Capitala Finance says no energy sector loans in default in Q1

Capitala Finance said that of the five companies in its investment portfolio with direct exposure to the oil-and-gas sector, all of them were current with debt payments.

“All investments continue to perform and the fair value of oil-and-gas investments was approximately 87.2% of cost at March 31, 2015, compared to 89.5% at Dec. 31, 2014,” an investor presentation today showed.

The investments are:

  • Sierra Hamilton $15 million 12.25% secured loan due 2018, marked $14.5 million at fair value as of March 31, 2015 (no change from Dec. 31, 2014), accounting for 6.1% of net assets
  • TC Safety $22.6 million investment (6.6% lower than Dec. 31, 2014 on a fair value basis), including a 12% cash, 2% PIK subordinated loan due 2018
  • U.S. Well Services $8.8 million 11.5% (0.5% floor) secured loan due 2019 (increased by $4 million since year-end due to previous unfunded commitment)
  • ABUTEC $4.9 million 12% cash, 3% PIK term loan due 2017 (down 4.2% from year-end on a fair value basis), for 2.1% of assets
  • SPARUS, Southern Cross, EZTECH $10.5 million investment fair value as of March 31, 2015, down 0.7% from year-end

These investments at fair value total $61.3 million as of March 31, 2015, or 11.8% of the total. Fair value is 3.6% higher than at year-end.

A breakdown of Capitala Finance’s portfolio by sector showed oil-and-gas services accounted for 7% of the total portfolio by fair value, and oil-and-gas engineering and consulting services accounted for 2.8% at the end of the first quarter.

As of March 31, 2015, Capitala Finance’s portfolio comprised 54 portfolio companies with a fair value of approximately $518.9 million. Of that total, 35% was senior secured debt investments, 45% was subordinated debt, 18% was equity and warrants, and 2% was the Capitala Senior Liquid Loan Fund I.

Capitala’s portfolio as of Dec. 31 consisted of 52 portfolio companies with a fair market value of $480.3 million. Of that total, 31% was senior secured debt investments, 46% was subordinated debt, and 23% was equity and warrants.

Capitala Finance targets debt and equity investments in middle-market companies generating annual EBITDA of $5-30 million. The company focuses on mezzanine and subordinated deals but also invests in first-lien, second-lien and unitranche debt. – Abby Latour

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Investors eye BDC portfolios for signs of more pain from energy sector

On the eve of first-quarter earnings, BDC investors are anxious to see whether the energy sector will inflict more pain on loan portfolios.

An analysis of the portfolios of 45 BDCs tracked by LCD shows that 31 energy-related companies with outstanding debt were in distressed territory at the end of 2014, in this case valued at 80 or less, which is a widely used definition of distressed debt. Of these, the average weighted fair value at year-end was 64 cents on the dollar.

Prior to last year’s oil price declines, there were just 10 energy-related companies with debt in distressed territory, at a weighted average of 38.5, an analysis by LCD of public filings of the BDCs showed.

First-quarter results for BDCs began to trickle in last week, and many more are expected this week. While oil prices have yet to recover fully, prices are off lows, and the outlook is relatively stable for the short term.

“While the energy exposure is still a concern, we are not expecting an influx of energy non-accruals in the quarter,” KBW analyst Troy Ward said in an April 27 research note. But if oil remains depressed, KBW expects to see an increase in loans booked as non-accrual in the second half of 2015.

Of all the distressed debt within BDC portfolios, energy accounts for about a quarter of the total. Distressed energy debt totaled $500 million of principal within BDC portfolios tracked by LCD, counted across various tranches of debt, at the end of the fourth quarter. That’s 23% of $2.2 billion by principal amount in total distressed assets.

Similarly, energy is the most concentrated sector of distressed assets across other measures of distress in the credit markets.

For example, the Oil & Gas sector accounted for 37.2% of the loans in the distressed ratio of the S&P/LSTA Loan Index. The distressed ratio tracks the percent of performing Index loans trading at a yield of L+1,000 or higher. Oil & Gas-related loans account for 4.7% of the overall Index.

Of all loans in the Index, Oil & Gas-related loans account for 4.7% as of April. Despite two defaults that totaled $1.7 billion –Walter Energy and Sabine Oil & Gas’ second-lien loan – the lagging default rate of the S&P/LSTA Loan Index by principal amount dropped to 1.26% in April, a one-year low, from 3.79% in March.

In another measure of distress in credit markets, S&P Capital IQ’s Distressed Debt Monitor, the ratio of U.S. distressed debt was steady, at 11.5% in April. Again, distressed credits are defined here as speculative-grade issues with option-adjusted composite spreads in excess of 1,000 bps over Treasuries.

The Oil & Gas sector had the highest proportion of debt trading at distressed levels, at 38%, and the highest share of distressed issues by count, at 72, and one of the largest by distressed amount, at 29.9%, as of April 15, according to Distressed Debt Monitor, which is published by S&P Capital IQ.

In a sign of stabilization in the sector, the Oil & Gas sector experienced the largest decline in the proportion of distressed issues, falling 3.9% in April, month over month, the Distressed Debt Monitor showed.

Within the BDC portfolios, energy debt accounts for 5.8% of all debt investments, or $60.7 billion (in outstanding principal).

“It’s not that things have dramatically improved, but the volatility has subsided for now. It’s reasonable to think that they are at a floor level now,” said Merrill Ross, an equity analyst at Wunderlich Securities.

Energy sector allocations vary between BDCs. Some have no exposure to the sector. At year end, CM Finance, PennantPark, Gladstone, Main Street, Apollo Investment, Blackrock Capital, TPG Specialty, and White Horse Finance had 10% or more exposure in oil-related energy, including equity investments, according to KBW research. The weighted-average fair value for energy debt across these eight lenders ranges between 86.5 and 97.9.

BDC Energy 4Q story May 2015

Fair values vary across portfolios and can be difficult to assess among small private companies. Sometimes differences across the same investment can be attributed to different cost-basis levels for each provider. The timing of changes in fair value also can vary.

Below are some examples of distressed Oil & Gas holdings as of Dec. 31, 2014.The implied bids are based on fair value to cost:

The 7.5% second-lien debt due Nov. 1, 2018 for Bennu Oil & Gas is marked at 83% of cost at Sierra Income Fund, whereas CM Finance and PennantPark mark it at 76 and 75, respectively.

The 8.75% senior secured loan due April 15, 2020 for exploration-and-production company Caelus Energy is marked at 93 at CM Finance, and 91 by WhiteHorse Finance.

The 12% mezzanine financing due Nov. 15, 2019 for New Gulf Resources was marked at 56 by Blackrock Capital Investment at the end of 2014, while PennantPark Investment marks the debt at 52. However, Blackrock Capital on April 30 reported first-quarter earnings, showing the 12% mezzanine loan now marked at 67.

A $7.5 million, 9.5% subordinated loan due 2020 to Comstock Resources was marked at $5.1 million at year-end by FS Investment, or 70 to cost. Comstock Resources, based in Frisco, Texas, is an oil-and-gas exploration-and-production company that trades on NYSE under the ticker symbol CRK.

Other distressed debt holdings in energy within BDC portfolios are of larger companies whose financial woes are well publicized.

Apollo Investment Corp. holds Venoco 8.875% notes due 2019 and had them marked at 55 as of Dec. 31, 2014. In early April, Standard & Poor’s cut the notes to D, from CCC+, and the corporate rating was lowered to SD, after the company announced the results of a below-par debt swap.

On April 22, Standard & Poor’s raised Venoco’s corporate rating to CCC+, and the senior unsecured notes were raised to CCC-, after the release of 2014 earnings and taking into account the significant loss of principal on the unsecured notes after the exchange.

In another closely tracked credit, some distressed energy sector debt in BDC portfolios is that of Sabine Oil & Gas, which defaulted on debt last month after skipping a $15 million interest payment on its second-lien term loan. Corporate Capital Trust holds 8.75% Sabine debt due 2018 and marked it at 78 in its 2014 fourth-quarter portfolio.

FS Investment (FSIC) showed a $6.3 million holding in SandRidge Energy subordinated debt due 2020, marked at 81. SandRidge Energy unsecured notes are trading in the high 60s, according to sources and trade data.

One distressed energy credit, Halcón Resources, will better weather the slump in oil prices due to the sale of $700 million of 8.625% second-lien notes due 2020 on April 21. The exploration-and-production company operating in North Dakota and eastern Texas intends to use proceeds to repay revolver debt and to fund general corporate purposes.

Main Street Capital has a holding of existing Halcón Resources bonds, the 9.75% unsecured debt due 2020, marked at 82, and HMS Income fund debt has a holding of the same debt marked at 87 (When marked to principal amount, the debt is marked at 75 at both BDCs.). – Kelly Thompson/Abby Latour

Follow Abby on Twitter @abbynyhk for middle-market deals, leveraged M&A, BDCs, distressed debt, private equity, and more.

Follow Kelly Thompson on @MMKTDoyenne.


3 months after shelving loan C&J Energy revives financing backing Nabors merger

Arrangers Citigroup, Bank of America Merrill Lynch, Wells Fargo, and J.P. Morgan are reviving their M&A loan deal for C&J Energy Services. A lender call is set for Wednesday at 11:00 a.m. EST. The deal backs the merger with a unit of Nabors Industries.

Of note, the purchase price declined from $2.86 billion at the time of the June announcement, to $1.5 billion, due to a $250 million reduction in cash, to $688 million, and declines in C&J’s share price. The issuer would have roughly $1.1 billion of debt at closing, and would be leveraged at roughly 2.2x. Nabors would own 53% of the merged business, and C&J shareholders would own 47%.

Arrangers haven’t provided an updated financing plan following the purchase price reduction.

The loan deal backing C&J Energy’s with the Nabors Industries completion and production-services business originally totaled $675 million and was split between a $300 million, five-year TLB-1 and a $375 million, covenant-lite seven-year TLB-2. The TLB-1 included total-leverage, secured-leverage, and interest-coverage tests, and was talked at L+350-375, with a 0.75% LIBOR floor, offered at 99, for a yield to maturity of 4.57-4.82%. The covenant-lite TLB-2 had been talked at L+375-400, with a 1% floor, at 99, to yield 5.02-5.28%.

That structure was later revised to a $640 million, five-year TLB that was talked at L+400, with a 1% LIBOR floor, offered at 98, with total-leverage, secured-leverage, and interest-coverage tests. In addition to the four arrangers, the line-up included senior co-managers Capital One and Comerica, and co-managers Amegy, DNB, Nova Scotia, and Regions. Bank of America is administrative agent.

The issuer is rated BB-/Ba2, with a stable outlook from both agencies. The loans are rated BB+/Ba1, with a 1 recovery rating.

C&J Energy Services is an independent provider of premium hydraulic fracturing, coiled tubing, wireline, pumpdown, and other complementary oilfield services with a focus on complex, technically demanding well completions. – Chris Donnelly



Oil & Gas Credits Comprise 4.5% Of Outstanding Leveraged Loans

leveraged loan oil and gas outstanding

The plunge in oil prices has pummeled both leveraged loans and, more famously, high yield bonds of late.

But while some 16% of high yield bonds support oil & gas related issuers (per the Bank of America Merrill Lynch High Yield Index), only 4.5% of outstanding leveraged loans back O&G concerns, according to the S&P/LSTA Leveraged Loan Index.

Year to date, oil & gas concerns have a bit more of a presence, accounting for 7% of new issuance in the U.S.

loan issuance by industry YTD


Oil & gas leveraged loans: Secondary prices sink, yields soar

oil gas borrowing costs


Though the impact of the recent plunge in oil prices on the broader S&P/LSTA Leveraged Loan Index is less severe than in the high-yield market, as discussed here, this week was nevertheless particularly brutal for loans in the sector.

As of yesterday’s close, the average bid price of first-lien oil & gas Index loans had tumbled to 90.35% of par, from 94.90 at the Nov. 28 close and down from 96.77 at the end of October, pushing the spread to maturity implied by the average bid to L+731, from L+600 at the end of November. – Kerry Kantin


Oil plunge taking no prisoners, though leveraged loans outperforming high yield (and the S&P)

Falling oil prices have taken a toll on price of energy-related stocks and credit instruments.

In the secondary loan market, credits such as Samson InvestmentFTS InternationalVantage DrillingFieldwood EnergyOcean Rig, and Paragon Offshore have taken a beating, with losses accelerating appreciably this week in the wake of the “Black Friday” plunge in oil prices.

That said, the sector’s damage to the broader market has been limited when compared to high-yield and equities. The reason is that oil and gas-related issuers make up 4.5% of the S&P/LSTA Index, excluding utilities. That compares to 16% for the Bank of America Merrill Lynch High Yield Index and 8.5% for the S&P 500, according to S&PDJ Index analyst Howard Silverblatt.

For this reason, energy-related issuers’ drag on loan returns was far lighter than for high-yield and equities since Nov. 1, as these tables show:

returns by asset class

returns, november

Within the oil and gas segment, loan prices have fallen less precipitously than high-yield and stock prices. That is understandable, of course, given that loans are higher in the capital structure.

oil and gas loan prices

Despite this relatively better performance, loan managers are concerned that oil-and-gas could present an unexpected credit risk to a market where default rates (excluding Energy Future Holdingsare running below trend ($$). For reference, about 35% of oil and gas Index loans are covenant-lite.

Since Oct. 31, the share of oil and gas Index loans trading below 90 has jumped to 39%, from just under 1%. For the moment, however, just 0.95% of energy loans are trading at 80 or less – the sort of distressed level that suggests the market is worried about immediate default risk.

oil gas trading levels


largest oil gas loan issuers


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Energy Future to scrap current reorg deal; sees potential new offers


Energy Future Holdings‘ pre-arranged reorganization plan, negotiated by the company prior to its bankruptcy filing, is, for all intents and purposes, dead.


During a brief status update that preceded this morning’s omnibus hearing in the case in Wilmington, Del., attorneys for the company told Bankruptcy Court Judge Christopher Sontchi that while the restructuring support agreement backing the pre-arranged plan has not yet been terminated, “it remains terminable.” The attorney said he expects in coming days that parties to the RSA will either move to terminate the agreement, or the agreement will be amended to terminate by its own terms on Aug. 8, giving the parties a few weeks to work on a replacement deal (see “IRS support for Energy Future’s tax deal is the key to reorg,” LCD, May 1, 2014, for a detailed description of the pre-arranged reorganization deal).


Either way the termination of the company’s current pre-arranged reorganization scheme as embodied in the RSA is the result.


The attorney blamed the disintegration of the pre-arranged deal on the increased trading prices of Energy Future debt in secondary markets since the company’s bankruptcy filing. He said he did not know whether the increase in debt prices would be permanent or temporary, or even the reasons behind the increasing prices, but he pointedly noted, “Trading prices do impact behavior.”


As a result of the increased prices, “parties have been reaching out to the company to suggest transactions that were not previously available to it,” he said, citing the recently sweetened offer from NextEra to acquire the company’s regulated utility, Oncor, as an example (see “NextEra, noteholder group up offer for Energy Future Holdings,” LCD, July 17, 2014, also reported on, for a detailed description of the NextEra offer).


Going forward, the attorney said, Energy Future intends to conduct a process to “vigorously pursue” new potential transactions.


As for the NextEra offer, the attorney characterized it as “very promising,” and said discussions over it would continue. Toward that end, he said the company would abandon its proposed $1.9 billion second-lien DIP for unit Energy Future Intermediate Holdings, the intermediate holding company for Energy Future’s 80% interest in Oncor.


As reported, that DIP, which was to have been provided by a combination of certain holders of unsecured toggle notes at EFIH and holders of unsecured debt at parent Energy Future Holdings, was to be converted into equity in the reorganized company and was a key feature of the pre-arranged deal negotiated by the company. But as also reported, the NextEra deal would, depending upon how it shakes out, either make such a DIP unnecessary, or would replace that proposed DIP with a different second-lien DIP facility, provided by NextEra and a group of EFIH second-lien lenders, that would be incorporated into the overall merger transaction.


One other area of note that generated discussion during the status update portion of the hearing was the anticipated structure of any contemplated reorganization scheme and whether it would need to be based upon a tax-free spin-off of unit Texas Competitive Electric Holdings, the intermediate holding company for the company’s unregulated power producing and retailing operations. As reported, addressing the complex tax implications of any reorganization have been a major sticking point as the company has sought to strike a deal among its creditors.


In opting for the tax-free spin-off in the pre-arranged plan scheme, Energy Future’s attorney said that the company had “explored the universe of potential structures.” But in comments delivered after the company provided its status update, an attorney for the indenture trustee for second-lien lenders at TCEH suggested that a transaction structure not based on retaining tax-free attributes for TCEH could be accretive by $2-3 billion of the unit, creating residual value for second-lien holders. – Alan Zimmerman




Bankruptcy: Energy Future seeks OK for 2nd-lien DIP as it evaluates rival offer


Energy Future Holdings’ unit Energy Future Intermediate Holdings (EFIH) filed a motion yesterday seeking approval of a $1.995 billion second-lien DIP facility, according to court filings.

The company had previously said the facility would be $1.9 billion, but added a $95 million “tranche B” to cover the facility’s closing fee.

The second-lien DIP is the final piece of Energy Future’s $11.8 billion of post-petition financing, which also includes a $5.4 billion first-lien DIP at EFIH and a $4.475 billion facility at unit Texas Competitive Electric Holdings.

According to the motion, the second-lien DIP facility calls for the payment of at least $146.25 million in fees, including the closing fee. Fees also include an $11.25 million participation fee specifically payable to Fidelity in connection with the exercise of its participation rights under the facility, which is described in more detail below.

Other potential fees include a $57 million alternate transaction fee, also discussed in more detail below, and a $380 million prepayment fee if the DIP is repaid in cash without consent other than upon acceleration.

Unsecured creditors of EFIH, comprised of holders of the company’s toggle notes (with about $1.57 billion outstanding) and holders of about $60 million of LBO notes issued by parent Energy Future Holdings that are guaranteed by EFIH, will have participation rights to fund up to 91% of the second-lien DIP, while Fidelity, by virtue of its ownership of unsecured debt of Energy Future Holdings that was issued through an unregistered offering, will have participation rights to fund the remaining 9% of the facility.

As reported, under the company’s proposed restructuring, the second-lien DIP facility will mandatorily convert to roughly 64% of the equity in reorganized EFIH .

As also reported, the proceeds of the facility are to be used to repurchase the company’s pre-petition second-lien debt. The company launched a tender offer to repurchase the debt, including a contested settlement offer for a disputed make-whole payment associated with the repurchase, on May 9.

The $1.9 billion of “tranche A” notes to be issued in connection with the facility carry interest of 8% per year, payable in cash, while the $95 million of “tranche B” notes – the closing fee add-on — are interest free. Interest on the “tranche A” notes will increase by 4%, payable-in-kind and compounded quarterly, if the company is unable to gain court approval by July 27 of an agreement with its 80%-owned unit, Oncor, under which Oncor would direct certain tax payments to the company (payments that were previously upstreamed to parent Energy Future Holdings) to ensure sufficient cash flow at EFIH to finance the restructuring transactions. If the Oncor agreement is not approved by April 29, 2015, according to the filing, it would also trigger an additional one-time 10% PIK fee on the outstanding “tranche A” and “tranche B” notes.

The administrative agent under the facility is Cortland Capital Market Services.

An alternate DIP?
As noted, the facility also carries an alternate transaction fee of $57 million.

According to the motion, the company said that on May 13 it received a “summary of potential terms for an alternative second-lien financing facility from certain second-lien creditors” containing many of the same terms as the second-lien DIP, but with lower fees, particularly the termination fee, a slightly lower interest rate, and certain other improvements over the existing facility.

According to a report last night from The Wall Street Journal, the alternate facility would be led by J.P. Morgan, and would carry an interest rate of 7%.

The company, however, has yet to sign on to the alternate facility.

“Although the nominal terms of the competing second-lien DIP summary appear, in some ways, economically favorable compared to the EFIH second-lien DIP facility,” the company said, “the proposal is still incomplete.” Among the factors cited by the company were the lack of a “commitment of any kind” in the facility, or even the identification of the parties that would provide the commitment.

Further, the company said that the alternate proposal could make it more difficult for Energy Future to obtain the private letter ruling from the Internal Revenue Service confirming that the division of the company called for in its restructuring scheme would constitute a tax-free transaction – the lynchpin of the entire restructuring.

“And, most critically,” the company said, “the [alternate] proposal did not address how the proposal could replace the current investment commitment while preserving the significant value created by having a restructuring support agreement in place that provides a framework for the debtors’ goal of an expedient, value-maximizing Chapter 11 proceeding that leads to a confirmable plan that avoids deconsolidation-related tax liabilities.”

The company also said, however, that it would “continue to evaluate the alternative proposal” between now and the hearing on the second-lien DIP, which is set for June 5.

According to a court filing earlier this week from the indenture trustee for the second-lien notes, if the company rejects the alternate DIP, the second-lien lenders behind the alternate loan “are likely” to object to the second-lien DIP as “not in the best interests of the estate.”

The company said it also received an alternate DIP proposal prior to its Chapter 11 filing from “certain second-lien creditors,” but it, too, had “significant drawbacks.” The company said it “chose not to engage in further negotiations … because [it] did not believe it was reasonably likely that the proponents would be willing or able to provide an acceptable level of deleveraging,” or would be willing to agree to other terms that would lead to “the level of consensus necessary to ensure a timely and successful reorganization.” – Alan Zimmerman


Bankruptcy: Amid first-day squabbles, Energy Future DIP nets interim OK


The bankruptcy court overseeing the Chapter 11 proceedings of Energy Future Holdings has given interim approval to unit Texas Competitive Electric Holdings to use up to $2.333 billion of its proposed DIP facility, according to a May 2 court order.

The entire facility, upon final approval, would be $4.475 billion. It is comprised of a $1.95 billion revolving credit facility (L+250, 0.75% LIBOR floor); a $1.42 billion term credit facility (L+275, 0.75% LIBOR floor); and a $1.1 billion delayed-draw term facility (L+275, 0.75% LIBOR floor) to fund a letter of credit collateral account in connection with an obligation to the Texas Railroad Commission (see “Energy Future DIP details; loans to roll up EFIH 1st- and 2nd-liens,” LCD, April 30, 2014, for details).

The company had been seeking authority to use up to $2.7 billion of the DIP on an interim basis – $800 million of the revolver ($533 million was authorized); $800 million of the term loan ($700 million was authorized); and $1.1 billion of the delayed draw facility (all of which was authorized).

According to Reuters, the lower borrowing amounts were agreed upon last night among the company and junior creditors of TCEH, who had objected to the DIP as excessive and unnecessarily cutting into their potential recoveries.

Separately, the bankruptcy court yesterday approved the payment of DIP fees in connection with the $5.4 billion first-lien DIP facility at unit Energy Future Intermediate Holdings (EFIH).

Wilmington, Del., Bankruptcy Court Judge Christopher Sontchi set a final hearing on both DIP facilities for June 5, according to the court orders.

As reported, the company’s proposed reorganization contemplates a tax-free spin-off of TCEH, which is the holding company for Luminant and TXU Energy, on the one hand, and the recapitalization of EFIH, which controls 80% of the company’s regulated utility Oncor, on the other (see “IRS support for Energy Future’s tax deal is the key to reorg,” LCD, May 1, 2014, for details of the company’s proposed reorganization scheme).

The company’s planned recapitalization of EFIH also calls for an additional $1.9 billion second-lien DIP to refinance the company’s pre-petition second-lien debt, to be provided by unsecured bondholders of EFIH and Energy Future Holdings, but the motion seeking approval of that facility has not yet been filed. That loan is slated to convert to an equity stake in the reorganized EFIH.

Total DIP borrowings would amount to about $11.8 billion.

Separately, Sontchi yesterday also approved, on an interim basis, joint administration of the case. That is unusual, insofar as joint administration of a large bankruptcy case is typically routine. A final hearing on joint administration is also set for June 5.

Sontchi’s interim order underscores the unique challenges posed by a case as large and complex as Energy Future’s.

Indeed, yesterday ‘first day” in the huge case was predictably chaotic, with an overflow crowd filling up three courtrooms. To use one measure, since the filing of the case on Tuesday, Sontchi has signed 91 orders admitting out-of-state lawyers to appear in the case “pro hac vice,” or “this time only.” No wonder several news reports on yesterday’s hearing noted that there is not a hotel room to be found in Wilmington.

Second-lien creditors at TCEH, owed about $1.6 billion, and unsecured noteholders at TCEH, owed about $4.9 billion, have emerged from the first-day hearing as the most aggressive objectors. According to court filings, under the company’s proposed reorganization plan the second-lien lenders and unsecured note holders would, along with holders of a first-lien deficiency claim, recover a pro rata portion of the company’s unencumbered assets. Court filings did not provide an amount for the recovery, but it is expected to be pennies on the dollar.

According to an affidavit filed in the case on April 30 by the company’s CFO and co-chief restructuring officer, Paul Keglevic, second-lien lenders objecting to the proposed reorganization scheme include Arrowgrass Capital, Appaloosa Management, and Marathon Asset Management. The objecting group of TCEH unsecured noteholders includes BlueCrest, Claren Road, Cyrus Capital, Deutsche Bank, DO S1 Limited, Fairway Fund, Fore, J.P. Morgan Securities, LMA SPC, and Pine River.

Keglevic’s affidavit said that Energy Future’s proposal had the support of a “majority” of creditors, which he described as a “consenting group of creditors…which lays the groundwork for a prearranged plan.”

On the EFIH side of the company, where senior creditors are to be paid in full and junior creditors will acquire equity in the reorganized unit, the company enjoys significant support. But even there, there are holdouts, as some first- and second-lien creditors have rejected a settlement and signaled they will litigate over whether they are entitled to a make-whole payment due to the payoff of their claims.

Drilling down on the TCEH side of the company, however, the company’s outlook is more uncertain. Keglevic said holders of about $9.9 billion, or 41% of the first-lien debt, consisting of Apollo, Oaktree, Centerbridge, Mason Capital, Fortress, Och-Ziff, Franklin, and Fidelity, supported the proposed plan.

The company has said it expects that level of support to grow, but it is a long way to the Bankruptcy Code’s threshold of two-thirds approval by amount and a majority by number that would be required to confirm the proposed reorganization plan, even assuming a cram-down of the junior debt holders. – Alan Zimmerman



Energy Future (TXU)’s path to Chapter 11: A long and winding road


Energy Future Holdings‘ Chapter 11 filing today in Wilmington, Del., represents the beginning of the final act for the largest leveraged buyout in history.

The extent to which the deal announced this morning will hold up in the face of the many risks and uncertainties inherent in any Chapter 11 filing remains to be seen, but in gaming out the company’s potential paths through Chapter 11, it is worth remembering that the road to this point has been, as the Beatles might put it, a long and winding one.

As has been widely reported, Energy Future’s troubles stem from 2007′s $45 billion LBO of the company, which at the time was known as TXU Energy. KKR, TPG and the buyout arm of Goldman Sachs engineered the deal, the largest in history. It was essentially a bet that increasing natural gas prices would provide the company’s coal-based generation plants with an edge, allowing them to charge increased prices. However, natural gas prices declined in the wake of the LBO, a trend that had the precise opposite effect, depressing the company’s earnings in the face of a mountain of debt.

Indeed, it didn’t take long for the company’s situation to head south. As early as November 2009, Energy Future was included in S&P’s speculative-grade default rate after being downgraded to SD on account of a distressed exchange. What’s more, the first-lien loan at unitTexas Competitive Electric Holdings has not traded higher than the low 70s since August 2011.

The challenge
More concretely, bankruptcy has been looming over the company since at least late 2012, when Energy Future began publicly discussing Chapter 11 as an option, and investors began gaming out the implications of a bankruptcy filing for the company’s complex capital structure.

The primary issue faced by the company, its creditors, and its equity sponsors as they have struggled over the past 18 or so months to develop a consensual reorganization plan has been how to apportion the company’s current value among a complicated, multi-tiered capital structure split between creditors of the company’s regulated utility business on the one hand and creditors of its unregulated power-producing and retail units on the other.

Layered over that already daunting challenge was the fact that the most efficient structure for addressing those complex capital structure and organizational issues – splitting the company between its regulated and unregulated businesses – would give rise to significant tax liabilities estimated in the neighborhood of $7-$9 billion. The issues are complex, but the liability would potentially negatively affect recoveries for, among others, holders of unsecured notes – representing the fulcrum security – at the company’s Energy Future Intermediate Holdings unit – the holding company for Energy Future’s regulated utility, Oncor, and would potentially impose a liability on TCEH first-lien lenders, as well.

Meanwhile, the equity sponsors that engineered and backed the deal, KKR, TPG, and Goldman, had already written down their $8.3 billion investment in the company to 5 cents on the dollar, but the private equity firms were nonetheless intent on using their operational control over the company during the negotiations to salvage whatever equity stake they could from a reorganization.

The negotiations
Following the company’s first public discussion of the implications of a bankruptcy filing in late 2012 (see, for example, “TXU bonds hit by tax-benefit disclosure,” LCD, Oct. 31, 2012, and “TXU offers tax clarification; EFH/EFIH parent bonds partly recover,” LCD, Nov. 6, 2012), the company embarked on a series of distressed exchanges aimed at extending debt maturities and improving liquidity (see, for example, “TXU debt advances after EFIH inks another distressed bond exchange,” LCD, Dec. 5, 2012; “TXU bonds mixed after co. launches RC extension, bond exchange deal,” LCD, Dec. 28, 2012; “TXU extends RC to 2016; inks $340M incremental TL,” LCD, Jan. 7, 2013; “TXU lowered again to D after EFIH inks 7th distressed exchange,” LCD, Feb. 1, 2013).

The exchanges came to a halt in mid-February of 2013, after Debtwire reported the company had hired Kirkland & Ellis to assist it with a restructuring (see “TXU debt dips further on report of Kirkland & Ellis hire,” LCD, Feb. 7, 2013). Given Kirkland & Ellis’ Chapter 11 expertise, the hire clearly suggested that whatever deal the company was ultimately able to work out, the likelihood was that it would involve a trip through bankruptcy court.

Indeed, on April 15, 2013, the company filed a Form 8-K with the Securities and Exchange Commission confirming that it had floated a prepackaged reorganization proposal to creditors.

The company also said it would make a scheduled May 1 bond interest payment in order to buy time to iron out details of a proposed plan.

Under that proposed prepackaged deal, first-lien creditors of TCEH would exchange their claims for a combination of reorganized EFH equity and their pro rata share of $5 billion of cash or new long-term debt of TCEH and its subsidiaries on market terms. TCEH would obtain access to $3 billion of new liquidity through a $2 billion first-lien revolver and a $1 billion letter of credit facility.

The equity distribution was to be in an amount to be determined, but the company’s equity sponsors told creditors they would support the proposal if they retained 15% of the reorganized equity, with the TCEH first-lien lenders receiving 85%.

The SEC filing did not provide further details, but emphasized that no deal had been reached and said that the company and its creditors were “currently not engaged in ongoing negotiations,” suggesting the disclosed terms were unlikely to lead anywhere.

Little was disclosed about the state of negotiations during the ensuing months as the company and its creditors negotiated with a non-disclosure agreement in place. Meanwhile, market attention turned to October, as the company’s next coupon payment was due Nov. 1, 2013. Indeed, this coupon payment was generally viewed as the final tripwire for Chapter 11, since it involved a $270 million payment to junior unsecured noteholders who, under virtually any restructuring scenario, would be far out of the money.

As a result, in September 2013, stories began to appear in the financial press about an imminent bankruptcy filing and details of a $2 billion DIP loan. The rumors suggested, again, that a prepackaged bankruptcy might be in the offing.

Confidentiality agreements prevented any on-the-record disclosure of the status of negotiations, however, until Oct. 15, 2013, when the company said in another Form 8-K filed with the SEC that a deal had not been reached.

At that time, the company detailed three competing proposals that were on the table, one from a creditor described in the filing only as a “significant creditor,” but widely reported to be Fidelity; one submitted by first-lien lenders at TCEH; and one submitted by certain creditors of EFIH (see “TXU Energy Future says no deal yet as creditors retreat from talks,” LCD, Oct. 15, 2013).

Over the next two weeks, negotiations and brinksmanship continued in the face of the looming coupon payment due Nov. 1, 2013. Given that the unsecured noteholders were well out of the money and trading in the low single digits, the company was widely expected to file Chapter 11 in lieu of making the payment.

But the company surprised the market and made the payment, saying it did so in order to buy more time to work out an out-of-court deal.

In a Nov. 1, 2013, Form 8-K disclosing the coupon payment and the status of negotiations, the company set forth the restructuring proposals still on the table, namely, a proposal from the company and its equity sponsors; a revised proposal from the first-lien lenders of TCEH; a new proposal from unsecured creditors of EFIH; and the proposal from a “significant creditor” that was unidentified in the filing, but was widely believed to be Fidelity.

If nothing else, the filing provided a roadmap for identifying the disputes among creditors standing in the way of a deal (see “Energy Future’s competing restructuring proposals underscore rifts,” LCD, Nov. 1, 2013).

Still, the payment appeared to come at a cost beyond the dollars involved. Upset holders of TCEH’s first-lien debt reportedly withdrew from the negotiations. Meanwhile, following the spate of SEC filings surrounding the critical Nov. 1, 2013, coupon payment, the company returned to radio silence. But given the atmosphere, and the withdrawal of the TCEH lenders – arguable the most important creditor class in the company – it is unclear the extent to which the company and its creditors made any progress over the next four months.

In late March, however, the TCEH lenders reportedly signed a confidentiality agreement and returned to the negotiating table.

The endgame
By this time, of course, Chapter 11 was a foregone conclusion, although the specific timing was still up in the air.

Following payment of the Nov. 1, 2013, coupon, attention turned to March 31 as the next critical date for the company. The company had another coupon to pay on April 1, so there was the potential of a financial default, but Energy Future had dodged those bullets before.

What made the March 31 deadline different was the fact the company’s 2013 Form 10-K was required to be filed on that date. The filing was widely expected to include a going concern warning from the company’s auditors that would trip a covenant violation that would be impossible to cure. That covenant violation, in turn, would trigger a cascade of debt accelerations and defaults.

Still, on March 31, the company managed to buy itself a little more time. Rather than file Chapter 11, the company said it would, indeed, skip $119.3 million of April 1 coupon payments with respect to certain of its first-lien notes, second-lien notes, and pollution-control revenue bonds at TCEH, and instead “use the permitted grace periods” the debt indentures provide.

Separately, the company also said that it would not be filing its Form 10-K with the SEC, as required, even as it confirmed that the filing, when made, would indeed include the expected statement from the company’s auditors substantially doubting Energy Future’s ability to continue as a going concern.

The non-timely 10-K notice gave the company until April 15 to file its Form 10-K, but on that date the company said it would not be filing the annual report, effectively triggering the covenant breach.

Given the 30-day cure period for the breach, that maneuver didn’t have much of a practical effect on the bankruptcy timetable – the termination of the grace period for the missed April 1 coupon payments still loomed on April 30 as the key deadline – but it underscored the fact that, finally, Energy Future had run out of time. That set the stage for key creditors to either agree to a structure for Chapter 11 reorganization, or leave their fates to vicissitudes of the unrestrained Chapter 11 litigation gods.

The company had finally reached the final fork in the road. – Alan Zimmerman