Distressed Investing Conference Notes: Part II (including Wilbur Ross comments on shipping sector)

Last week, we reported notes from the Beard Group's 18th annual Distressed Investing Conference. Distressed Debt Investing contributor Josh Nahas, Principal of Wolf Capital Advisors, a Philadelphia based investment advisory firm focused on distressed debt and corporate restructuring, was in attendance. Here is more notes from the conference:

Baggage & Benefits: Current Issues in the Ownership of Distressed Debt and Bankruptcy Claims

Panelist:

• Paul N. Silverstein, Panel Moderator, Partner/Co-Chair Bankruptcy & Restructuring Practice, ANDREWS KURTH LLP
• Geoffrey A. Richards, Group Head, Special Situations and Restructuring, WILLIAM BLAIR & COMPANY L.L.C.
• Jane Sullivan, Executive Vice President, EPIQ BANKRUPTCY SOLUTIONS

The first topic discussed was credit bidding and the Philly News and Palco decisions and how those decisions were unfavorable to secured creditors who, prior to those rulings, had always assumed to have an absolute right to credit bid except in the case of malfeasance. Section 363(k)of the bankruptcy code allows for credit bidding except for “cause” which the 3rd circuit in Philly News went to define broadly, not just a bad act.

However, in In re River Road Hotel Partners LLC the 7th Circuit affirmed the bankruptcy court’s ruling, rejecting the debtor’s bid procedures motion on the grounds that it precluded credit bidding. In that case, the court took the same approach as the dissenting opinion of Judge Ambro in Philly News which was based on the principles of statutory construction. There is now a split between the 7th Circuit and the 3rd and 5th Circuits and the appellate circuits as to the interpretation of Section 1129(b)(2)(A)’s “fair and equitable” standard. River Road along with another debtor in a similar case RadLax have appealed the decision to the Supreme Court.

Issues relating to the risks of trading with Plan Support Agreements ("PSA") were discussed. One result is that creditor will be required to disclose exact amount of holdings. Counter parties need to know whether they actually hold title to instruments (assignment vs participation) and whether the securities are held currently or out on loan. It was recommended that if you sign a PSA it is best not to sit on the UCC because of potential conflicts in your fiduciary duties.

Next, the panel tacked the issue related to WAMU and post-petition interest. The panel viewed as a troubling and unsound decision where a ruling by Jude Walrath of the US Bankruptcy Court in Delaware held that creditors with a contract rate of interest (bondholders) of a solvent debtor were only entitled to Federal Judgment Rate on post-petition interest. In the opinion, she admittedly disavowed her previous statements in In re Quorum Healthcare Corp where she had upheld post-petition interest at the contract rate. She did uphold a contractual subordination clause between the Sr and Junior lenders that will require the junior lender to turn over their recovery to the senior lenders until the senior lenders have recovered their post-petition interest.

The panel all agreed that as a result, investors should be modeling base case recovery waterfalls in solvent debtor case assuming judgment rate not contract rate, at least for cases in Delaware until there is more clarity on the issue.

Perhaps the most disturbing and far reaching decision for distressed investors is Judge Walrath’s findings with regards to potential insider trading claims. In her ruling, Judge Walrath found in favor of the equity committee having a “colorable” claim of insider trading against members of a steering committee which had formed to negotiate a settlement with the debtor. The 4 fund group had established provisions for cleansing of inside information, and lifting of trading restrictions when negotiations had closed. The panel believed that this decision may significantly impact the ability and willingness of creditors to actively participate in negotiations with debtors. This could increase the time it takes to get a deal done in bankruptcy, as well increase the amount of money spent litigating, rather than negotiating.

The last issue the panel briefly touched on was Judge Kevin J. Carey’s decision to reject both plans in the Tribune bankruptcy. Carey said neither plan was confirmable but appeared to favor Tribune’s plan, labeling the competing plan as “speculative.” The issue surrounds Fraudulent Conveyance claims against those who financed the 2007 LBO of the company. There are questions surrounding the ability of the creditors to step into the debtor’s shoes and pursue the claims, since fraudulent conveyance actions are prosecuted by the debtor on behalf of the estate.

Transportation & Shipping: Investment Tips & Traps

Panelists

• Wilbur L. Ross, Chairman and Chief Executive Officer, WL ROSS AND CO. LLC (Pre-Recorded Statement)
• Edward O. Sassower, Panel Moderator, Partner, KIRKLAND & ELLIS LLP
• John P. Brincko, President, SITRICK BRINCKO GROUP, LLC
• Mark Friedman, Senior Managing Director, EVERCORE
• Daniel G. Montgomery, Managing Director, MESIROW FINANCIAL CONSULTING, LLC
• Steven Strom, Managing Director and Global Head of Restructuring, JEFFERIES & CO.

Wilbur Ross opened with a 20 minute overview of distressed shipping sector. He spoke via a pre-recorded video as he was in Ireland meeting with regulators about his investment in Bank of Ireland. Mr. Ross spoke briefly about his investment in Navigator Holdings and Airlease, however he spend most of his time providing an astute overview of distressed shippers.

In the distressed shipping sector, he first noted that the majority of ships are financed by European banks which are under increasing strain and have dramatically curtailed lending. Shipping is already struggling due to the glut of ships that have come on the market from the mid 2000s boom as well as from declining economic activity. Moreover, shipping is still a highly fragmented industry with few barriers to entry. There are a large number of charter operations with 1 or 2 vessels who compete aggressively on price. He noted that currently shippers require $4 of assets to generate $1 of revenue, not a recipe for good returns on capital. With charter rates down over 45% from their 2007 peak, Mr. Ross predicted that the market would not reach equilibrium for at least another year if not more.

As a result of these factors Mr. Ross predicted that the next couple years would be difficult for shippers and that the way the industry finances itself would be fundamentally transformed and that private equity and alternative investors would play a significant role. He believed that banks were going lower the LTVs that they lend against to the 50% range while they previously had been closer to 80%. He noted that a great deal of ship financing over the last several years came from German KG tax shelters, but indicated that this source of funding was not likely plays as big a role going forward.

In addition, he felt that the current opaque corporate structures where operators are competing against their public company owners would need to change and that the business would need to become more transparent. Mr. Ross predicted there would be opportunities for those who funds willing to take a long view and capable of dealing with the multi-jurisdictional issues and untangling the complex corporate structure.

Moving to the panelists in attendance, John P. Brincko, President of Sitrick Brinkcko who specializes in the trucking space spoke on the current problems facing the sector. He pointed out that the business has become heavily commoditized, is highly fragmented with many independent owner/operators and has little pricing power. To make matters worse many of the truckers, including YRC which went through a restructuring are saddled with expensive union contracts. He felt the companies with expensive labor contracts, and particularly YRC, would likely need to file for bankruptcy to reduce operating costs and remain competitive.

Other panelists noted the free fall bankruptcies of Omega Navigation and Marco Polo and said those cases could influence future restructurings in the shipping space. Steve Strom of Jefferies cited Omega as an example of a foreign shipper filing in the US as a good test case. (Jefferies is advising the debtor). Mark Friedman of Evercore noted that there are a large number of publicly traded shippers priced under $10 per share with 12-15 shipping companies trading at $2. He thought many of these names could be good short candidates.