Amend and Extend or Amend and Pretend?

In the last 6 months, we’ve seen a number of “amend and extend” transactions. Typically they involve: The extension of the maturity of a term loan and/or revolver (typically for syndicated, non-investment grade loans). This is only for lenders who agree to the extension (i.e. some lenders may keep the original maturity Increasing loan pricing for lenders who agree to extend (to reflect current market conditions and the higher credit risk of the borrower) and an amendment fee. Covenant relief for the borrower (reflecting operating performance below original the targets). Why an Amend and Extend? During normal economic times, a borrower would do a new syndication as the maturity date for an existing facility approaches. So why are we seeing amend and extend agreements rather than new facilities? Because many of these companies would have a hard time getting a new syndication done. The loan market is much more selective for high risk credits, and many of these companies have high leverage and weak cash flows. Amend and Pretend? It is clear why a borrower would want an amend and extend (despite the higher cost) – they get covenant relief and one or two more years to turn around the business and generate cash for debt repayment. But why are lenders agreeing to these transactions? Do they really believe the borrowers will be able to repay the loans 2 years later, or are they just deferring the day of reckoning – the day when the borrower will need to do a major financial restructuring (or even a bankruptcy) and the lenders will have to write down the value of...

What Happens After a Default?

With the weak economy, we are seeing more companies breach covenants in their loan agreements. Such a default typically gives lenders these right: Acceleration (i.e. “call the loan”) – declare the principal of the loan to be immediately due and payable. This typically would result in the bankruptcy of the borrower since they do not have the cash on hand to repay the loan. Foreclose on collateral – As with acceleration, this would result in the bankruptcy of the borrower. Stop funding unused revolver commitments. Banks will typically continue to allow some revolver borrowings because cutting off the revolver would often result in a bankruptcy. After a covenant default, banks typically do not exercise their rights – they do not call the loan or foreclose on collateral, and they often allow the borrower to continue to borrower under the revolver. Banks know that these actions would result in bankruptcy, and it is in everyone’s interest to avoid bankruptcy.   So what really happens? Most covenant defaults result in an amendment (or waiver) to the loan agreement. The financial covenants that were breached are loosened in order to get the borrower out of default. Ideally, the company and banks should see the covenant breach coming and work out an amendment before the default happens. A good example of this is the recent amendment done by Actuant Corporation (ticker ATU), a diversified industrial company headquartered in Wisconsin. The company was forecasting deteriorating financial performance which could have breached covenants. Before the defaults happened, the company negotiated an amendment which increased its leverage covenant from 3.5x to 4.5x (with future step-downs) and...

Marchionne Madness? Can Fiat Really Help Chrysler?

When someone asked Sergio Marchionne what he would do if someone asked him to start a car company from scratch, he replied, “Lie down until the feeling passes.” Anyone counting on him to do for Chrysler what he did at Fiat has to be hoping he won’t be tempted to lie down soon. Marchionne is the man behind the nearly miraculous turnaround at Fiat. Before he took over in 2004, Fiat’s car company had been losing money at a bankruptcy-inducing rate. In less than two years it was profitable and growing.     The Turnaround at Fiat How did he do it? He overhauled management, replacing twenty senior managers with energetic talent from the company’s middle ranks. He tackled the sales problems at Fiat by revamping one faltering product line, the Fiat Bravo, and introducing a new one, the Fiat 500. He cut costs, not by closing plants or laying off workers, but by making key processes more efficient. For example, he cut the time to market on the Fiat Bravo from 36 months to 18 months. He raised €1.5 billion by getting General Motors buy itself out of a joint venture with Fiat. He reduced capital spending needs through joint ventures, like sharing an assembly plant in Poland with Ford. He also worked tirelessly to convince Fiat’s managers, workers, and lenders to back his plan.   Successful Turnarounds Anxious lenders and bondholders are wondering if he can do the same at Chrysler. But with problem credits on the rise and more companies facing turnarounds, the broader question is, what can we learn from all this? What are the...