Credit Analysis & Debt Markets for Distressed Companies Flashcards

In the US leveraged loan market, 'covenant-lite' loans are problematic in distress situations because:

Answer: They lack maintenance covenants that would trigger early warning defaults, allowing problems to worsen before lenders can intervene

Without maintenance covenants requiring regular financial ratio tests, covenant-lite borrowers can deteriorate significantly before lenders have contractual grounds for intervention.

What is 'payment in kind' (PIK) debt?

Answer: Debt where interest is paid by issuing additional debt rather than cash, deferring the cash burden while compounding the obligation

PIK debt allows a distressed company to conserve cash by rolling unpaid interest into additional principal, but this compounds the debt burden over time, often worsening the eventual restructuring challenge.

The 'debt service coverage ratio' (DSCR) is calculated as:

Answer: Net operating income divided by total debt service (principal and interest payments)

DSCR measures how many times operating cash flow covers debt service obligations, with a ratio below 1.0x indicating the company cannot service its debt from operations.

In a US Chapter 11, 'adequate protection' payments are made by the debtor to:

Answer: Compensate secured creditors for any diminution in their collateral value during the bankruptcy, maintaining their economic position

Adequate protection preserves the constitutional protection against governmental taking by ensuring secured creditors are not harmed by the automatic stay's restriction on their ability to enforce liens.

What is the significance of the 'automatic stay' in Chapter 11 for a distressed company's creditors?

Answer: It immediately halts all collection actions, lawsuits, and creditor enforcement efforts against the debtor, giving the company breathing room

The automatic stay provides immediate relief from creditor pressure, creating the protected environment the debtor needs to develop and negotiate a restructuring plan.

A 'credit bid' in a Section 363 sale allows a secured creditor to:

Answer: Use its secured claim as currency to bid on the collateral securing its loan, without requiring actual cash payment up to the face value of its debt

Credit bidding allows secured lenders to acquire the collateral securing their loan by tendering their debt claim rather than cash, effectively protecting against sales at values below their claim.