Curious how you take capital leases into account for a ch11. Assuming you use a multiple to come up with the EV. Assume you have $200mm in EBITDA at a 5x multiple for $1bn in EV and $200mm of cash on balance sheet. Pre-free distributable value of $1.2bn. Assume 0 fees for easier math.
Assuming the following cap stack:
- $600mm in 1L secured by $300mm in direct assets ($300mm in deficiency claim)
- $100mm in Capital Leases
- $700mm in Senior Unsecured
- $600mm in 1L secured by $300mm in assets ($300mm in deficiency claim)
- 50% before deficiency ($900mm of value remaining)
- 90% after adding the recovery at the SUN level on the deficiency claim. (300+(80% *300)) / 600
- $100mm in Capital Leases
- Full recovery assuming that the asset covers the lease/debt.
- This should reduce the distro value right? You're paying interest and using an EBITDA multiple so my thought is 100% yes. ($800mm of distro value)
- $700mm in Senior Unsecured
- Add in the $300mm deficiency claim from the 1L for a total of $1bn in SUN claims. Recovery at the SUN level is 80%
Obviously a high level example but curious on any feedback. My thoughts on the cap lease is you treat it like 1L debt. Assuming the asset covers the amount then it's 100% otherwise it's a coverage plus a deficiency claim.
So I have worked in equipment finance and restructuring and so I feel qualified to answer this. The reality is that a lot of times restructuring bankers just don't care about the capital and operating leases and so they go unimpaired. Sometimes as a lessor you may just get no payments for a bit due to the automatic stay. In my experience, my old firm started to get paid after a month or two of no payments after applying some pressure. That being said, remember leases per Chapter 11, can be terminated or continued. I think leases getting terminated is much more relevant on the real estate side or in companies where leases are a huge part of the cap stack. In short, the less significant part of the capital structure, the less significance it gets. But ultimately its a first lien claim on a specified unit of equipment. The trick in equipment leasing is to lease "essential use" equipment where its hard for a company to risk losing that access. As a result, sometimes, despite the limited underlying collateral value, software makes a great capital lease investment
Work in credit - firm views it as priming but generally it’s small enough that it’s not a big driver of a higher attachment point. If capital leases are a large portion of the capital structure, you’ll need to do more work on what the collateral is and how essential it is to the business.
Thank you for the comments Studentofthegame and yankeeclubber. Agreed - I'm looking at Spirit Airlines - decent amount of cap leases (~$1bn). 99% chance they are continued so in that sense it should prime the rest of the debt in the waterfall. If they go through a ch7 then it's a question of does the asset cover the lease - anything that isn't covered becomes a SUN deficiency claim.
Question on the leases - do you make any adjustment or take the value from the 10Q/k?
Silly question as not in credit. Why do you apply 80% and not full recovery on the unsecured portion of the 1L?
Because the unsecured don't receive a full recovery. Any 1L claim that isn't covered by actual liens flows to a GUC deficiency claim. In this case there is a total of $1bn in GUC claims ($300mm deficiency claim + $700mm of unsecured debt) and only $800mm in distributable value remaining. GUC recovery is 80%. So the 1L receive $300mm from the direct collateral + 80% of their $300mm at the GUC level.
Not investment advice - simple example for discussion purposes.
Is this correct? 1L senior secured typically gets a corporate guarantee too and should recover 100% before senior unsecureds get a penny back. I don't see a scenario in which the 1L gets 100% in this case. The 1L will argue the SUN get too much.
If there's only $300 of actual liens the rest is pari to the unsecured. There's no other guarantors here - if there were, might be able to recover more
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