Lehman Brothers Bankruptcy

A number of years ago, when I knew nothing about distressed, my portfolio manager sat me down and said, "Our friends at XYZ hedge fund [name redacted] are telling me these Enron bonds are interesting - start working through it." Over the next 6 months I cut my teeth (hard) on figuring out how much bond holders would receive and what return that translated to. It was one of the best exercises that I've ever been put through as an analyst.

In my opinion, the best situations for distressed debt investors to make out-sized returns are when the bankruptcy filing is unexpected. I remember when Solutia filed in 2003 and Parmalat soon after. In both situations, no one had any idea what to make of the situation. Uncertainty creates opportunity. Chaos as it were. In that vein, of every situation I've encountered in my professional career, Lehman, and its various 'flavors' has been one of the most complex.

On a daily basis I am receiving over 200 trader runs on various Lehman instruments. The most liquid of these instruments are the LBHI bonds, or Lehman Brothers' holding company. In addition, you have runs on "LBSF", "LBCS", "LCPI", "LBIE", "LBT", "LBCC", "LOTC", LBHI Euro, LBHI Yen etc etc. While these instruments are more illiquid, each may hold the possibility of a solid risk adjusted return.

Earlier in July, a diverse group of creditors agreed to a settlement that will (more than likely) enable Lehman to exit Chapter 11. Similar to Enron, this settlement resolves around a partial substantive consolidation (80/20) split. This settlement was agreed upon by a "Who's Who" of hedge funds and prop desks (dubbed the PSA Creditors):

Angelo, Gordon & Co., L.P.

Barclays Bank PLC

Barclays Bank S.A.

BNP Paribas

Canyon Capital Advisors LLC

CarVal Investors UK Limited

Contrarian Capital Management LLC

Credit Suisse International

Credit Suisse Loan Funding LLC

Credit Suisse Securities (Europe) Limited

Cyrus Capital Partners, L.P.

Davidson Kempner Capital Management LLC

DB Energy Trading LLC

Deutsche Bank AG

Elliott Management Corporation (also Elliott Associates, L.P.

Elliott International, L.P. The Liverpool Limited Partnership)

Fir Tree, Inc.

GLG Ore Hill LLC

Goldentree Asset Management, LP

Goldman Sachs Bank USA

Goldman Sachs International

Hayman Capital Master Fund, L.P.

King Street Capital Management GP, L.L.C.

Knighthead Capital Management, L.L.C.

Morgan Stanley & Co. International PLC

Morgan Stanley Capital Group Inc.

Morgan Stanley Capital Services LLC

Mount Kellett Master Fund II, L.P.

Oak Tree Capital Management, L.P.

Och-Ziff Capital Management Group LLC

Paulson & Co. Inc.

Silver Point Capital, L.P.

Societe Generale

Societe Generale Asset Management Banque

Societe Generale Bank and Trust

Taconic Capital Advisors L.P.

The Baupost Group, L.L.C.

The Royal Bank of Scotland plc

Varde Partners, L.P.

York Capital Management Global Advisors, LLC

This group of creditors held over $100 billion (!) of claims against Lehman Brothers.

While the value proposition was definitely there when the LBHI bonds were trading in the teens, another aspect of this case was that A LOT of capital could be put to work with very little correlation to the market with very little downside. And that is still probably the case.

Like in all bankruptcies, the disclosure statement here lays out contemplated recoveries for the various creditor constituencies. And like most bankruptcy cases, these recoveries cannot be relied upon to make actual trading decisions. For instance, LBHI Senior Bonds are contemplated to recover 21.1% whereas in the market as of this afternoon the bonds were trading (depending on the specific bond) between 26 - 26.5%. While in "dollar value" that may not look like a lot, in reality it's a ~25% difference. Why the disparity?

• As in most cases with financial assets as collateral for creditors, there is a perception that there has been a sense of conservatism and that, over time, these assets throw off cash that increases recoveries to creditors
• The fact that no one really knows the recovery on foreign inter company receivables. We do know that the recovery of inter company receivables from foreign affiliates, at less than 10% is far below similar (domestic for instance) recoveries contemplated in the disclosure statement - It's also a HUGE number where a 1% bump means $500M more recovered for LBHI
• Litigation awards that could go any which way

These are just a few factors. In addition, returns to investors depend dramatically on when cash actually gets paid out. The fact that the plan / disclosure statement is on the docket means the likelihood of more timely distributions increases. It will be a sad day when this case finally comes to a close (I believe it accounts for something like 70% of all trade claims).

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Linked In Groups

For those that do not know, about a year ago I started a Linked In group focused on distressed debt investing - specifically related to corporate securities. I had found most groups on Linked In were related to CRE, which albeit interesting, is not what I wanted to focus on with this site. Currently, there are over 2,000 members in the group. For those are interested in that group, here is the URL: Distressed Debt Investing Linked In Group

Also - this week I started a new group focused on analysts and portfolio managers that cover the insurance industry (both on the buy and sell side). As some of you know, and have been discussed in the past, despite being a generalist on a day to day basis, I have the most knowledge and connections in the insurance industry and thought it would be a good way to network with other analysts and portfolio managers. Here is that URL: Insurance Analysts Linked In Group

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Distressed Debt Weekly Links of Interest

What I am reading this weekend:

Third Avenue 2nd Quarter Commentary for their various funds (will have a post up on this soon) [Third Avenue Management]

Ambac's Disclosure Statement [Ambac Chapter 11 Docket]

Citron Research's short thesis on ZAGG [Citron Research]

An incredible piece on change of control provisions in bankruptcy, specifically in the Young Broadcasting [Bankruptcy Law Blog]

Notes from Charlie Munger's last "Wesco meeting" [Inoculated Investor]

Fantastic piece on how cheap old tech is versus recent tech IPOs [Washington Post]

Most comprehensive notes I've seen yet from May's BRK Annual Meeting [Dr. David Kass' blog]

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Advanced Distressed Debt Concept: Credit Bidding

One of the more complicated tenets of bankruptcy proceedings that has seen a number of circuit courts disagreeing is that of credit bidding. Credit bidding, under section 363 (k) of the Bankruptcy Code, allows a secured lender the ability to "credit bid" its claim to ensure that the collateral backing the secured claims are not sold for less than the secured claim itself. One of the more famous cases dealing with credit bidding was the Philadelphia news case. In that case, the US Court of Appeals for the Third Circuit (important because Delaware is in the Third Circuit), ruled that a bankruptcy plan may allow a sale of the debtor's assets (that are subject to a lien) without giving secured lenders the chance to credit bid as long as the secured creditors receive "indubitable equivalent" of their claim.

Recently, the United States Court of Appeal for the Seventh District ruled in River Road Hotel Partners, LLC v. Amalgamated Bank that a secured creditor has the right to credit bidding, essentially in direct opposition to the aforementioned Third Circuit's ruling. What does this mean? That this issue may go to the Supreme Court.

To explain this very difficult, but incredibly important issue better, I reached out to George Mesires of Ungaretti & Harris, who has allowed me to re-post a fantastic piece he's written explaining the importance and implication of the Seventh District's ruling. Enjoy!

Finance and Restructuring Update: Seventh Circuit Hands Secured Lenders a Major Victory - Splits the Circuits by Holding that Secured Creditors Have Right to Credit Bid Under Plan Sales

Introduction

On June 28, 2011, the United States Court of Appeals for the Seventh Circuit affirmed the Bankruptcy Court for the Northern District of Illinois’ decision and held that a secured creditor has a statutory right to credit bid its debt in the sale of assets proposed under a non-consensual plan of reorganization pursuant to Section 1129(b)(2)(A) of the Bankruptcy Code. See River Road Hotel Partners, LLC v. Amalgamated Bank, Case No. 10-3597, __ F.3d __ (7th Cir. June 28, 2011). The case is significant for at least two reasons. First, the Seventh Circuit is the first judicial circuit to recognize that a secured creditor has the absolute right to credit bid at an auction sale held pursuant to a plan of reorganization if such sale seeks to sell the assets free and clear of liens. Second, the Seventh Circuit decision splits from its sister circuits (the Third and Fifth Circuits) and potentially makes the unsettled question of law ripe for consideration by the United States Supreme Court.

In its decision, the Seventh Circuit splits from the Third Circuit’s decision in 2010 in Philadelphia Newspapers and the Fifth Circuit’s decision in 2009 in Pacific Lumber, which held that, as a matter of law, a debtor may preclude a secured creditor from credit bidding when a debtor sells its assets pursuant to a plan of reorganization and provides the creditor with the indubitable equivalent of its claims. See In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3rd Cir. 2010); see also In re The Pacific Lumber Co., 584 F.3d 229 (5th Cir. 2009). Citing favorably to Judge Thomas L. Ambro’s dissent in the Philadelphia Newspapers case, but conducting its “own independent analysis of 1129(b)(2)(A)’s meaning,” the Seventh Circuit held that the plain language of Section 1129(b)(2)(A) does not authorize the confirmation of a plan of reorganization that denies a secured creditor the right to credit bid in connection with a plan sale.

Background - Sales of Assets Outside the Ordinary Course in Bankruptcy

In bankruptcy, a debtor may sell its assets outside of the ordinary course of business in two ways: (i) under section 363 of the United States Bankruptcy Code the (“Bankruptcy Code”); or (ii) pursuant to a plan of reorganization under section 1123 of the Bankruptcy Code.

Under Section 363, unless the court for cause otherwise orders, a secured creditor may credit bid its claim. Credit bidding is the ability of a secured lender to offset its claim against the purchase price of the property. See 11 U.S.C. §353(k); 3 Collier on Bankruptcy ¶363.09 (Alan N. Resnick & Henry J. Sommers eds., 16th ed. 2010). For a secured lender, credit bidding helps to ensure that the collateral is not sold for less than the face amount of the debt, and can preserve the ability of the secured creditor to participate in any appreciation of the value of its collateral. In other words, the secured creditor uses some or all of the amount of its claim as a source of payment at an auction such that if the secured creditor is the winning bid, no exchange of money need occur and the amount of the bid is offset against the amount of the outstanding debt. Credit bidding protects the secured lender against attempts to sell the collateral too cheaply if the secured creditor thinks the collateral is worth more than the sale price.

Alternatively, a debtor can sell its assets pursuant to a plan of reorganization. A plan of reorganization can be approved over the objection of creditors, including a secured creditor, under the “cramdown” provisions of the Bankruptcy Code. To cramdown a secured creditor, among other things, the reorganization plan must be “fair and equitable” to the secured creditor. The “fair and equitable” standard may be satisfied by showing that the plan provides: (1) that the holders of such claims retain the liens securing such claims and receive deferred cash payments having a present value equal to the value of their collateral; (2) for the sale of the collateral free and clear of liens (with such lien attaching to the sale proceeds of the sale) but subject to the secured creditor’s right to credit bid (the “Sale Prong”); or (3) for the realization of the secured creditor’s claim by some means which provides the secured creditor with the “indubitable equivalent” of its claim (the “Indubitable Equivalent Prong”).

The River Road Hotel Partners Case

In the River Road Hotel Partners case, the debtors proposed selling substantially all of their assets, consisting mainly of the InterContinental Hotel Chicago O’Hare, pursuant to a plan of reorganization. As part of its plan, the debtors sought to deny the lenders the ability to credit bid their debt as a matter of law under the Indubitable Equivalent Prong, and for cause under Section 363(k).

In its bid procedures motion, the debtors cited the plain language of 1129(b)(2)(A)(iii) and Philadelphia Newspapers to seek to deny the lenders the ability to credit bid as a matter of law. Even if the court denied the debtors’ request to preclude the lenders from credit bidding under section 1129, the debtors argued that the lenders should be precluded from credit bidding for cause. The debtors cited the following factors, among others, as establishing cause under Section 363(k): (i) there exist disputes regarding the priority of competing secured creditors; (ii) granting an unsecured creditor the right to credit bid would chill the bidding process; and (iii) the lenders “precipitated” the debtors’ chapter 11 cases by “improperly refusing to provide funding” under the loan agreements.

On October 5, 2010, Judge Bruce W. Black of the bankruptcy court denied the debtors’ bid procedures motion citing Judge Ambro’s “well-reasoned dissent” in Philadelphia Newspapers. In that dissent, Judge Ambro noted that “it seems Pickwickian to believe that Congress would expend the ink and energy detailing procedures in clause (ii) that specifically deal with plan sales of property free of liens, only to leave general language in clause (iii) that could sidestep entirely those procedures.” Philadelphia Newspapers at 329. Judge Ambro also reasoned that denying the lenders the ability to credit bid would only benefit stalking horse acquirors by allowing such acquirors to potentially acquire assets below market value. Further, the court found that the debtors failed to demonstrate “cause” sufficient to justify barring the lenders to credit bid at auction.

After certification of appeal to the court of appeals in October 2010, the Seventh Circuit’s ruling on June 28, 2011 held that “the plain language of 1129(b)(2)(A) does not clearly authorize confirmation of the Debtors’ reorganization plans” because the statute does not have a single plain meaning – “there are two plausible interpretations of the statute: one that reads Subsection (iii) [the Indubitable Equivalent Prong] as having global applicability and one that reads it as having a much more limited scope.” River Road Hotel Partners, LLC v. Amalgamated Bank, 10-3597, __ F.3d __ (7th Cir. June 28, 2011) (citing i, 599 F.3d at 324-27 (Ambro, J., dissenting)). Looking beyond the text of Section 1129(b)(2)(A) – as it must if the statute does not have single plain meaning – the Seventh Circuit was influenced by the way auctions are recognized and the way secured creditors are treated elsewhere in the Bankruptcy Code. In both Section 363(k) and 1129(a)(2)(B)(ii) a secured creditor is permitted to credit bid, which “promises lenders that their liens will not be extinguished for less than face value without their consent … Because the Debtors’ proposed auction would deny secured lenders the ability to credit bid, they lack a crucial check against undervaluation. Consequently, there is an increased risk that the winning bids in these auctions would not provide the Lenders with the current market value of the encumbered assets [i.e., indubitable equivalent value].” River Road Hotel Partners, __ F.3d __.

The Seventh Circuit found also that canons of statutory construction weighed against the debtors’ proposed interpretation of 1129(b)(2)(A). Specifically, the debtors’ interpretation would render the first two Subsections of 1129(b)(2)(A) superfluous: if “Subsection (iii) permits a debtor to sell an asset free and clear of liens without permitting credit bidding, then it is difficult to see what, if any, significance Subsection (ii) can have. Similarly, the Debtors’ interpretation would permit properly-designed reorganization plans to sell encumbered assets without satisfying the conditions set forth in Subsection (i). We cannot conceive of a reason why Congress would state that a plan must meet certain requirements if it provides for the sale of assets in particular ways and then immediately abandon these requirements in a subsequent subsection.” River Road Hotel Partners, LLC v. Amalgamated Bank, 10-3597, __ F.3d __ (7th Cir. June 28, 2011).

Since 2009, debtors have sought to leverage the Pacific Lumber and Philadelphia Newspapers decisions and seek to deny secured creditors the right to credit bid under plan sales. The Seventh Circuit’s ruling should be deflating to emboldened debtors, at least in the Seventh Circuit, and provide some assurance that secured creditors in the Seventh Circuit may exercise their right to credit bid under both Section 363 of the Bankruptcy Code and an auction sale proposed under a plan of reorganization. However, because this judicial decision does split the judicial circuits, there may now be disparate results, making this issue ripe for resolution by the Supreme Court.

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List of Special Situation/Post Re-Org Equities Traded on the Distressed Desks

Over the long weekend, I went through my dealer and broker runs to come up with a equities that are either:

1. Post Re-Org Equities
2. Equities trading at distressed levels
3. Companies currently in bankruptcy
4. Equities that used to trade at distressed levels and are still held by a number of distressed funds.

You will notice on the list below that if the issuer stock is not traded publicly, I have marked it as "Privately Traded on Desks." These situations require investors to sign a confi agreement to receive information on the company. They are usually very illiquid (Delphi being a very good exception) and more often than not, if a desk is telling you to buy these securities, it means they have a large seller on the other end. Fortunes are made in these securities in bull markets, but when things go south, you will see them quoted down to unheard of levels. And because they are so rarely traded, you have to rely on the marks given to you by the desks. Yes you can fight them on it, but its rarely a worthwhile effort. They are sometimes called "hedge fund hotels" and "roach motels" (at least when you can't get out of the security).

Of the listed equities below, they would make excellent application ideas on the Distressed Debt Investors Club. There are 40 spots left of the 250 member limit. We currently have over 3,000 buy side and sell side guests. If you are interested in applying, please contact me. Without further ado, here is the list of special sit stocks traded off the distressed desks:

ABH - AbitibiBowater

ABVT - AboveNet Inc

ACW - Accuride

[Privately Traded on Desks- S1 Filed] - Aleris Inc

[Privately Traded on Desks- S1 Filed] - Ally Financial

ALLY 8.125 - GMAC Capital Trust Preferred

ALLY 8.5 - Ally Financial Perps

ARHN - Archon Corp

ACAS - American Capital

[Privately Traded on Desks] - American Media, Inc

[Privately Traded on Desks] - Angiotech Pharmaceuticals

[Privately Traded on Desks] - Anvil Holdings

[Privately Traded on Desks] - Ashmore Energy

AVRW - Aventine Renewable Energy

AUMN - Golden Minerals

BKEP - Blueknight Energy Partners

BLC - Belo Corp

[Privately Traded on Desks] - Building Materials Holdings Corp

[BLLY or Privately Traded on Desks] - Bally Total Fitness

BGPIQ - Borders Group

[Privately Traded on Desks - 144A] - Broder Brothers

BUFR - Buffets Restaurants

[Privately Traded on Desks] - CDX Gas Inc

CHTR - Charter Communications

CCHJW - Charter Warrents

CCMMW - Charter Warrents

CHHP - C&D Technologies

CCMO - CC Media Holdings

[CEMJQ - Privately Traded on Desks] - Chemtura Stubs

CHMT - Chemtura Equity

CNB 7.875 - Colonial CAP Trust Preferred

CNB 8.875 - Colonial BancGroup Preferreds

CIT - CIT Group

CDELA - Citadel Broadcasting Class A

CDELB - Citadel Broadcasting Class B

CDDGW - Citadel Broadcasting Warrents

CMLS - Cumulus Media

CODE - Spansion Inc

COSH - Cooper-Standard

[Privately Traded on Desks] - Crescent Resources

DAN - Dana Holding

[Privately Traded on Desks] - Deep Ocean Group (f/k/a Trico Marine)

DEXO - Dex One Corp

DIMEQ - Wamu/Dime Bancorp Warrant

DRL - Doral Financial

DPH - DPH Holdings (Delphi)

[Privately Traded on Desks] - ECI

[Privately Traded on Desks] - Education Media & Publishing

[Privately Traded on Desks] - Elkhorn Mining

EPL - Energy Partners

[Privately Traded on Desks] - Express Energy Services

FCSC - Fibrocell Science

FDML - Federal-Mogul

FMCC - Freddie Mac & All Flavors of Preferreds

FNMA - Fannie Mae & All Flavors of Preferreds

FRP - Fairpoint Communications

FSNN - Fusion Telecommunications

FTWR - FiberTower

[Privately Traded on Desks] - Freedom Communications

GGP - General Growth Properties

GLBC - Global Crossing

GLBS - Globus Maritime

GLPW - Global Power Equipment Group

GM - General Motors

GM 4.75 - General Motors Convertible Preferreds

GM/WS/A - General Motors A Warrants

GM/WS/B - General Motors B Warrants

GRA - WR Grace

GSAT - Globalstar

GRKT - Greektown Superholdings

GSIG - GSI Group

GCVRZ - Sanofi Adr

[Privately Traded on Desks] - Haights Cross Communications

HAWKQ - Seahawk Drilling

[Privately Traded on Desks] - Hayes Lemmerz

HEARQ - HearUSA Inc

[Privately Traded on Desks] - Hellas Telecommunications

HWLT - Hawaiian Telecom

[Privately Traded on Desks] - Hawkeye Renewables

[Privately Traded on Desks] - Affinity (fka Herbst Gaming)

HHC - Howard Hughes

ICOG - ICO Global

[Privately Traded on Desks] - ION Media

[Privately Traded on Desks] - Insight Health

ITWG - Internationational Wire Group

[Privately Traded on Desks] - Journal Register

[Privately Traded on Desks] - KGen LLC

LEA - Lear Corp

LYB - LyondellBasell

LALWF - LyondellBasell Warrents

[Privately Traded on Desks] - Mark IV Industries

[Privately Traded on Desks] - Marsico Capital

MASWF - Masonite Worldwide

[Privately Traded on Desks] - MediaNews

MERC - Mercer International

[Privately Traded on Desks] - Merisant Worldwide

[Privately Traded on Desks] - Mesa Air Claim

[Privately Traded on Desks] - MGM Studios

MMPIQ- Meruelo Maddux

MTOR - Meritor Inc

[Privately Traded on Desks] - MXEnergy Holdings

MX - Magnachip Semiconductors

[Privately Traded on Desks] - North Atlantic Drilling

NNHE - Neenah Enterprises

[Privately Traded on Desks] - Newark Group

[Privately Traded on Desks] - Newhall Land Development

NRTLQ - Nortel Networks

NTKS - Nortek

NVIGF - Navigator Holdings

NOF NO - Northern Offshore

[Privately Traded on Desks] - Oriental Trading

[Privately Traded on Desks] - Pacific Ethanol LLC Units

[Privately Traded on Desks] - Penton Media

[Privately Traded on Desks] - Philadelphia News

ORMT - Ormet

PBSOQ - Point Black Solutions

PHOS - Phosphate Holdings

PPC - Pilgrim's Pride

PNC/A - Postmedia Network Canada

PTGI - Primus Telecom

QLTY - Quality Distribution

QUAD - Quad/Graphics

[Privately Traded on Desks] - Readers Digest

ROIAK - Radio One

[Privately Traded on Desks] - RHI Entertainment

RMYI - Remy International

[Privately Traded on Desks] - Satelites Mexicanos (SATMEX)

SALM - Salem Communications

SBGI - Sinclair Broadcast

SEAOF - SeaCo Ltd

SEMG - SemGroup

SIX - Six Flags

SFI - iStar Financial

SGGH - Signature Group Holdings

SGU - Star Gas Partners

SOA - Solutia Inc

SPB - Spectrum Brands

[Privately Traded on Desks] - Stallion Oil

[Privately Traded on Desks] - Star Tribune

SPMD - SuperMedia

TMB CN - Tembec Inc

TSTRQ - TerreStar

TPCG - TPC Group In

TRMAQ - Trico Marine Prepetition Equity

TROX - Tronox Inc

[Privately Traded on Desks] - Trump Entertainment

TPCA - Tropicana Entertainment

[Privately Traded on Desks] - Tropicana Las Vegas

USCR - US Concrete

[Privately Traded on Desks] - US Power Gen

[Privately Traded on Desks] - US Shipping

VRML - Vermillion

VC - Visteon Corp

VTSS - Vitesse Semiconductor

WALK - Walking Co Holdings

WAVE - Nextwave Wireless

WM 5.375 - Wamu Trust Convertible Preferred

WAMUQ - Wamu Preptition Equity

[Privately Traded on Desks] - WCI Communitities

[Privately Traded on Desks] - Wolverine Tube Reorg Equity

XOHO - XO Holdings

XRM - Xerium Technologies

VKSC - Viskase Cos

[Privately Traded on Desks] - Vitruvian Exploration

[Privately Traded on Desks] - Young Broadcasting

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