Saturday, March 26, 2011

Moody's on Distressed Debt Exchanges

Longtime readers of Credit Bubble Stocks know that we like to be involved in distressed debt exchanges, like Callon Petroleum, Evergreen Solar, Yellow Roadways, and US Concrete.

I was reading a white paper by Moody's about how they evaluate distressed exchanges - whether they consider one to be a default or not. Here are some of the factors they look at:

"Certain types of exchanges obviously constitute monetary loss – the face value of interest and principal on the new securities is less than that on the old securities. Other types of exchanges are presumed to constitute monetary impairment, although this may not always be enough to determine that the exchange was distressed. Examples include transactions which involve an uncompensated extension of term (e.g. a straight exchange of notes for identical notes with a longer maturity), an uncompensated change in the amortization schedule which increases duration, or an uncompensated lowering of relative priority of claim (e.g. an exchange of bonds for preferred stock). Uncompensated covenant waivers may also be viewed as imposing a monetary loss on investors, if the covenants in question are viewed as material to the value of the instrument in question..."
The paper also addresses holdouts:
The Trust Indenture Act (1934) could prevent issuers from altering the principal, coupon or maturity of a bond without the unanimous approval of bondholders. Therefore, a group of bondholders can refuse to agree to a mutually beneficial debt exchange, i.e. and “hold out”, unless a specific set of demands is met. In so doing, however, they hinder the ability of the majority of the bondholders to scale down the debtor corporation’s over-leveraged capital structure. Obviously, the end game in the hold-out paradigm is to pay off the maturing claims of those “holding-out” with any savings which otherwise would be realized by a proposed recapitalization.
At the time the paper was written, Moody's said that distressed debt exchanges were less common during periods of high default rates. However, that did not seem to hold true during the most recent credit cycle.

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