Docket Update: Marathon Seeks Appointment of Examiner in AMR's bankruptcy

Today, Marathon Asset Management filed a motion (Docket #5089) to appoint an examiner in American Airline's bankruptcy. Marathon has been all over the AMR bankruptcy docket since the commencement of the case including being a part of a group of creditors represented by Vedder Price disclosed in a Rule 2019 docket entry (other creditors included Anchorage, BlueMountain, Cyrus Capital, Trilogy Capital, to name a few). In the document, Marathon states that it owns "well over a hundred million dollars of claims against the Debtors, including substantial claims against American Airlines"

The motion to appoint an examiner stems from arguments from Marathon (and other creditors) that questionable transactions occurred between AMR Corporation, American Eagle Airlines, Inc and American Airlines, Inc in the months proceeding the bankruptcy. The document above (the motion to appoint an examiner) lays out specifics of Marathon's arguments and a fascinating read for those that are involved in the American Airlines bankruptcy case. Specifically, claims traders that have participated in various parts of AMR corporate structure.

The document summarizes Marathon's main contention:

"In the weeks leading up to the filing of the Debtors’ chapter 11 cases, American Eagle and American Airlines consummated a series of intercompany transactions that resulted in American Airlines assuming $2.26 billion of dollars in additional debt that American Eagle previously owed to the Financing Parties (the “Prepetition Transactions”). On their face, the Prepetition Transactions raise serious questions as to whether American Airlines received fair value in exchange for incurring the billions of dollars in debt and as to whether these transactions were otherwise improper." 

And continues in more detail later in the document:

"According to the Rule 9019 Motion, at the time of the Prepetition Transactions, American Eagle’s outstanding debt to the Financing Parties was approximately $2.26 billion. The Debtors claim that the value of the 263 regional jets at the time of the transfers was $1.8 billion, or $426 million less than the amount of the assumed debt. In addition, the Debtors claim that American Eagle cancelled certain intercompany payables of American Airlines to American Eagle and settled other intercompany receivables and payables...

...While, arithmetically speaking, it appears possible from the face of the Rule 9019 Motion that the transactions entered into between American Airlines and American Eagle just before the Debtors’ bankruptcy filing were an “even swap,” there is insufficient public evidence to reach that conclusion. It is no comfort that the Debtors make a bald assertion by the Debtors that avoidance of the $2.26 billion in debt assumed by American Airlines is “at best, remote.” To the extent that the transactions were in fact an “even swap,” it is unclear why they would have helped clean up the American Eagle balance sheet for the planned spin-off, or why they would have resulted, just months later, in a proposed deal with the Financing Parties, described in the Rule 9019 Motion and below, in which American Airlines is abandoning some of the Aircraft, and in which the Aircraft Parties are agreeing that the Aircraft are worth hundreds of millions of dollars less than they were supposedly worth a year ago."

For those that are not closely following the American Airlines bankruptcy case, the corporate structure is essentially AMR Corporation at the top as the parent of American Airlines, Inc and American Eagle Airlines, Inc. As Marathon noted in the motion, it holds "substantial claims against American Airlines" or American Airlines, Inc. By American Airlines, Inc assuming substantial debt from American Eagle, the claims pool at American Airlines, Inc got a lot larger (assets in theory also increased, but as the motion points out, assets were far less in reality). The bet here is that these transfers are avoided and the claims pool shrinks and recovery (all else being equal is higher) for American Airlines, Inc claims. Currently, AMR Inc claims trade in the low 40s context (AMR Corp - the double dip claims trade in the mid 60s).

A hearing date for the motion has been set to November 8th (objections due by November 1st). We will keep readers updated on how the proceedings play out. Marathon's motion is embedded below:

AMR - Marathon Examiner Motion

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Hedge Fund Letter: Castle Union

A few months ago, Distressed Debt Investing interviewed Toan Tran and Steve White of Castle Union Partners, LP as part of our emerging manager series. It was a fascinating interview well received by a number of readers.

This weekend, I received Castle Union's first letter to investors which discusses some of the philosophies and positions of the fund. From reading this letter, I have more confidence in what I wrote a few months ago: These two investors are stars with bright futures.

My favorite quote from the letter: "Steve and I have a substantial portion of our liquid net worth invested with you in the Fund, and we will not expose ourselves and you to the risk of permanent capital loss simply to say we are 'fully invested'. Whether we are 76% cash or 5% cash does not change whether an idea is suitable for investment." Fantastic stuff. Enjoy the letter!

2012 q3 Letter Ddic

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Docket Update: AMR Moves to Refinance Certain EETC at Par

This afternoon, American Airlines filed a motion with the bankruptcy court to repay certain existing prepetition debt. In a subsequent 8K/press release, the company notes, that in addition to obtaining post petition financing of $1.5B, AMR will also (my emphasis added):

...use cash on hand (including proceeds of the New EETC) to indefeasibly repay the existing prepetition obligations secured by the Aircraft, as applicable, which are currently financed through, as the case may be, an EETC financing entered into by American in July 2009 (the “Series 2009-1 Pass Through Certificates” (CUSIP: 023763AA3)), a secured notes financing entered into by American in July 2009 (the “13.0% 2009-2 Senior Secured Notes” (CUSIP: 023771R75)) and an EETC financing entered into by American in October 2011 (the “Series 2011-2 Pass Through Certificates” (CUSIP: 02377VAA0)), in each case without the payment of any make-whole amount or other premium or prepayment penalty.

Members and guests of the DDIC will know that I've been involved in the American Airlines bankruptcy since its very beginnings via the 2001-1 EETC (A and B tranche specifically). This trade has worked out wonderfully and I've since taken off most of the trader. For those interested, you can find the write up here: Hunter AMR Write-Up

As noted above, AMR will attept to repay three pieces of paper (I've included notional amounts according to Bloomberg and trading levels prior to announcement):

• 2009-1 EETC: 108.5-109.5 -> $446M
• 13% 2000-2 Secured Notes: 106.25-107.25 -> $174M
• 2011-2 EETC: 106.75-107.75 -> $704M

...without paying a make-whole amount, premium, or prepayment penalty. If all this paper is taken out at par, investors will lose (market loss) approximately $100M. 

Needless to say, a number of law firms better start sharpening their pencils because those note holders will not go down without a fight. Especially with that much market loss staring them in the face. 

I've really only spent significant time with the 2009-1 EETC. I've spoken to many parties even before the filing and my read was that AMR didn't have to pay the make-whole. The language is difficult, and there looks to be some drafting oversights, but net/net I believe those bonds in particular can be taken out at par (the indentures are embedded in the motion below). I didn't think they would actually do it (refinance the paper), but demand for airline collateral is red-hot now and they will be able to cut substantial interest expense and free up collateral in this move. The motion notes: "If the Debtors are able to take advantage of the existing low interest rate environment and issue the New EETC at rates comparable to the recent financings described above, the interest expense savings by the Debtors would be well in excess of $200 million."

Other investors believed otherwise hence the premium pricing on the bond which was still well back of similarly over-collateralized, high quality EETC. I believe some investors even thought there was a chance these deals had to be taken out at the make-whole which would also explain the pricing. 

I would not expect the bonds to trade directly to par. There will still be option value here for litigation claims, some sort of mediation or agreement in principal in a premium refinancing. 

I have embedded the motion below. A hearing is set to occur at the end of October on the motion.

AMR EETC Refinancing

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Quick Admin Update

I wanted to provide readers with some quick updates re: Distressed Debt Investing:

• Posting will recommence this week with significantly more frequency. I will be announcing a number of new series and exclusive interviews with hedge fund managers and distressed debt professionals in the coming weeks.
• I spent the last few days answer emails over the past month that I had yet to respond to. If I didn't get back to you, please resend the email and I will respond.
• A number of investment conferences are coming up. If you would like coverage or advertising for the event, please email me.
• Many of you know this, but I maintain a Public Linked In group. You can join here: http://www.linkedin.com/groups?gid=2604443
• The Distressed Debt Investors Club continues to grow nicely. I often get emails about membership opportunities. Here are a few things I'd like to say: 
• DDIC members come from many of the largest hedge funds and investment bank in the worldI speak to Chief Compliance Officers quite often to  answer their questions regarding the service. Our compliance policies can be found here: DDIC Compliance
• There is a member only job forum on the site. While it is slow going now, I plan to expand this feature for members
• I have capped membership at 250 members. Like other services in this area, some members can no longer post or have moved on to a different part of the investment world. There is a natural churn in membership. Right now there are probably about 25 open spots. Members are required to post one idea every six months with at least one of them being distressed related.

As always, thanks for your continued support, suggestions, and readership. I have the best group of readers out there.

And finally: Who in their right mind invested in a drive-by holdco PIK toggle dividend deal with an 8 handle?

-Hunter

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The Catch 22 about CLOs

A few weeks ago, I noted it was sellers market in credit. Since then, the market has had some very heavy days and some rather strong days. A few deals have even been pulled from the market on the bond side. With that said, the primary market was hefty to say the least, settling a monthly record with over $47.5B of paper being priced according to JPM. Winners in the month were trading names typical of this stage of the cycle with names like Petroplus, Ambac, Affinion, and Geokinetics seeing large price moves higher.

Leveraged loans also delivered a strong month. And frankly, the technicals felts a lot stronger than the high yield market. According to JPM, $34B loans priced during th emonth making it the 12th most active month ever. For the year, the CSFB Leveraged Loan index is up 7.80% with JPM reporting leveraged loans have gained 8.66% year to date.  All in all it was a very strong month (and so far year) for leveraged finance.

One vehicle that also shined this month were CLOs. 13 new CLOs priced in September with a total value of $6.2B. On a year to date basis, $32B of CLOs have priced which is nearly 3x as much as last year. This is still a far cry from the nearly $90B that priced in 2007. Just today LCD reported yet another CLO being priced by Och-Ziff with AAA garnering a L+148 coupon. I am hearing the forward pipeline is very strong with underwriters and arranging banks pushing the product hard on asset managers. Less reported, but still widely important: Secondary CLO spreads tightened up and down the capital structure.

I often talk about uneconomic sellers being the path to riches in investing. Find someone that HAS to sell, provide that seller with liquidity at a steep discount, profit. Capitalizing on problem or issue that has no impact (or very little impact) on the intrinsic value of securities is a profitable endeavor. The opposite is also true: Buying as asset or asset class because you have can be a terrible UNPROFITABLE endeavor. If a high yield manager is doused with inflows, he or she may have to put that capital work into a well-bid market where all of their peers have the same problem: Too much capital, not enough liquidity/sellers, buying assets higher.

When you think about the data I listed above of $6.2B of new CLOs vs $34B of primary loan issuance you wouldn't think there would be a problem. But then you start ticking off other salient factors:

• According to JPM, $9B of paper was paid down during the month (amort, bond for loan issuance)
• Refinancings accounted for nearly 50% of volumes in September
• There was an additional ~$1B capital coming into the asset class via retail inflows and possibly more from non-bank / non-CLO participants

So, with that said loan managers had to put $9B of paper to worth  (because it was paid down), and 50% of the volume was simply refinancing. So - realistically there was about $17B of new paper, up for grab for loan managers. $6.2B + $1B of new capital + $9B of pay downs gets you pretty close to that number. Now this is a simple exercise that doesn't take into account CLO managers that are past their reinvestment window and are unable to deploy new capital into loans except via amend and extends (which isn't really new money capital - but its a way to stay in the game and collect manager fees).

I have used the term in the past, but I think "feeding the beast" is an appropriate analogy for CLO structures. CLOs, due to their leverage, have liabilities to pay. To pay these liabilities, CLOs investing in underlying loans of corporations and capture an arbitrage spread. Assuming a few defaults here and there with modest recoveries, everyone, including the equity holders should be happy with their performance. But what if there weren't any underlying loans to buy?

CLOs need underlying loans to survive. In their ramp up, "warehousing" period, loan managers buy up loans to start the arbitrage machine in motion. When the market is really hot, managers are crawling over one another to try to get the best allocation to work for them as efficiently as possible. When the market is really slow and not a lot of private equity or M&A activity is happening to fuel issuance, again CLO managers are fighting to get allocations or bidding up existing paper to feed the beast. 

I worry the next cycle for leveraged loans will be a lot more painful than 2008. I worry a scenario where CLOs outside their reinvestment period are unable to purchase loans and there is simply just too much supply of loans to go around and prices have to clear at a level to get non traditional buyers into the market. This creates a vicious cycle where performing CLO tests will begin to fail (OC cushion) and they too will be less likely to purchase loans at a discount. And since TRS are not what they used to be, hedge funds may have to wait until loans get even lower because a L+500 asset at 80 doesn't quite hit the hurdle rate at 3x leverage (maybe 5x). Given the changes regulation like Dodd Frank has graced us with, dealer inventories are light and markets will be very very wide. And finally, many investors got a free pass (temporarily painful one) in the last cycle the matra of CLO AAA being an unbreakable structure is becoming accepted as religion is downright frightening.

The way I see it: Only an uneconomic buyer would buy a dividend deal with no covenants at these spread levels. 

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