz is a very liquid, high beta CDS name that has very few underlying cash bonds.

Finally, though not really part of the screening process, if an issuer has an affiliate that is more liquid than the existing entity in the current CDX, the more liquid affiliate will replace the more illiquid entity. In this particular roll, the holding company of Avis (Avis Budget Group, Inc) will replace Avis Budget Car Rental and TCEH (Texas Competitive Electric Holdings) will replace Energy Future Holdings.

10 credit roll is definitely large. For reference, the credits that are leaving trade around 350 basis points today and the ones coming in trade at 600 basis points. Because of weaker credits being included and extending the portfolio 6 months, this index (which also has a 500 running spread) will trade lower than the HY16. One can calculate the theoretical difference between the two indices, which most dealers are placing around 2.5 points. It will trade slightly wider than that (i.e. the roll market) as those using the HY Index as a hedge will cover their legacy position and establish new ones in the HY17 (supply / demand technical imbalance). If the technicals get too far from intrinsic value, I'd still expect arbitrageurs to keep the market in balance. I will note that many people I've talked to that use the HY index as a hedge have already covered their position to simply get ahead of any nasty roll technicals.

If you are interested in learning more of the CDX Index rules, Markit has a document outlining all the gory details here: CDX Index Rules

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Third Avenue on Sovereign Debt Debacle

In previous posts in the past, we've highlighted the fantastic commentary from Third Avenue's Focused Credit Fund. The fund commentary for the most recent quarter is again out, and I'd thought I'd highlight the discussion on sovereign risk. You can read the entire commentary here: Third Avenue 3Q 2011 Shareholder Reports. Enjoy!

Sovereigns, Corporate and Bankruptcy

Our investors have been asking us about sovereign debt ever since the question of European solvency emerged in 2010. The prospect of truly high-yield debt, paying in some cases north of 20%, emerging from the European Union instead of the more traditional confines of the emerging markets, has some bond buyers salivating and others just plain scared. Government debt is supposed to be the safe stuff, after all. A compelling case can be made for that, unless things go wrong. At the moment, the potential for things to go wrong for sovereigns is very high. They have bonds coming due and need access to the capital markets in order to refinance them.

Sovereigns have three things going for them, from an investor’s point of view:

• They can print their own money, so a sovereign borrower that issues debt in its own currency can avoid default. However, investors risk serious currency devaluation. For example, the Brazil 10-year bond issued in U.S. dollars yields 3.5%, while the equivalent maturity bond issued in the local currency (the Brazilian real) yields 8.5%. This difference in required return reflects investors’ uncertainty or concerns about the possible devaluation of the real. In addition, if a significant amount of a country's debt is issued in a foreign currency or the country has given up control of its own money supply (as with the Eurozone countries) they can find themselves at the mercy of the capital markets and face an increased risk of default.

• A government can raise taxes on their citizens and corporations or raise other fees, in order to cover its obligations, though political considerations can temper this impulse.

• There are international agencies, banks and financial arrangements that can come to the aid of a failing sovereign borrower, while most corporate borrowers have to stand or fall on their own.

Corporate borrowers cannot print money and they cannot raise prices and just expect to keep their customers. A country in worse financial shape can use its central bank to kick the can down the road. Corporations also cannot appeal to the International Monetary Fund or the World Bank for a rescue. With very few exceptions, an overly indebted corporation that is unable to meet its obligations will be allowed to fail, no matter how important its managers and shareholders think it is.

While that might make it sound like sovereign debt has a certain safety to it that corporate debt does not, this is largely illusory from the point of view of a debt holder. When you own sovereign debt, you have very little leverage with your borrowers. Because a sovereign’s debt is backed by the full faith and credit of the sovereign entity, once faith is gone liquidity evaporates and a sovereign’s ability to borrow ceases. The liquidity crisis can create a solvency crisis. Conversely, if a corporation experiences a liquidity crisis it does not necessarily create a solvency crisis, as its assets may be used as collateral to raise capital at some point in the capital structure. If all else fails, you have the court system to seize assets.

From a creditor’s perspective, the weaknesses of holding sovereign debt are directly attributable to the lack of protections afforded by a bankruptcy code.

• A sovereign entity can delay restructuring its debt indefinitely.

• A country’s land, assets or people cannot be repossesed by lenders.

• A country cannot be wound down or reorganized into something else.

• A country’s leaders are beholden to constituencies other than bond holders.

• Ultimately, a country’s leaders cannot be forced by creditors to make decisions that they do not want to make.

While we have been discussing this in terms of a country’s debt, sovereigns are really a broader category that includes municipal debt and debt issued by Native American tribes to fund casinos operating under the Indian Gaming Regulatory Act. Municipal debt can be broken down into two categories – general obligation bonds and revenue bonds. General obligation bonds act like sovereign debt, as they are backed by the full faith and credit of the state or municipality issuing them. Revenue bonds, on the other hand, are more like corporate debt, as they are backed by assets or a revenue stream (such as a bridge or toll road) and rates can be raised or, theoretically, assets seized in order to pay bondholders.

In recent history, we have seen countries choose default and receive scant economic punishment for doing so. Russia defaulted in the late 1990s and saw its cost of borrowing skyrocket. But a few years later, conditions normalized. In 2001, Argentina, which had linked its currency to the U.S. dollar and had, thus, given up the ability to print money to cover its debts, chose default over an austerity and divestiture programs pushed by the International Monetary Fund. Argentina’s bondholders lost 70% on average. It has been said that buying Argentina’s bonds is like getting remarried (the triumph of hope over experience). Only in Argentina’s case, it is like remarrying the same person three times and expecting a different outcome. Unlike private companies, countries do not dissolve just because they default. They live to borrow another day.

One of the unifying characteristics of all of these sovereign bonds is that the interests of debt holders are often not paramount in the event of insolvency. Governments are accountable to (or fear) their people first and foremost. Politicians are sometimes even rewarded for not making unpopular concessions to bondholders. As mayor of Cleveland in the 1970s, Dennis Kucinich allowed his city to default, rather than agreeing to sell its public utility. That decision made him wildly popular with his constituents and is the main reason he is a congressman thirty years later. It may not be right from the creditor’s perspective, but it is reality.

The Focused Credit Fund owns one municipal bond issue, backed by the revenue of 9,000 parking spaces around Yankee Stadium and one bond tied to a Native American owned casino.

The advantages of holding corporate debt become clear when a company faces the threat of a potential restructuring:

• Managers have strong incentive to pay lenders because they stand to lose their jobs and equity if they do not.

• Corporations can sell some of their assets or divest businesses in order to pay obligations.

• Corporations can be wound down and their assets sold to pay creditors.

• Corporations can be reorganized into new businesses, with the new equity going to its creditors.

• Corporations in financial trouble can be purchased by a more financially secure company.

• There are clear laws, procedures and precendents that govern the U.S. corporate bankruptcy process, whereas anything goes in a sovereign default.

• The U.S. bankruptcy code sets forth a clear priority for claims that assures that debt holders are treated fairly in order of their rank and seniority in the capital structure.

• There is a limited time of exclusivity for the debtor in bankruptcy before debtholders can gain control.

The corporate borrowers that we are discussing here are either governed by U.S. bankruptcy law or something similar. In countries with unfriendly or uncertain bankruptcy laws, and in the area of sovereign debt, the interests of creditors are not as protected. The absolute priority for claims provides a structure that borrowers and lenders can use to work through solvency and liquidity issues. For example, a corporation can offer to exchange existing debt for more senior paper in order to extend maturities and reduce short-term debt obligations. Since there is no similar absolute priority of claims with sovereign debt (witness the recent debt ceiling debate about which U.S. creditors would be paid first in the event of default), this type of exchange is difficult, if not impossible.

When a sovereign issuer faces a solvency crisis, the willingness of the government to pay its creditors becomes the key issue. A corporation almost always wants to pay, in order for management to save itself. It will sell prize assets to do so. A country will not. Could you imagine the U.S. government selling Yellowstone National Park to China and then letting a foreign government run it for profit? The decision by Greece’s government to divest some of its assets in order to pay bondholders is at the root of much civil unrest there. Around the world, we have seen leaders elected on a platform of not allowing foreign bondholders to take from the people. Lenders to corporations are not so often treated as pariah outsiders. When a company is in the zone of insolvency, its Board of Directors becomes accountable to its lenders and can be compelled by a court to act in their creditors’ interests.

Setting outright invasions aside, there is no merger and acquisition market for countries. In the corporate world, resource conversions can serve both debt and equity holders well. Germany cannot buy Italy and make it more German. A corporate restructuring or resource conversion has the potential to deliver equity-like returns for creditors, because assets that the corporation might have bought at a discount can later be sold at a premium. Sovereigns cannot offer such returns, because they cannot be restructured.

Ultimately, the buyer of sovereign debt is making the leap of faith that the borrower will repay, even when times are tough and even if it is not politically expedient to do so. The owner of corporate debt has to trust their borrower as well, but that trust can be enforced through the lender’s legal claims on the borrower’s assets. We feel safer in that more tangible world of debt investing.

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On Value Traps

Over the past few months, we have seen a number of prominent distressed managers dip their toes into shipping:

• WL Ross Looks to Exploit Shipping Market (Ross)

• Ships Come in as Deals Heat Up (more Ross, Carlyle, Tiger Group, Fairfax Financial, Morgan Creek)

• General Maritime Announces Completion of $200M Oaktree Investment (Oaktree Capital)

I've been to a number of shipping event the last few months. I would guess that approximately 50% of the attendees are analyst and portfolio managers from distressed debt funds. Many people think there is real value in that space (pick your flavor - for this post I'll be using the 'tanker' market as the prime example), but very little capital is flowing into the space. How does one reconcile that?

The common reaction I receive when I ask a peer if he / she is looking at the shipping sector: "The fundamentals are only going to get worse from here, so we are going to wait until the supply/demand imbalance gets sorted out." If everyone believes that though, does that not inherently mean the opinion is priced into the various securities of tanker companies? Howard Marks shares a similar sentiment in "The Most Important Thing" regarding the debt market:

"Whenever the debt market collapses, for example, most people say, 'We're not going to try to catch a falling knife; it's too dangerous.' They usually add, 'We're going to wait until the dust settles and the uncertainty is resolved'

The one thing I'm sure of is that by the time the knife has stopped falling, the dust has settled and the uncertainty has been resolved, there'll be no great bargains left. When buying something has become comfortable again, its price will no longer be so low that it's a great bargain. Thus, a hugely profitable investment that doesn't begin with discomfort is usually an oxymoron." (my emphasis added).

To me, the reason that you are not seeing capital flow into the space are two fold:

1. 90% of money managers very much care about short term results. The number could in fact be higher. The most precious capital is sticky capital (hence the reason why many asset managers have gone public, why Sardar Biglari took over Steak N' Shake, why Phil Falcone set up Harbinger Group, why closed end funds fight off people like Phillip Goldstein, etc etc). Because in most cases, capital is not sticky, short term results are monitored religiously at the expense of long term value creation. I.E. I can't buy this stock today because it may go lower in the interim.
2. There are very few investments in the shipping industry (via the public markets) that offer a meaningful margin of safety.

Point 2 is what the rest of this post will focus on.

Warren Buffett has famously said, "The first rule of investing is don't lose money; the second rule is don't forget rule number one." And Ben Graham wrote in Security Analysis: "An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative."

I can, with VERY high confidence, say that at some point in the future, spot rates for VLCC (Very Large Crude Carriers or 200,000 DWT or more) will be higher. It might not be next year, or the year after, or the year after that. But at some point, VLCC rates will be substantially higher than they are today (negative TCE rates in some instances). Here is a chart (For reference -This is the rates for VLCC going from the Middle East to the Far East) :

You will notice that forecasting price in this segment is remarkable difficult. You will also notice that at multiple points in the past 10 years, VLCC day rates have been over 200x today's rates.

Buying on that opinion alone (that rates will be higher one day) would be speculating. Because most shipping companies are massively levered, with both recourse and non-recourse, ship level debt, buying the bottom part of the capital is akin to betting the sector turns before 1) the debt comes due or 2) covenants are breached. And, if you are wrong, you get zero.

Let's take an opposite extreme example: You start a shipping company with 100% equity. No debt whatsoever. In this scenario, outside of some working capital draws that may occur if day rates stay negative for a long time, you are essentially buying an at the money call option without an expiration date. There is then no theta decay. On an asset with massive volatility. How much is that call option worth? A significant amount of money.

Wilbur Ross is one of my favorite investors. Here is the formula:

1. Determine an industry that has staying power (i.e. will be around in 20 years) that is under severe stress
2. Purchase the senior bonds of a company in that industry at distressed levels
3. File the company, and convert your senior ownership to a majority equity share
4. Clean up operations
5. Wait

Whether it be coal, steel, banking, servicing, or auto parts, these are industries that will be around for a long time and benefit from a growing domestic and global population and middle class (Full disclosure: I do not know enough about his International Textile Group to comment). And because they will be around for a long time, there will be times when investors or acquirers value these industries dearly and will pay a much larger multiple on much higher run rate cash flows than you did. That's where the waiting part comes in.

(Editor Note: That is not to say you cannot make money in industries that will not be around in 20 years. If you had invested in USMO, a PAGING company, at the beginning of the year in 2009, you would have made 84% [assuming reinvesting the fat dividend there] vs 36% for the S&P [again assuming reinvested dividends]. But that is buying an un-levered company at the depth of market pain. )

I very much worry about buying into industries, even at relatively fair prices, that I do think need to exist in 10 years. That's the ultimate value trap. Some flavors of hard line retail (electronics) fit this bill. Is RadioShack (RSH) a bargain at 3.25x forward EBITDA? Maybe, but I'd rather pay up a few multiples for a company in an industry I am certain will be around in 10 years.

Like tankers - now I just need to find a way to do it in an unlevered entity or at the top part of the capital structure. Any ideas?

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NewPage Bankruptcy Filing

This morning, paper producer NewPage, filed for Chapter 11 protection in Delaware. For those interested, you can view the bankruptcy claims agent site here:

NewPage Bankruptcy Claims Agent Site

Here are the relevant docket filings:

• Declaration of CEO in Support of Filing (where you will find a good background of the case)
• Declaration of J. Blake O'Dowd, Managing Director of Lazard, in support of debtor's motion for DIP Financing (good break down of capital structure - see below)

In an exhibit in the second link, Lazard has a great breakdown of the capital structure which I've pulled out for readers:

At the end of the day, JP Morgan's distressed trader went out with a 86.25 / 87.25 market on the 11.375% First Lien Senior Secured Notes and a 12.5 / 14 market on the 10% Second Lien Notes.

JP Morgan, which has underwritten the DIP and is leading the syndication sent out a new issue announcement detailing the terms of the DIP:

• $350M First-Out DIP ABL Revolver, $250M Second-Out Term Loan
• Pricing on Term Loan: L+750, 1.50% Floor, with OID TBD (I'm hearing 99)
• Use of Proceeds: Refinance pre-petition revolver, fees, and GCP

In my opinion, the most important take away from CEO George Martin's declaration was the LACK of discussion of negotiations between various parties. Generally you will see an affidavit / declaration, in the "Events Leading to Chapter 11" section a summary of the negotiations between stakeholders leading up to an event. In this case all we get is this:

"Lazard’s efforts were met with a general market unwillingness to provide the Debtors with additional financing or to increase the Debtors’ borrowing base. The lack of market interest in an out-of-court restructuring, coupled with the Debtors’ increasing needs to service, and in the near term refinance the majority of, their long term debt obligations, convinced the Debtors that an out-of-court restructuring was becoming increasingly unlikely."

The "draft" DIP Credit Agreement was also filed on the docket. You can find it here:

NewPage DIP Credit Agreement

In it, a minimum consolidated EBITDA covenant is established at $275M with a max quarterly capex covenant (starting in Q1 2012) of $25M. In addition, the DIP projections show a very aggressive cash build for NewPage as the cash leakage from onerous interest payments are shut off.

Even as a second out piece of paper, the DIP looks to be a safe investment for the conservative investor with a ~10% IRR.

Press reports have indicated that Apollo and Avenue Capital hold more than $400M of NewPage's 10% 2nd lien bond as of June of this year.

Simply put: This one could get ugly and a valuation fight will surely arise similar to what we saw in Smurfit Stone. It will ultimately be up to the judge to decide which valuation argument to go with (i.e. second liens will fight for a large valuation to be in the money, whereas first liens will fight for a lower valuation to keep all the goodies for themselves). And as always, management will play a decisive role here in that they will be looking out for themselves to see which creditor provides the best "management compensation plan" in its suggested plan. Always follow the incentives.

Add in an underfunded pensions and two classes of debt beneath the "warring" classes and I think you'll see some fireworks. Stay tuned.

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