Ch 8: Insolvency Regimes and Debt Structures Flashcards
What are the corporate life stages and possible outcomes?
Going concern -> Pre-insolvency measures (outside help) -> Insolvency
Insolvency can lead to one of the 3 outcomes:
- Liquidation
- Firm/Assets sale to another firm
- Reorganization (too big to fail)
What is priority ranking?
Priority ranking determines the order in which creditors will be paid in insolvency.
Ranking:
- Priviliged creditors - insolvency costs, wages, tax
- Secured creditors
- Unsecured creditors
- Subordinated creditors - contractual or organizational structure
- Shareholders
How are structurally subordinated bonds rated?
IG:
if priority obligations of total assets compared to the subordinated bond are more than 20%, the subordinated bond is rated one notch below the corporate credit rating.
HY:
If priority obligations of total assets compared to the subordinated bonds are more than 15%, the subordinated bond is rated one notch below the corporate credit rating.
If the priority obligations are more than 30% of the total assets, the bond is rated two notches below the coroprate credit rating.
What is the role of a guarantee?
A guarantee places the credit risk of the issuer on par with that of the guarantor.
A guarantee can mitigate a structural subordination.
What is the role of intercompany loans?
Intercompany loans can put the creditor at par with other creditors to the borrowing entity. It is important that the loans are well documented, senior and extended to the cash-generating subsidiaries.
Intercompany loans can mitigate a structural subordination.
What is a secured creditor?
Creditors are secured when they benefit from security of collateral in support of a debt instrument. If the company defaults, the lender can repossess the collateral to satisfy its claim against the company.
What are the 3 types of collateral?
- Financial assets
- Tangible assets
- Intangible assets
Name 4 financial assets used as collateral.
- Cash
- Traded securities
- Receivables (incl rents)
- Insurance policies
Name 4 tangible assets used as collateral.
- Inventories/stocks
- Transportation equipment
- Real estate (buildings)
- Equipment
Name 4 types of intangible assets used as collateral.
- Rights and patents
- Contracts and concessions
- Nontraded securities
- Intangible assets
Is the collateral claim valid?
Creditors must verify that the borrower has publicly filed and stated that the beneficiar of the collateral has priority rights to the pledged collateral.
The pledge must be recorded in a public registry.
The registration should not expire before the bond and should not loose its priority if it expires and is re-registered.
Name 6 key building blocks of structured products (asset backed securities/securitizations).
- Transfer of assets into a single-purpose financing vehicle
- Appointment of servicers and trustees
- Modelling of cash flows to assess payment probability
- Enhancement of credit by tranching debt into various subordinated layers
- Establishment of a liquidity facility
- Tailor-making debt terms, to be governed by covenants and triggers
Name 5 key characteristics of a SPE.
01: Bankruptcy-remote / Independent entity
02. Restrictions on objectives and powers - a SPE has single purpose by definition
03. Debt limitations
04. Independent director
05. No merger or reorganization
Name 2 roles of the liquidity facility in structured products.
The liquidity facility provides a liquidity bridge in the event of a mismatch between the time when the cash flows are collected and the time when the debt service is due.
The liquidity facility provides liquidity to the most senior creditors during a liquidation until the assets are liquidated. The facility services the interest payments in the meantime.
What is a covenant?
A covenant determines what the borrower can and cannot do.
