Hoping for Failure!?

[Joanne98]

posted by Jason Kilborn

As if negotiating a confirmable reorganization plan weren't difficult enough already, apparently credit default swaps (CDS) are making it even more difficult. The March 7th issue of the Economist has a great sidebar article, aptly entitled "Burning down the house." The author helpfully analogizes CDS to fire insurance--if a corporate borrower defaults (i.e., the house burns down), the CDS seller pays the buyer for the loss. That seems like an acceptable hedge if the buyer of a CDS is the lender, but what if high-risk investors (speculators?) buy CDS, banking on a corporation's default (akin to "naked short selling" of a company's stock, a tactic also under attack of late).

This explosive situation comes to a head if the borrower company attempts a reorganization. Now you've got very dedicated and often aggressive investors hoping for your failure! If they have enough riding on the CDS paying out, one can easily imagine a CDS holder offering to buy a blocking position (34%) of the unsecured debt of a company attempting reorganization--which the CDS holder can probably do for a song in light of the pending reorganization (and the payout on the CDS will almost inevitably be more than a plan promises to unsecureds). I've heard lots of grousing among judges wanting to know how certain "creditors" voting unsecured claims came to own those claims--now I understand why these judges want that info and what scary info they might find if the question is answered. I presume the "not in good faith" votes of CDS holders voting down a reasonable reorg plan could be equitably subordinated or classified (rejected). What a nightmare for debtor's counsel! All that work to then have your plan fail because investors with no real skin in your game tank your deal so they can collect the equivalent of hazard insurance on your failure.

It gets worse when national borders are involved. The Economist article mentions the Chapter 11 case of LyondellBasell, initiated in early January. Apparently, some CDS holders want to force the debtor's European parent to default, bringing in the complications of a cross-border reorganization. That would so complicate the case that the chance of a total meltdown--and a payout on the CDS--would spike, so DIP lenders have ponied up just to avoid that eventuality. The strategies of securing plan support are FAR more complex today in the CDS-influenced and cross-border complicated world of reorganization. I guess that's why the bankruptcy lawyers get the big bucks.

http://www.creditslips.org/creditslips/2009/03/hoping-for-failure.html

Why credit-default swaps make restructuring harder to pull off


LYONDELLBASELL, the world’s third-largest petrochemicals producer, should have “Danger, inflammable substance” signs posted on its debt. Its struggle against insolvency is a cautionary tale in the era of credit derivatives. As defaults soar, it is one of the first big firms to have its restructuring complicated by holders of credit-default swaps (CDSs). It is unlikely to be the last.

Last month the company’s European arm missed an interest payment. Its woes, however, began much earlier. In the heady days of 2007 Basell, headquartered in the Netherlands, bought its American rival Lyondell in a $19 billion deal, all financed with debt. Leveraged buy-outs usually take place in stable industries. The petrochemicals industry is cyclical, but caution was in short supply as the buy-out cycle neared its end. Then came the commodities boom, which made LyondellBasell’s feedstock more expensive. After the bust it had $26 billion of debt. In early January its American unit filed for Chapter 11 protection.

Now, ominously, some creditors would like to see the European parent default as well. The firm has obtained a temporary restraining order to prevent them from making claims against the European parent. It secured a grace period, and now has less than a month to make the missed interest payment.

The cause of this turn of events is the proliferation of CDSs on the company’s debt. A CDS works like a fire-insurance policy: the holder pays a regular premium, but if the house burns down there is a big payoff. With CDSs, the payoff is triggered by a default—and filing for Chapter 11 did indeed trigger some CDSs. Now other CDS holders would like to see a default in Europe, to provoke a payout. Unsecured creditors who hold CDSs might prefer default to a lengthy restructuring: to them, the insurance policy is worth more than the house.

But there are good reasons to keep the European operations out of insolvency while the company restructures in America, says Mark Hyde, a specialist in cross-border restructuring at Clifford Chance, a law firm. Bankruptcy proceedings in Europe are messy, and merely to avoid the tangle of multiple jurisdictions is appealing. By contrast, America’s Chapter 11 has the advantage of enabling the firm to obtain “debtor-in-possession” financing, which is senior to all other types of capital. New creditors are therefore willing to step in and fund operations while restructuring takes place. The firm has received a DIP loan of $8 billion, the largest on record. That is a red, gasoline-soaked, rag to CDS holders.


http://www.economist.com/finance/displaystory.cfm?story_id=13240662

Are they saying what I think they're saying? Investors are buying credit default swaps on debtors trying to re-organize? I think we need HEARINGS on this!

:mad:

[westerebus]

1. Not this week.

AIG is fresh out of money. Can they come back next week when the Lil' Kim launches a new missile and the media can run up the flag of danger close. It's easier to do the deal that way.