Opinion

Felix Salmon

The big bankruptcy fights begin

By Felix Salmon
June 4, 2009

Proof that you don’t need elaborate CDS conspiracy theories to find lenders trying to drive borrowers into default:

Some of the largest lenders to the private equity groups that led the $23.8bn buy-out of Clear Channel Communications intend to turn down a proposed debt exchange, hoping to drive the radio and outdoor advertising company towards default.

The company, taken private in a leveraged deal that came to symbolise the excesses of the buy-out boom, has proposed a swap of some parent company debt for debt in Clear Channel Outdoor Holdings…

However, some of its largest senior creditors say they would rather wait, in the hope the company will violate its lending agreements, enabling them to force a default and to take control of its equity at a steep discount.

This might have been part of the game plan all along, for the junior lenders. In a highly-leveraged deal such as this one, the chances of default are quite high — and the junior lenders, being junior, are generally well aware of the downside risk. But at the same time they’re also well aware of possible upside: if the company violates its covenants and the junior lenders take control of the company, they can actually end up making more money than if Clear Channel simply made all of its debt payments in full and on time. As ever, the closer you are to equity in the capital structure, the more like equity your investments behave.

Fights within the confines and around the edges of bankruptcy can be extremely brutal and dangerous, even when there’s no CDS complication, and both risks and potential returns are very high in these situations. Expect much more of this kind of thing over the next five years or so, as leveraged loans mature with little if any chance of being rolled over easily.

A lot of fortunes will be made and lost within the private-equity and hedge-fund industries, but thankfully the systemic consequences are likely to be minimal. After all, in nearly all of these cases the underlying companies are still very profitable, assuming they can get their debt load down to a reasonable level. So we’re not going to see all that much in the way of damaging liquidations. And in fact if the companies do emerge from these fights with lower debt loads, that will help them borrow and invest more going forwards, which should help, rather than hurt, the economy.

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