No Exit
The credit market woes are now finding their way into the bankruptcy and restructuring world, driving up borrowing costs for troubled companies
By Aleksandrs Rozens February 4, 2008
Solutia Inc., the St. Louis industrial products manufacturer, was set to leave bankruptcy court supervision last month.
A former chemicals business that was once part of the Monsanto empire, Solutia employs 5,700 people and has annual revenue of $3.8 billion. The company had been under bankruptcy court supervision since December 2003, when its yearly sales were $2.4 billion. Solutia managed to broaden its customer base under court supervision, cut costs and increase prices to match its own rising costs. Sales materials for its exit financing show that the company looked to further reduce costs and de-lever its balance sheet while divesting non-core businesses upon exiting from court supervision. In the fourth quarter, just as it got a commitment from Wall Street for exit financing, it saw an improvement in net income from the previous year.
Many companies limp out of bankruptcy. Solutia was poised to sprint.
But on Jan. 22, Solutia was told by its Wall Street banks -- Citigroup, Goldman Sachs and Deutsche Bank -- that credit market conditions prevented them from being able to complete that exit financing. A day after he was told of the problem, Jeffry Quinn, Solutia's chief executive, questioned why the $2 billion financing could not be completed. "While we disagree with the position asserted by the lead arrangers, we intend to continue to work with them to successfully syndicate the exit facility," Quinn said in a statement.
Quinn was not available for further comment, but a spokesman for Solutia says the company's CEO is still working on finding exit money. As far as when the company would emerge from bankruptcy, that, too, was uncertain. "There is no new emergence date," the company spokesman says.
Solutia may not be alone. Other companies in bankruptcy may find themselves spinning their wheels under court supervision for longer than expected. Also, they may find that they won't get as much money as they hoped for their exit. Delphi -- the auto parts giant that filed for bankruptcy in 2005 -- has found it is taking longer than expected to get its exit loan, say bankruptcy professionals.
"We have seen some highly publicized deals stop dead in their tracks. Lines of credit in excess of $1 billion are tough to clear," says Mitch Drucker, a partner at New York's Garrison Investments, a credit opportunity fund. "The absolute size of each exit financing is an issue in this market due to the reduced universe of buyers of leverage loans."
"You are seeing the credit markets shrinking. You are seeing big banks pulling out of commitments," says the head of a commercial bank's restructuring group.
At the root of the jump in costs for troubled companies is pervasive concern about risk that has emerged in Wall Street's credit markets. The problems may have started within a subset of the world's largest credit market - the US mortgage bond mart - but the spasms are being felt throughout Wall Street's lending businesses. That includes financing businesses emerging from bankruptcy as well as underwriting loans for companies entering bankruptcy.
Not only is there a re-evaluation of leverage, but one of the important sources of debt for Wall Street -- the collateralized debt obligation (CDO) market -- has been shuttered. Now banks, which could count on reselling their loans through syndicate desks, are being forced to keep the loans on their balance sheets. That means they are cautious about who they lend to and what terms they offer.
"The issue is not just a distressed [debt] or bankruptcy issue. It has an awful lot to do with the volatility in the credit markets," says one veteran bankruptcy attorney involved with some of the largest bankruptcy cases who declined to be named. "The volatility in the credit markets right now is greater than it has been in a long time."
The changes in the credit markets have forced restructuring professionals to adjust exit plans and this can impact the value of a company marching out of bankruptcy. A change in how much a business can borrow upon its exit from court supervision will have an impact on how much money creditors will get back from their corporate debtors.
"Capital is still available for companies entering and exiting bankruptcy. But it has become more expensive and the institutions providing the capital are once again the traditional lenders and less the alternative lenders who became so prominent in the last few years," says Ken Buckfire, co-founder of Miller Buckfire, a New York banking boutique that specializes in restructuring and merger advisory work.
Changes in the DIP recipe
Getting debtor-in-possession, or DIP, financing has been relatively easy in recent years because credit on Wall Street has been readily available for not only less credit-worthy, subprime consumers but less credit-worthy businesses, including those in bankruptcy. Subprime consumers and corporations could readily find borrowers because of the collateralized debt obligation market. That CDO market has been hobbled by the credit storm.
"The exit and the DIP market has really mirrored the overall market in a lot of ways," says Kevin Lavin, a senior managing director at FTI Consulting, which also specializes in restructurings. "Deals were super competitive over the last couple of years. Fees and pricing, the interest rates, kept going down and down."
When it comes to underwriting DIP loans, a banker with a Wall Street firm active in financing bankrupt companies says that some industries like auto makers and home builders are out of favor, while some manufacturers and busineses involved with the energy sector can readily get financing.
These days the DIP likely will be done with existing creditors -- a shift back to the way things were done three or four years ago. When it comes to DIPs, terms are not as favorable; they are more expensive and they will have a shorter commitment period. Previously a lender would commit six months forward, now the commitment for a DIP financing is good for 30 to 90 days because of the wild credit market gyrations.
Another dynamic seen in recent years is that the investment banks competed with each other to invest in deals. As one lender with a Wall Street firm sees it, "investment banks were acting on a mercenary basis to take deals away from each other. In a changed paradigm, banks are more focused on their own deals and less focused on taking deals away," this lender says.
What will free up lending for DIP borrowers or companies looking for exit money? Believe it or not, more failed M&A transactions financed purely by leverage. "We're in tougher market conditions. The backlog of LBOs is getting shorter as financial sponsors cancel merger agreements. That reduces the debt overhang," says one lender.
Generally, spreads or yield premiums over Libor have widened on DIP loans. The banker with the Wall Street firm that offers DIP loans and exit money to bankrupt companies says that pricing has risen by 125 basis points to 150 basis points over the last year.
According to a bankruptcy veteran with another New York bank, some of the new DIP loans and exit loans include so-called "Libor floors." Libor rates have dropped in recent months as European central banks add liquidity to the global monetary system. With Libor floors, lenders are assured that there is a limit to how low borrowing costs can get for a borrower. "You are getting people asking for Libor floors. That was not even part of the negotiations before the current market conditions," says the market veteran, adding that in many cases the Libor floor is set at 4% or 5%.
Last week, Dura's exit financing included a $170 million loan priced at Libor plus 1,000 basis points. The deal is said to have had a Libor floor of 3.75%.
While the pool of DIP lenders in recent years included commercial banks, investment banks and hedge funds, some commercial banks held off from lending because there simply wasn't enough of a yield premium or enough of a fee to justify underwriting the loan. Today, though, the yield premiums have ballooned, which may bring back some smaller commercial banks.
"You're certainly seeing an increase in DIP financing pricing and activity," says Garrison's Drucker. "They [DIPs] are no longer cosmetic lines of credit. They are being used to refinance pre-petition debt such as first and second lien loans," he says. "You have real exposure in DIPs so pricing is going up."
But, Marcia Goldstein, head of the bankruptcy practice at Weil Gotshal, says that it may be too early to tell how exactly the credit market problems will impact DIP lending. "I don't think we've seen enough activity yet to judge how competitive DIP lenders will be in terms of pricing," she says.
While exit money may be hard to come by, Goldstein believes that banks will still offer competitive DIP loans because these are shorter term loans with court- protected collateral. "DIPs should be easier to come by than exits," says Goldstein, adding that exit loans are "necessarily longer term credits which must be viewed under different criteria."
New market conditions
Not all notable bankruptcies these days are being derailed. Calpine and Dana are about to emerge from bankruptcy -- largely because they secured their exit financing from Wall Street's banks prior to the changes in the market.
That said, the rise in the cost of DIP financing was evident.
Last week, Quebecor World USA, the printer of titles such as Time and Cosmopolitan, received a $1 billion DIP loan. The loan's revolving credit facility, totaling $400 million, was priced at Libor plus 2.25% and the term portion of the loan, totaling $600 million, was priced at Libor plus 3.75%. A year ago, Delphi managed to get a $2 billion term DIP loan paying Libor plus 250 basis points. Calpine last March snared $4 billion at Libor plus 225 basis points and Federal Mogul's $605 million term loan was at Libor plus 175 basis points in May.
Solutia's exit may be stalled, but the company still is fighting to keep alive the commitment it got from Wall Street last fall. Solutia retained Quinn Emanuel Urquhart Oliver & Hedges, the largest law firm in the US devoted solely to business litigation, and the company asked the US bankruptcy court in New York's Southern District to approve the hire of the law firm.
According to court papers filed last week, Solutia wants Quinn Emanuel to advise it "regarding their ability to initiate actions to protect their rights under the commitment letter and related documents and enforce the commitment parties' legally binding commitments" and "commence and conduct any and all litigation necessary or appropriate to assert" its rights.
But, the veteran bankruptcy attorney involved with some of today's biggest cases noted that the increased use of material adverse change clauses is not without precedent. One leading capital market bank in New York invoked the market MAC clause in the wake of 9/11.
What do the new conditions in the credit market mean for the bankruptcy process?
"Creditors may now be nervous about a debtor's ability to get a commitment from Wall Street lenders and enforce it," says Richard Levin, head of restructuring practice at Cravath, Swaine & Moore. So, he adds, "the creditors might not be willing to sign a deal with a debtor until an enforceable commitment is on the table. This in turn could slow the restructuring process."
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