Booth's Distressed Investing and Restructuring Notes

On April 13th, Chicago Booth held its 7th Annual Distressed Investing and Restructuring Conference. The organizers of the event have graciously provided us extensive notes for the conference which we've laid out below. I heard it was an amazing event from many readers.  Enjoy!

Opening Keynote Speaker: James Grant, Founder, Grant’s Interest Rate Observer 

• Mr. Grant began by addressing Ben Bernanke’s March 20, 2012 lecture at George Washington, where the Federal Reserve Chairman blasted the Gold Standard. 
• Mr. Grant expressed his thoughts that Distressed Investors were likely a much better group to efficiently allocate capital to the Banking Sector during the crisis than was the Federal Government. However, in a pinch, there is very little the Fed will not do to “save” us as illustrated by the $2 Trillion dollars it created out of thin air.  
• Bernanke’s Fed has defined price stability as a positive rate of inflation; less than 2% would be deflation.  Mr. Grant pointed out that if Bernanke is a historian he is not the kind that reads and writes history. Milton Friedman, in his study of the last quarter of the 19th century, showed that price levels decreased between 1 and 1.5% while the economy experienced the greater technological advancements than any previous 25 year period in history. Nevertheless, Bernanke seams unaware of the benefits of creative destruction and bargains (value/distressed investment opportunities). Mr. Grant illustrated this point (Creative Destruction) by referencing the opening of the Suez Canal, which caused certain economist in London to wonder if they should have filled “the thing” up with dirt as it rendered storage related segments of the London economy irrelevant. 
• Continuing his point on how the Federal Government allocated capital differently than a distressed investor would have, Mr. Grant mentioned that during the last quarter of 2008 TALF lent money at a rate of 1% during the same time period that banks were lending to each other at 3.5%; Morgan Stanley borrowed $100+ billion, which was much higher than its market cap.
• Mr. Grant is convinced that the Fed (Ben Bernanke) does not fully understand the markets or the crisis. The statement that “the only solution is for regulators to monitor all financial institutions” is horrible; historically banks did not only take risks but they bore those risks as well. 
• Mr. Grant’s final comments addressed the possible consequences of suppressed interest rates as he expressed his believe that Bernanke is wearing interest rate “Beer Goggles”. He likened the current regulatory situation to the Seaman’s Act of March 1915, which set new requirements for lifeboats and was drafted in reaction to the Titanic disaster. On July 24, 1915 the SS Eastland, a passenger ship, due to the additional weight burden of the Seaman’s Act mandated lifeboats, rolled over while tied to a dock in the Chicago River killing 844 passengers and crew members. Our new crisis engendered policy response financial regulations will have negative consequences. Similar to the Seaman’s Act of 1915, the risks associated with these regulations were not incorporated in the thought processes that ultimately lead to their creation.           

Legal Panel:  Sponsored by Davies Polk & Wardwell LLP 

Moderator: Donald Bernstein, Davis Polk & Wardwell LLP

Panelists:
Douglas Baird, University of Chicago Law School
Anup Sathy, Kirkland & Ellis LLP
Damian Schaible, Davis Polk & Wardwell LLP
Eugene R. Wedoff, United States Bankruptcy Judge, District of Northern Illinois 

The legal panel discussed three primary topics: (1) Credit Bidding, (2) Insider Trading, and (3) Regulatory Licenses as Collateral

Credit Bidding:

• After a court’s decision on the value of a claim, the creditor may still receive more than the ruling amount in the event of an asset sell.
• Credit bidding, the ability for a creditor to bid their debt with their cash alongside bidders that only bid cash, may be eliminated by the courts; 7th Circuit River Road Hotel case.
• Panel Consensus -> Credit bidding should remain an option as: an all cash bid may not be possible for a cash strapped firm, bidders have the right to finance however they would like (credit bidding is self-financing), creditor syndicates have mixed financial backgrounds and should have financial flexibility to better coordinate, government entities may have no other way to bid due to the inability to raise fund.
• In regards to the bidding structure, Judge Wedoff discussed the issue of eliminating some of the bidders from the auction. However, doing this would create a non-market price.  

Insider Trading:

• Borrower provided non-public information used inappropriately can lead to a firm’s claim being eliminated following the infraction
• There are contracts that allow all parties to trade after the fact as they demand that the firm publically release all information that the insiders had access to during the restructuring/stressed situation. 
• Some firms have come in and out of blackout periods to trade. However, judicial decisions indicate judges’ inpatients with investors who have done this. Also, firms with the same information have made very different (sometimes offsetting) investment decisions signaling that insider information may not always provide an investing edge. 
• Some firms have chosen to hire a trusted third party to act on their behalf’s so they may remain able to trade the name in the market. One panelist expressed doubt in this solution due to its potential principal/agent issues. 

Regulatory Licenses as Collateral (licenses and air travel):

• When you have a regulatory asset that cannot be sold, can you use the economic benefits associated with those assets (licenses)? 
• FCC licenses cannot be sold. However, a lien can be levered on the income that can be generated from the license. As a firm cannot pledge the license the question is can a firm pledge the proceeds associated with the license? A case in Colorado concerning an FM station received a court ruling of “no” to the question citing that (1) the license has not been sold and (2) all licenses must be approved by the FCC.
• One panelist vocalized the believe that the Colorado Court should have ruled differently and cited joint venture corporations that have similar structures and economics (Southern District of New York upheld this argument). Judge Wedoff believes that in such a scenario you would not be able to enforce the lien. However, the world loves “work-arounds” and in reality licenses can be placed in SPVs that can than pledge the economic value.
• Can Slots (the right to take off and land during certain times), Gates (where passangers board and un-board), and Routes (flight paths into airports, which are limited) be pledged as assets? 
• Bonds have been issued that were secured by Slots, Gates, and Routes. The American Airline Case will eventually tell us if they can be posted as collateral. However, as one panelist stated, gates are likely a canard while slots and routes may be ruled as regulatory licenses (proceeds may be pledged but not the licenses). 

KEYNOTE SPEAKER: Jonathan Lavine, Managing Partner & Chief Investment Officer, Sankaty Advisors, LLC  

• Distressed investors should constantly run their decision trees to located and evaluate potential opportunities. Distressed companies and distressed sellers provide compelling opportunities. A retailer CFO stated “the availability of money is more important than the cost of money”. This means high returns may be extracted from supplying liquidity to an illiquid situation. Firms that never go bankrupt can provide compelling investments; bank debt (leverage loans) outperformed junior debt during the recession. 
• An investors decision trees should include the following questions: how healthy is the industry, does anyone care if the company disappears. Ask yourself what must you as an investor need to believe; will anyone care about the displaced industry (horse buggies) when new technologies are introduced to the market (Ford’s Model T)? 
• Why do firms go bankrupt? (1) liquidity crisis (but good company),(2) insolvent (bad capital structure with viable business model), (3) unviable (bad business model). Typically defaults peak 18 to 30 months after peak issuance. 
• The biggest mistake a distressed investor can make is assuming that tomorrow the world will be like it was yesterday. Tomorrow the world may be as it was 10 years ago or it could be in a state we have never seen before. 
• ETF’s may provide fire sell opportunities. Global macro factors, such as Chinese inflation, may provide opportunities as well. If Chinese labor prices rise while our income is fixed, higher prices at Walmart would mean we are importing Chinese inflation, which could engender distressed opportunities. 
• Sankaty is looking at what the elections in the US & France (and elsewhere), sovereign balance sheet leverage, commodity price increase (oil, gold, etc), financial oppression, and the drop in natural gas prices may do to asset valuations. 

Restructuring Case Study: TerraStar Networks. Sponsored by The Blackstone Group

Moderator: Steve Zelin, Senior Managing Director, The Blackstone Group

Panelists: 
C.J. Brown, Managing Director, The Blackstone Groupl
Douglas Brandon, General Counsel, TerrStar Networks 
Rachel Strickland, Partner, Willkie Farr & Gallagher LLP
Arik Preis, Partner, Akin Gump Strauss Hauer & Feld LLP

• Terra Star was formed to take advantage of terrestrial networks by filing the gaps of land line based cell coverage. After bankruptcy the strategy was to hold its FCC license for as long as possible as it would likely have significant value. 
• An auction was executed with 75 non-disclosure agreements sent out to extract the most value from the asset. However, only 3 non-disclosure agreements were returned signed. 
• The auction was a naked auction (no leader to provide a starting bid amount), which can lead to very small bid amounts. In this case, the result was a successful bid of 22 cents on the dollar for assets that proved to be worth roughly 60 cents. Thus, the return was ultimately about 300%. 
• Collective action proved difficult in this case due to the classic problem of concentrated benefits and defused costs. At the end of the day, only one company was willing to put up the money and was rewarded handsomely.  

Investment Banking Panel.  Sponsored by Peter J. Solomon Company

Moderator: Nat Gregory, Professor, University of Chicago Booth School of Business 

Panelists:
Dan Aronson, Lazard
Mona Baruah, Rothschild 
John McKena, Miller Buckfire
Durc Savini, Peter J. Solomon Company 

• Bankruptcy court damages businesses, is costly, and very contentious. However, to resolve the issues out of court you need 100% consent and many times you will have a hold out problem. 
• Pre-packaged bankruptcy is fully negotiated and is documented whereas a pre-negotiated deal does not solicit votes. 
• Every year since the onset of the financial crisis there has been an increase in pre-packaged bankruptcies, while restructurings have trended down. The substitution away from full restructuring is in large part due to time constraints and the interruptions restructurings force onto businesses. 
• Chapter 11 equates to spending a lot of money and to conserve value and prevent a bankruptcy free fall it is better to avoid this scenario. However, in a constrained DIP situation the bank controls everything and liquidity is not available for middle markets companies due to Dodd-Frank. 
• A good business with a bad capital structure is a strong candidate for a pre-packaged deal. However, a pre-packaged bankruptcy may take two months so if you are cash strapped you may not be able to afford this option. 
• The success of any deal depends heavily on intrapersonal skills, ensuring that participants actually own the bonds and have the power to make the deal. No party wants to receive the worst deal and everyone wants the best deal while no insider information may be used to make the deal (if the deal sours all information must be made public).
• SEC is very strict on the details; real non-copied signatures, no faxes, hard deadlines, etc
• Loan to own investors may be good for situations where time is very valuable as they will get things done, which protects against a bankruptcy free fall. However, these investors do not always maximize value. 

Distressed Investing Panel

Moderator: David Small, Grosvenor Capital Management

Panelists:
Matt Dundon, Pine River Capital Management
James Ganley, Carval Investors 
Kathleen Steele, Zell Credit Opportunities Fund

• Each member of the panel presented a specific distressed investment example that their respective firm’s participated (is participating) in. The discussion included a broad walk through of these investments with focus on the key issues associated with each opportunity.  
• An electric generation company in Boston was discussed broadly with an emphasis on a few points. Predicting the fulcrum security is crucial as is avoiding the loss (management selling) of assets that are crucial to post distressed value realization.
• A national moving company was also discussed. The company had an interesting dynamic in that it also provided executive relocations services, which included home sells. These homes were being put back to the company in significant numbers due to a lack of enforcements of agreements that would have dramatically reduced the number of company owned homes on the balance sheet. Systematically reducing the number of homes on the balance sheet through agreement enforcement meaningfully improved the firm’s credit profile as did other operational and procedural changes. 
• The panel was optimistic about continued opportunities in the distressed space but insisted that relationships and the ability to move into different sectors when necessary is crucial to gaining access to the most attractive deals.