I'm reading through the Scheme Explanatory (i.e., document which sums up the restructuring for the creditors prior to signing the scheme of arrangement (UK law)) and in the pro-forma balance sheet goodwill has been created. How?
This is a debt for equity restructuring from a few years ago, mezz/2nd wiped out, senior took ownership, 70% cash pay debt flipped to PIK, enhanche margins, the whole shabang. The assets have been written-down, goodwill was impaired prior to the RX so why would goodwill then be created in the Newco? Sure, goodwill is a plug but why kid yourself? Just write the debt down that bit more to the naturally sustainable level right?
Cheers for any input
If all of the assets have been written down pre-restructuring/acquisition, then the FVINA of the firm for the purposes of the acquisition would, I believe, be held to be at that written-down value, or close to it. If you pay more for the firm than that FVINA, then you've got yourself some goodwill to be accounted for.
Conceptually, if you don't create goodwill, you are arguing that the value of the company does not exceed the FMV of assets (incl tax attributes). If that is the case, you would not be in a reorg, but a liquidation (best interest of creditors).
But in these cases there isn't a true "sale", it's a transfer of assets to the Newco with the assigned liabilities as per the scheme of arrangement. I understand the concept of goodwill which you’ve rightly stated being an excess in purchase price, but there’s no reason why your purchase price cannot equal the value of the assets and result in no goodwill.
But what i don't understand is why the creditors would assign a value to the company which is based on a plug figure. They’re writing down their debt, so too with the asset (obviously no equity left), so why, in the event of a liquidation further down the line, expose themselves to being under collateralised by way of a lack of physical security. Is it purely a calculated risk so that they write down less of their debt?
The creditors don't "assign" the value, it is determined by the financial advisor, typically the debtor's advisor. Obviously, this value can be challenged. If the reorg value, when calculated, does not exceed the FMV of assets, bankruptcy code calls for a liquidation, not a reorganization. If the reorg value does exceed FMV of assets, then you have to assign goodwill.
Also, there is typically little additional security to be offered in a reorg, so collateral is not the concern. Typically, creditors are moved down the capital stack in a reorg, not up. So, a previously under-secured secured creditor becomes a creditor with a secured portion, an unsecured portion, and potentially some equity. An unsecured creditor often ends up with debt with a lower face value and a larger portion of equity. Creditors, once committed to the idea that a reorg will maximize their recovery, are in search of an appropriate capital structure to prevent a future event.
There are also opposing forces when negotiating the reorg value. The most senior un- or under- secured creditor will typically be pushing for the lowest valuation, so that they can gather the most relative value in the reorg. Junior creditors successively push for higher valuations and prepetition equity pushes for the highest valuation.
Sure, and the seniors did take all the equity but why not impair your debt that slice more to have a higher recover in the event of liquidation? There are of course political forces at play here, e.g., the other senior creditors may not sign off on the scheme. I'm not debating the value placed, but just the reliance on a plug figure on the Newco's balance sheet.
Naturally. And that's where independent / court involvement is require to determine economic interest in the company.
But I'm just struggling to see why the creditors of the Newco wouldn't care that there isn't enough physical collateral if the company couldn't survive as a going concern later on....or do lenders just not think like this, are they usually confident in the companies business plan and it's ability to refi later on or generate enough cash...seems a tad optimistic, especially in the case of this business (housing).
p.s. cheers for the input, always good to bounce this stuff around.
It sounds like this is really the crux of your question remaining to be addressed. Typically, the post-petition creditors look a lot like the pre-petition creditors. Possible exceptions include exit financing/claims traders. Exit financing is almost always secured or relatively senior. So, creditors in OldCo were undersecured or completely unsecured. They estimate that their recovery under a liquidation currently will be less than their recovery under a plan of reorganization. So, they view the businesses prospects as good enough to warrant agree to having an unsecured claim in a company exiting BR. Often, the recovery to unsecured in a liquidation is in the 20% range, so you don't need much of a belief in the company's plan to be on board. It is really all relative to your position pre-petition.
There may also be some confusion surrounding the priority in liquidation. Secured lenders get the value of their security of the value of their security interest, whichever is less. If the collateral is less than the secured claim, the claim is bifurcated and the under-secured portion becomes general unsecured (not always, but usually). So, in a the first BR, a secured lender will have their security interest adjusted downwards to the value of the collateral and will get something else for their undersecured portion. In a subsequent liquidation, they still have their security interest and the value, assuming no further impairment/write downs, they would still receive the full value of their collateral. In the first BR, if there were more creditors than just the senior, the bifurcated portion of the secured will be treated the same or better than the unsecured so that their position is not subordinate to the previously unsecured creditors (in a subsequent BR).
If this is off base, I may not be understanding your question -- maybe illustrate with some numbers?
Yea i think i'm just trying to get a solid handle on the rationale / pragmatic approach to it. Also I would say there seems to be an Atlantic divide whereby in Europe secured bank debt generally accounts for a larger proportion of the debt and fewer bonds (this is assuming non-investment grade debt), so creditors were always facing security of some sort, typically a share pledge and fixed charge over assets. But yea, ultimately we're in agreement, it's just the creditors thinking it's in their best interest.
I think this is the main difficulty from trying to learn from transaction write-ups; they rarely describe the decision making process, which is often what i find most interesting
If you ever have the chance to watch while someone does the fresh start accounting adjustments, it will make complete sense after seeing it once. I am not sure if IFRS treats it much differently than GAAP from an accounting standpoint, but I do think that you are right -- more bank debt in Europe.
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