With JPMorgan scooping up 85-year-old Bear Stearns last week for $2 per share, it is safe to say that deteriorating credit conditions and market jitters continue to hack away at the U.S. economy.
Taking advantage of the current situation is law firm Thacher Proffitt & Wood, which has drawn upon its expertise in the structured finance and capital markets sectors to form a distressed asset practice group.
"In this environment, what the clients need, and will need in the future, is someone that is able to sit down with them and assess their exposures on certain complex financial transactions, what remedies they have, and either work them out to recover [these assets] or, if [the client] wants, to dispose of them," said Hugh McDonald, a partner in the bankruptcy and creditors' rights group, who is heading up the team with structured finance partner Christopher Lewis.
McDonald joined the firm just over two weeks ago from Allen & Overy's bankruptcy group. He comes to Thacher Proffitt with 18 years of experience dealing with bankruptcy, restructuring and litigation issues associated with bankruptcy cases.
He began his legal career at Dewey Ballantine (now Dewey & LeBoeuf) back in 1990 and has been witness to several real estate cycles since then. While the decision to have McDonald co-chair the distressed asset group was made after his arrival, his entry rounded out the firm's restructuring capability. A new brochure for the group was expected to go out to clients last week. Thacher will continue to add to the team both internally and through additional hires, McDonald said.
A focus area for the group has been the rise in CDO workout situations after an event of default. With various parties each having different objectives, you need to be able to understand not just what the notes say but how the entire structure operates, McDonald said.
He added that it is critical to determine what the obligations of each of the parties involved are. "Only at that point can you make a determination as to whether or not some of the tranches are out of the money, whether the first tranche may get a recovery should they choose to liquidate, or can they even liquidate at this point and what triggers exist to force liquidation? All of that has to be analyzed and assessed as part of any approach, whether it is as a buyer, an owner or a participant in any of these structures," McDonald said.
Despite sporadic CDO litigation, the general push is for these structures to undergo a workout before heading to court. "In court, whether it is for litigation or a restructuring, the value of the underlying investment diminishes. To the extent that a resolution can be had out of court, it is usually in the creditor's best interest to do that," McDonald said.
On the corporate side, with the wave of bankruptcy filings expected as the economy sinks into a recession, the exit financing and the debtor-in-possession facility will also become a more critical focus for the team. Because of the lack of liquidity in the market, investors are not willing to take risk at certain levels, which is making it increasingly difficult to secure exit financing and rise out of bankruptcy, McDonald said.
For example, auto parts supplier Delphi recently returned to market with a second attempt at an exit facility, after its first attempt failed to garner investor interest in mid-January. A $3.3 billion transaction, the deal was split between a $1.7 billion first lien and a $1.6 billion asset-backed revolver, arranged by Citigroup and JPMorgan, according to ASR sister publication Bank Loan Report. The facility also includes an additional $2.8 billion commitment from General Motors.
Trouble Gets Complicated
Other sectors beginning to see turmoil include retail, as evidenced by a recent slowdown in sales, and financial institutions, which are at risk for further write-downs. "Moody's Investors Service is saying there will be further write-downs, in the tens of billions, just on the mortgage side, and I don't think they have taken into account the losses on the home equity lines, auto loan securitizations or credit cards," McDonald said. Furthermore, "when you take into account the increase in oil prices due to the devaluation of the currency, you are going to find more and more sectors getting pinched."
Adding fuel to the fire, all these sectors have started participating in the various sophisticated financial instruments that Wall Street has created over the years. "Every bankruptcy filing will be more sophisticated and more complicated because of that," McDonald said. "You are dealing with parties now that may not be directly related to the debtor, for example the credit default swap participants. They might not have a direct relationship with [the companies], but the downgrade or the filing of that entity may trigger other sectors."
The new group will also be able to advise on the structuring of credit opportunities funds, as traditional funds begin to shift their focus to the distressed side. "There are a lot of opportunities with regard to very complex financial instruments," McDonald said. "If you were to stack the closing documents for some of these transactions straight up, you would be talking [about] several feet of paper."
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