RX Interviews:

Interview Questions &

Answers

Restructuring Interviews
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York

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A Note Before Beginning:

This report contains actual questions and answers you may face in a restructuring
interview.

RX interviews can be thought of as having two-sides: RX-specific questions that test

whether you know what RX is all about and traditional investment banking technical
questions that you have likely seen before (e.g. walk me through the three statements,
etc.).

Because so few students (whether undergraduate or graduate) understand what RX

banking really is, if you can impress your interviewer with your practical understanding of
RX you’ll be well ahead of the game.

With that said, you should also know your traditional banking technical questions very
well. Some RX shops will ask quite a few of these (although RX interviews are becoming
more and more RX-focused as time goes on).

So, this report covers the RX-specific questions you’ll likely in an interview. For the
traditional technical questions, I’ve created a separate “Accounting & Valuation Q&A”
report for you to go over. That report goes over the most popular accounting & valuation
specific questions (with an RX spin on them) you’re likely to encounter.

However, you should still spend time going through all the other IB guides you can get
your hands on to make sure you know all the accounting and valuation questions you
could be asked.

Number of Questions & Answers: 143

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 Contextual RX Questions

What do we do here in RX?

Restructuring really comes down to helping a company right-size (or restructure) their
capital structure to ensure they can succeed well into the future.

The role of a RX banker is to understand the capital structure of a company, who holds
their debt, and then come up with creative solutions that can ensure the company’s long-
term sustainability in the easiest, cheapest way possible.

For example, sometimes this could just be exchanging notes comes due next year for
another security with a longer duration. Sometimes this could mean a lengthy Chapter 11
process with no pre-pack that drags on for years.

Of course, this all is operating under the understanding we have the debtor mandate. If
we have a creditor mandate then our objective is to ensure that we are coming up with,
and advocating for, solutions that maximize the returns of the creditor.

What do you think an analyst does within RX? What’s the work entail?

An analyst’s job is first and foremost to support those around them in whatever way
possible. Sometimes that will mean doing ad-hoc things for a MD like putting together a
slide on the largest bond holders for a certain tranche of debt within a company.

In a more structured sense, though, an analyst will be expected to run industry screens,
create profiles, and then be involved in pitches and live deals. Pitches and live deals
always have an analyst on them, along with usually an associate, VP, and of course MD.

The day-to-day work varies a great deal, but will involve things like creating cap tables,
pro forma cap tables, ensuring proper formatting in all materials, etc.

What do you think an associate does within RX? What’s the work entail?

An associate’s role in RX – which is perhaps a bit distinct from M&A – is to both oversee
analysts when put on a deal team for a pitch or live deal, and also be involved in the day-
to-day cap table building, scenario analysis, etc.

When on a pitch or live deal, the associate will be expected to communicate directly with
the VP or MD on the deal and communicate that back down to the analyst who will do the
majority (but not necessarily all) the work. In short: an associate may very well spend a
significant amount of time on doing profiles, building pitch decks, etc. but also will be
expected to properly delineate rolls to analysts too.

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Why don’t you work in RX at a BB of some kind? Why come to this smaller
investment bank?

Large, full-service banks (including the BBs) do not have traditional restructuring
practices. This is primarily because on so many mandates they would be conflicted.

Because it’s generally not great for a bank to have done DCM (debt capital markets) or
ECM (equity capital markets) activities for the company and now turn around and pitch
the company on restructuring; having had played a role in the company getting into its
currently inferior capital structure to begin with!

Why do you want to come to this investment bank in particular?

Obviously, answers will vary depending on what bank you’re talking to. I’d bring up a few
deals of interest and mention the normal things surrounding culture. To be honest, I don’t
think anyone really cares about the specifics of your answer; it’s more a question asked
to see if you can be diplomatic not to see if you say anything overly interesting.

What are the two-sides of a restructuring? Who do we advise?

There’s the “debtor” side, which is the company, and the creditors side, which is the bond
holders or loan holders. Debtor mandates involve just dealing with one party: the
company. Creditor mandates usually involve dealing with a large number (it can be three
or it can be ten or more) bond or loan holders within a certain class who band together.

So, for example, maybe the unsecured bonds are likely going to be an impaired class and
then will have to vote on a POR (plan of reorganization) in bankruptcy. The bondholders
will then gather together (not necessarily all of them, but a significant amount, usually
enough to have a blocking position which is 33.4%) and hire a RX shop like HL to advise
on what they should demand, how they should negotiate, and what they should ultimately
accept or reject.

All major RX shops will take on debtor or creditor mandates, but some are known to do
more of one than the other. For instance, HL does more creditor mandates while PJT,
Evercore, and Lazard do more debtor mandates. However, like I said, all will take either
creditor or debtor mandates. For instance, see PJT’s involvement with Legacy Reserves
where they are advising GSO (Blackstone). PJT is known more for their debtor mandates,
but they are very active on the creditor side as well.

What kinds of “deals” do we do?

What makes RX such an interesting space is how diverse the set of deals you’ll be
working on are.

Because every company has a different capital structure, with different points of stress in
it, nearly every restructuring solution will feel unique and novel.

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With that said, you have two broad categories of deals: out-of-court restructurings and
Chapter 11s.

Within each of these categories, there are many permutations. Within out-of-court
restructurings you can have deals involving extensions of maturities (“amend and
extend”), exchanging of securities, and wholesale reconfigurations of the entire capital
structure.

Within Chapter 11s you can have pre-packs (to get in and out quickly), long Chapter 11s,
and 363 asset sales.

How do deals come into the firm?

For debtor side mandates, there are two ways in which deals normally come in:

1. The MD knows a partner at a sponsor (PE firm) and the partner reaches out about
a portfolio company they would like to re-work (meaning restructure their capital
structure)

2. The MD gets industry screens, has profiles built for him or her, and then puts out
a feeler to see if the company is looking for options to be presented to the CEO
about potential restructurings (e.g. the MD doesn’t know anyone at this company
and is essentially cold calling on them)

Note: MDs can often get referrals from lawyers dealing with the distressed company as
well, so cold calling isn’t the best wording. The point is that RX MDs are not going to
traditionally have relationships with CEOs – the way M&A bankers would – because a
healthy company has no reason to talk to RX MDs.

On the creditor side, you’ll often get groups created that are led by known distressed
funds. Often distressed funds will have preferred MDs/RX groups to work with. Indeed,
often these distressed funds have alumni of the RX groups they then give mandates to!

Is there a deal that interests you that we’ve done?

You should have a deal prepared to talk very briefly about. Choose something out-of-
court, because this way there will be only limited information online (meaning, there won’t
be info found on PACER as there would be for a Chapter 11). This way you can’t get
caught flat footed being asked for details you could know since much of the info is public.

In order to do this, just Google “[bank name] restructuring term loan” and you’ll find news
clippings for recent deals. The reason why I tack on “term loan” is that it helps bring more
relevant news articles. For instance, here’s a recent article around PJT advising Constellis
on their out-of-court restructuring.

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It gives you all you need to know for an interview in terms of how the deal was structured
and because it was out-of-court (so no big legal filings) you won’t be anticipated to answer
questions around the more nitty-gritty details since they aren’t publicly available.

If you need any help finding a deal to talk about, just reach out to me.

Why RX? Why not M&A?

This is an important question that you’ll almost certainly be asked. You should think about
it yourself and, before anything else, actually determine that RX is right for you. With that
said, a good answer will go something like this:

In my view, RX combines finance, law, and a bit of psychology together in a way that’s
entirely differentiated from M&A. With RX, there’s more novelty, which leads to deals all
looking quite unique relative to M&A because every company gets into trouble for slightly
different reasons due to their different capital structures, industries, and past decisions.

One of the benefits of RX – relative to most M&A groups – is that you’re touching nearly
every industry eventually and you’re almost always busy (whether it’s a recession, with
lots of RX happening, or it’s a bull market with bad cyclical dynamics for certain industries
like retail in 2015-2020).

Of course, a downside of RX is that you can’t just leave to go do corporate development

if you’re tired of banking after two or four or six years. So, I understand that choosing to
do RX shouldn’t be a decision made lightly but should rather reflect something that I am
serious to committing to for my career. I’ve made that decision.

Note: This last line is very important. Show that you understand that M&A has more
“traditional” exit ops into corporate America.

Who are the kind of clients we deal with?

Broadly speaking there are two kind of clients on the debtor side: companies in distress
(either private or public) and companies in distress owned by sponsors (PE funds).

On the creditor side RX shops normally represent bond holder committees, which are
groups of bond holders within a certain class. They have enough voting weight to need
to be dealt with by the company in any potential RX so this group hires a RX shop to
advise them on how to extract the most value from their position. Creditor mandates can
often include only one creditor if they hold a large enough notional value of bonds / loans
in what will likely be an impaired class.

How do our clients end up choosing us over some other firm?

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In RX, it’s a bit more complicated to answer than in M&A. It’s unlikely, when dealing with
a private or public company in distress, that you’ll have a pre-existing personal
relationship with them. This is different than in M&A where maybe you know the CEO of
XYZ company who does an M&A deal every two or three years, so he constantly is
coming back to you for advice.

You’ll often get picked by private or public companies because of having a superior pitch,
superior transaction experience, or some combination of the two. There’s also the
possibility that the company’s law firm knows the MD at the firm well, so recommends the
firm to the company.

When dealing with companies in distress owned by sponsors, it’s more normal for a
partner at the PE firm to have a working relationship with a MD at a RX shop. So that’s a
bit more like M&A where a relationship could materially move the needle.

On the creditor advisory side, you’re dealing with a lot of “fast money” (distressed hedge
funds) and as a result they may pick you because they’ve worked with you before on
other mandates (or have lots of alumni at the firm who are still close with the RX group).

When do we normally start talking with potential clients?

Normally you’ll begin talking to potential clients far before they’re actually needing to make
a choice about restructuring. You’ll have prepared a profile and know their capital
structure and when they’re likely to get into trouble.

Ideally you would like to pitch clients well before they reach the breaking point (where a
creditor could push them into involuntarily filing a Chapter 11), because this way you can
try to work out some kind of out-of-court restructuring. Sometimes Chapter 11 is the best
option, however, but it’s still best to try to have a pre-pack or at least a solid plan of action
prior to entering into Chapter 11 (meaning you don’t want to get a call for advisory services
when they’re about to file and the company is on fire).

So, in short: you’re normally talking to potential clients well before they are truly in trouble.
You’re normally talking to them when the writing is on the wall and they need to start
thinking strategically about alternative paths.

If you’re looking for news and intelligence on distressed companies, where do you
turn?

Debtwire, Reorg, and The Deal primarily. You may also look at credit rating agency
reports (S&P Global Intelligence is actually very good).

What is usually included in an RX pitch?

Every RX pitch is slightly different, but it will generally include the following elements:

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 1. Executive Summary

2. Situation Assessment of Industry and Company

a. Overview of company’s financials, graphs of EBITDA, leverage ratio, etc.

b. Overview of terms (covenants, etc.) of current debt

3. Potential Restructuring Alternatives

a. Include two to four potential ways to restructure the capital structure

b. Provide explanations, timing, and rationale

4. Appendix
a. Additional Analysis
i. For example, liquidity rollforward and debt holders list
b. Case Studies
i. Case studies of past successful and novel restructurings done by the
team
c. Qualifications

How do you present restructuring alternatives to the client?

You will normally have a slide that shows the cap table as it currently is and a pro forma
cap table showing what it will look like if this alternative moves forward.

You’ll then likely include graphs showing decreased leverage, decreased cash interest
payments, etc. if this alternative is pursued.

You’ll normally have a slide that also goes over the pros and cons, timeline, key parties,
and the strategic rationale.

Can you tell me some of the kinds of projects you’ll be working on as an analyst or
associate?

It’s best to say that you’ll be doing the following things for the first few months, or over the
summer. Then mention down-the-road you’ll be involved in more existing or new live
deals and pitches.

▪ Refreshing a screen
o If a screen was last updated a year ago then prices of where loans/bonds
trade are out of date along with the LTM EBITDA, credit ratings, etc.
Refreshing just means updating and it’s very simple to do given that the cap
table is already done – you’re just making sure it reflects the current reality.
▪ Creating a new screen
o As previously discussed, you may be asked to screen an industry and
create screens that will look like what I showed you

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 ▪ Creating a profile
o Profiles are always being created and are a good task to give to junior
people since they can be wrong without it being the end of the world (since
they are only for internal use at the firm)
▪ Joining an ongoing pitch
o You may get slotted into a pitch that’s currently ongoing. Since the pitch will
already be active, much of the Excel and PowerPoint will be complete, so
you’ll be given specific tasks around updating it to reflect how the MD wants
to present it (perhaps coming up with a new structure, refreshing the cap
table to reflect most recent prices, aligning things differently in PowerPoint,
etc.)

Can you tell me some of the tools you’ll be utilizing on the job?

See the full list and description in the Overview report, but you can give the following list
if asked:

▪ ReOrg
▪ Debtwire
▪ PACER
▪ MarkIt
▪ Bloomberg
▪ CapIQ
▪ FactSet
▪ The Deal
▪ Trace
▪ BamSEC

General RX Questions

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What are the characteristics of a distressed company in need of restructuring?

Like anything in RX, it’s complicated! The more nuanced you can make your answer,
even if it’s a bit rambling, the better. Your interviewer knows when they ask these kinds
of questions that there’s no “simple” answer.

Generally speaking, a distressed company will have some of the following characteristics:

▪ Limited liquidity
o Remember what a liquidity table looks like; it includes what you can draw
on a revolver, plus cash, minus letters of credit outsides, and minus
restricted cash
▪ High leverage ratios throughout the capital structure (including at senior secured
positions)
▪ “Maturity walls” upcoming that are unlikely to be able to be re-financed
o An easy way to tell if the market thinks a security can be re-financed is if it’s
trading well below par, then it’s unlikely
▪ Decreasing equity price if public
▪ Butting up against covenants
▪ Low secondary pricing across the capital structure
o For example, if MarkIt is showing the TLA at 75 then the company is
obviously in trouble as that’s about as high as you can get (beyond a
revolver)
▪ Recent downgrades, in particular for credit trading low in the capital structure
o Remember that historically 30% of companies with debt instruments trading
in the c’s will default in 12-24 months
▪ Declining interest coverage ratios
o Showing inability of EBITDA to clear cash interest payments
▪ Increasing amount of distressed debt hedge funds buying up classes that could
potentially be impaired
o A good sign of distress is (obviously!) if distressed hedge funds are buying
up big pieces of the capital structure
▪ Limited secured basket space
o Often there will be covenants around how much money can be raised in the
secured section of the capital structure preventing new issuance there,
which puts a company in a bind if it can’t refinance existing secured debt

What’s the way distressed investors approach making investment decision (four
steps)?

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 1. Analyze the most recent financials to determine the capital structure. Determine
total debt and relative priority given the legal (security and seniority) and structural
(operating versus holding company) considerations
2. Value the capital structure given market trading prices
3. Analyze recent EBITDA trends and determine the relative leverage (on EBTIDA
multiple basis) of the various levels of the capital structure at both face and market
value
4. Consider whether, given conservative or appropriate industry valuation metrics,
the business is likely worth more than current trading levels.

Note: Step 1-3 are included in every cap table.

Does a distressed company always file for bankruptcy?

No! This is one of those questions that most easily finds out who knows what RX banking
is and who doesn’t.

Most RX transactions will be out-of-court and thus very low profile. Out-of-court is always
the preferred option if at all possible.

Unfortunately, most books on distressed debt or restructuring (the few that exist) focus
entirely on the Chapter 11 process. But much of what you will do will focus on trying to
keep companies out of Chapter 11 if at all possible.

You have a leverage ratio of 5 and a coverage ratio of 5. What is the interest rate?

The first thing you should do when answering any questions that will take a few steps is
write down what you know. Don't worry about being judged for not doing it all in your head
as absolutely no one will do that.

So, we know that the leverage ratio is Debt / EBITDA and that it equals five. We also
know that the coverage ratio is EBITDA / interest expense and that is equals five as well.

What we're being asked for (an interest rate) is what we need to isolate, but is obviously
not explicitly within any of our formulas.

This leads many interviewees to begin to get nervous. The key to answering this question
is taking a step back and saying, "What component of these equations could tell us about
the interest rate?"

The obvious answer is obviously interest expense and that the interest rate is simply
going to be the percent multiplied by the outstanding debt that gets you the interest
expense.

Put another way, the coverage ratio (for the purposes of this question) can be expressed
as (r)(Debt) where r is the interest rate (what we're trying to solve for.

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We know the coverage ratio is 5. Therefore, we can set up the equation as 5 = EBITDA /
(r)(Debt). We can then transform this to 5*(r)(Debt) = EBITDA and then divide both sides
by Debt.

We'll then have 5*r = EBITDA / Debt. Notice that EBITDA / Debt is simply the inverse of
the leverage ratio. So we can now say 5*r = 1/5.

The final step is simply dividing both sides by five, which will get us: r = 1/25 or 4%, which
is your answer.

If a company does file for bankruptcy, what precipitates that?

A company almost always declares bankruptcy itself. This is because the company wants
to draw down revolvers, miss certain payments strategically, prepare a list of critical
vendors, and try to get in the best position to come through the Chapter 11 process
quickly.

Occasionally you’ll have a company forced into bankruptcy “involuntarily” by creditors as

a result of a technical default (technical defaults mean something that doesn’t involve
missing an interest payment).

A company ultimately files for bankruptcy because it just can’t refinance its maturities
coming due, no matter what it tries, or can’t meet its cash interest payments. It therefore
needs to figure out a fundamentally new capital structure to continue. Chapter 11, even
though it is a restructuring, is a last resort for a company (if for no other reason than
management often has lots of equity that will be entirely, or almost entirely, wiped out).

What can a company in distress do to right-size?

Again, a very broad question. Generally speaking, the company can:

▪ Do an exchange of old debt coming due for new debt

o The new debt will usually have higher interest rates, to reflect risk, but
longer maturities preventing the need to refinance in the near term
o The new debt can have a PIK element to reduce cash interest
o For an example, see the Toys ‘R’ Us example here
▪ Complete asset sales to raise cash (although this is quite rare in practice, as assets
worth quite a bit would be the more promising area of the company and you don’t
want to be left with a terrible shell of a company!)
o This is distinct from asset sales made in Chapter 11
▪ Extend out current maturities
o Often done by giving a “consent fee” and “paydown”; meaning you pay
down a term loan (giving them cash) and pay the revolver a pre-determined
consent fee (usually 1-2%) in order to extend the date of the maturities
▪ File for Chapter 11 with a pre-pack (a pre-done Plan of Reorganization that allows
the company to get through Chapter 11 in just a few months)

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 ▪ File for Chapter 11 without a pre-pack (and then right-size while in Chapter 11,
which can take years)

What is a cap table?

A cap table (capitalization table) shows all the debt securities that the company has issued
along with their maturity, coupon rate, credit rating, market price (if relevant), and normally
leverage and interest coverage ratio.

Cap tables are the primary thing that RX bankers create and update. Often there will be
additions made, beside cap tables, in pitch books showing liquidity available.

The most important part of cap tables are arguably the footnotes, which detail the specific
attributes of parts of the debt that are relevant (secured basket amounts, springers, etc.)

If we have EBITDA = $40m, EV/EBITDA = 5x, Senior Secured Debt of $150m,

Unsecured Debt of $100m then what is the value of equity and the value of debt if
a Chapter 11 is imminent? Where would the Unsecured Debt trade?

This is a simple waterfall question. EV is just going to be 5*40 or $200m. This fully covers
the Senior Secured portion so they are made whole. This also provides a 50/100 recovery
on the unsecured debt (where $50 is what is left over after dealing with the Senior
Secured).

This means that the unsecured debt will be the impaired class in the eventual Chapter
11. They will therefore be the class who can vote on a POR and will get the reorganized
equity of the company as compensation for the impaired nature of their holdings.

Therefore, you would not expect the Unsecured Debt to trade at 50, which is what you
would expect in a pure recovery analysis, but rather some amount above it. This reflects
the value of the reorganized equity they will have coming out of Chapter 11.

One can think of the spread between 50 and whatever the bonds are actually trading at
as being a rough approximation of the equity value that the bonds will eventually have
and the inherent optionality to that equity (meaning the equity could become worth a lot
and at the very least won't be worth a negative amount, so it has some positive expected
value to it by definition).

Equity value is going to be marginally above zero. Prior to a Chapter 11 there's always a
bit of embedded optionality to equity. After all, what if there's a big turnaround in the
company? What if there's an out-of-court restructuring with favorable terms? What if the
CEO finds $200m while walking to work?

We have a small group of bonds (let’s call them the Unsecured Notes) coming due
in a year. They’re only $50m and the company has $70m in liquidity. Nothing else
matures before these Unsecured Notes. Yet these Unsecured Notes are trading at
60 cents on the dollar. What’s going on here?

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This is a pure restructuring question meant to gauge just how much you know about the
capital structure dynamics that drive restructuring events.

At first blush this fact pattern may not make much sense. We have Unsecured Notes
coming due in a year with nothing else in the capital structure maturing before them.

Further it doesn't appear there's even a need to roll these Unsecured Notes over
(meaning there's no need to refinance them). We can just pay them off with the ample
liquidity the company has.

As a restructuring analyst or associate one thing you will spend countless hours doing -
and trust me, they seem like countless hours - is scouring credit documents and public
financials for the exact terms of different parts of the capital structure.

One of the things you will always be keeping an eye out for is what we call "springers" or
"springing maturities". A springer is simply an express term that says something to the
effect of, "If Loan or Bond X has not been re-financed by Y date, then this Loan or Bond
will spring Z months before X's maturity date."

In other words, if by a certain date a loan or bond lower in the capital structure has not
been mostly or completely re-financed than some loan or bond higher in the capital
structure will have its maturity date spring forward.

So for example, a term loan (let's call it the Term Loan A or TLA) could have said that if
the Unsecured Notes still have more than $10m outstanding by six months prior to their
maturity date, then the full TLA will mature three months prior to the maturity date of the
Unsecured Notes. In effect the TLA jumps the cue.

Why is this done?

More senior pieces of the capital structure want to ensure that a situation doesn't arise
where some junior piece of the capital structure gets paid out, using up all or most of the
liquidity of the company, leaving less for the more senior piece of the capital structure
when they come due.

So, moving back to our example here, why would these Unsecured Notes be trading at
70?

Well it's because there's likely a springer on some more senior piece of the capital
structure that's much larger in size. So, if the Unsecured Notes are not refinanced or paid
off in full, the more senior piece of the capital structure will mature before it, which the
company may not have the capacity to roll over or pay off in full. This could precipitate a
restructuring and maybe the estimated recovery value of the Unsecured Notes is only 50
or 60 on the dollar.

Now the obvious retort is: there's ample liquidity to just pay off (forget about refinancing!)
the Unsecured Notes. Why not just do that?

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Liquidity is not synonymous with cash. Perhaps the company has $2m in cash and $68
of an ABL that they can draw. However, the ABL may have certain terms surrounding the
draw that preclude the company from drawing all or most of it.

Further, perhaps the company has declining EBITDA, poor FCF, etc. making it impossible
to go out and raise new debt to roll over these Unsecured Notes (despite the appearance
of ample liquidity).

So, the chain of events would be:

• The Unsecured Notes can't be paid off in full using liquidity (because the liquidity
primarily comes from a revolver that has certain terms precluding further draw
downs)
• The Unsecured Notes can't be refinanced because of the overall poor financial
performance of the firm (despite the appearance of having ample liquidity)
• The company does not have a year to figure things out, but rather has 6-9 months
because of a springing maturity on a much larger, more senior piece of the capital
structure exists
• Therefore, these Unsecured Notes are trading down significantly because time is
running out for the company to figure out how to reconfigure their capital structure
and in the event of a Chapter 11 the Notes will be impaired and perhaps only
deemed to be worth 50-60 (or an out-of-court will occur where the Notes will be
asked to take a big haircut)

Alright. There's a lot here, I know, and the reality is you could come up with a number of
potential answers to this style of question (that's partly why it's asked!).

However, as a general rule if you know a thing or two about restructuring you want to
make sure your interviewer knows.

For example, an answer that wouldn't necessarily be wrong for this question could just
be, "The company has had a major class action suit against it and so no one will refinance
any part of the capital structure and the company will almost certainly file Chapter 11.
That's why the Unsecured Notes are trading down."

There's nothing wrong about this answer per se. It could very well be the case. However,
it doesn't really show you know what restructuring is. The answer above explicitly gets
into what liquidity is, what springing maturities are, and implicitly covers what maturity
walls are.

A bond has a current price of 80, 10% coupon, and matures next year. What’s the
YTM? Will the YTM be higher if it matures in two years?

Bond math will likely come up in your interview. All that will be required is to know the
YTM formula and generally have an understanding of when yields are going to be higher
or lower.

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For this question, think about YTM = (c + (FV - P)) / P where c = coupons, FV = face
value, and P = current price. This can be used to get the exact YTM when we’re dealing
with a maturity in the following year.

Note: Your interviewer will assume annual coupon payments (not semi-annual) and a FV
of 100 in these questions. Unless told otherwise, don't ask for clarification.

Note: If you are asked, YTM decreases as coupons become more frequent. So YTM will
be lower if coupons are paid quarterly as opposed to annually, etc.

Note: If you’re asked what the current yield is, it’d just be the coupon divided by the
current price (10/80) so 12.5% as you can check on the YTM calculator linked below.

Therefore, for this question with a maturity next year we have a YTM of (10 + (100-80)) /
80 = 0.375 or 37.5%. This is the exact YTM as you can check on a YTM calculator.

If the bond matures in two years, then the YTM will be lower. This should be intuitive as
instead of getting the $20 (FV - current price) within the year, you have to wait two years.

When dealing with maturities that are more than a year out then you should pivot to using
the traditional YTM estimate formula. It’s important to remember that this gives you an
estimate, not the exact YTM.

The formula is just (C+((FV-P)/n))/(F+P)/2, where n is the number of years to maturity.

So, for this example it’d be (10 + (20/2))/(180/2) or 20/90 or 22.22%.

Bond math questions are almost always set up this way in interviews and once you do
one of them it doesn’t matter how the variables change. However, I’d recommend creating
some questions of your own in this format – with different prices, coupons, and maturities
– to make sure you have it all down.

You can use this YTM calculator to check your answers. You should always get the exact
YTM when the bond matures next year and you should always get the exact estimate
(using the more involved formula I gave) for maturities more than one year out.

A company has $50m in EBITDA with comparables trading at 6x. The company has
$400m in debt with 0 in cash. What’s the company’s enterprise value and equity
value? What does the debt trade at?

Enterprise value is simply 50*6 or $300m. Obviously, equity value can’t be negative
(remember we aren’t talking about shareholder’s equity here, which can be negative).

So how does the right-hand side of the equation end up equaling $300m?

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The answer is obviously that debt will trade at a discount when the debt of the company
is well in excess of the EV. Think about it this way: if the EV is not enough to make the
debt whole, why would debt trade at par?

So we say that debt is trading at 75 (0.75*400=300).

Now many interviewers will expect you to say that equity value is zero. In the event of a
Chapter 11 this would be largely true as the debt would be impaired so there would be
virtually nothing left over (minus perhaps a “tip”) for equity holders.

In reality, there will almost always be some residual equity value because as a kind of call
option. Maybe there’s a massive turnaround suddenly, maybe the CEO finds hundreds of
millions under his cushions, who knows! The answer is that debt trade at 75 and equity
will have some extremely modest value, but it won’t have a defined value. Just say equity
will have a “non-zero value” or “slightly positive value”.

What if, carrying this example forward, the CEO actually does find $100m under his
cushions at home. What happens to debt and equity value?

Equity value is still going to be some very small non-zero or slightly positive value.
However, debt will trade up to par (100) because now there is full asset coverage.

So, the difference made by finding this $100m is just that debt will actually be worth par,
not 75.

Here’s another way to think about it: if we have $400m in debt and an EV of $300m, debt
is underwater by $100m. If we find $100m in cash then we can just go into the open
market (theoretically, of course) and buy $100m of debt.

Now there’s a bit of a chicken and egg problem here. We could buy the debt at a discount
(75 cents on the dollar) and actually be ahead of the game. But if are pretending this is a
perfectly rational, efficient market hypothesis world the CEO would immediately
announce, “Hey, I found $100m” and bonds would respond by trading up to par because
there’s now full asset coverage and no need for a discount to be there.

Then the company could go and buy $100m of the debt (which would be at par). If the
company suddenly found $100m then bought all its discounted debt back (because
investors didn’t know the company found $100m that would certainly be securities fraud).

So, with that debt bought back EV would be $300 (as EBITDA and the multiple haven’t
changed) and the debt will now be $300m outstanding all trading at par. So $300m =
$300m again.

These two questions are a bit confusing for some because normally EV calculations don’t
involve debt trading at a discount (often just the face value is utilized).

Just understand that this is a stylized example that frequently comes up in interviews and
what your interviewer really wants to see is that you understand debt trades at a discount

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and an influx of cash (when bonds are trading at a discount) accrues to the benefit of
those high up in the capital structure (the debt), not those at the bottom (the equity).

If I were to give you a company and I wanted an overview (quickly) of what’s

important, how would you go about answering that?

When asked questions like this, you should think of the examples I give in the Overview
Report detailing the kinds of screens, profiles, and pitches you’ll actually be creating.

When you’re asked anything related to “how would you think about a distressed company”
you should think about the primary page in a profile. What does it include?

Overview & Recent News Maturity Schedule

Bullet #1: What the company does. Here you’ll paste in the maturity schedule
you made in Excel.
Bullet #2: Recent news, from DebtWire or
ReOrg, detailing why the company is in It’ll show when the debt of the company
trouble. comes due (i.e. where the maturity walls
are).
Bullet #3: More recent news, maybe on
S&P downgrading their bonds, etc.

Cap Table

Here you’ll paste the cap table you made in Excel (just like for the screen). It’ll show the
cash on hand, secured debt, total debt, LTM EBITDA, and the terms of the debt.

You may also include an area for liquidity, which will be the ability to draw on a revolver
plus the cash available (minus letters of credit outstanding and minus restricted cash.

What are “maturity walls”?

Maturity walls refer to graphs that accompany profiles/pitches that show when maturities
within the capital structure come due.

If a company has poor ratios, poor FCF, poor liquidity, etc. and has large amounts of its
capital structure coming due soon it faces an issue: it needs to either extend those
maturities out, so it can then have time to turn the company around, or it needs to
refinance them (who will refinance if the company is preforming poorly?). A company can
have poor financials but be able to wait things out for years if no maturities are coming

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due. The same cannot be said if maturities are coming due soon, which is why RX
bankers care so much about them.

How do you determine how much liquidity a company really has?

You take their revolver capacity, subtract the amount currently drawn, and add their
current cash or cash equivalents (also minus letters of credit outstanding and minus
restricted cash, if relevant).

What’s a revolver?

A revolver (sometimes called a “revolving ABL”) is essentially like a credit card with a
certain limit. You can draw it down at any time and pay it back (partly or all) at any time.
However, it does have a maturity date. A revolver is secured debt, sitting at the top of the
capital structure, backed by more liquid assets like inventory or AR.

How do revolvers work?

For example, a revolver could be $100m, which can be draw down and paid back as
needed. Many compare it to a corporate credit card. How large a revolver ends up being
depends on the amount of collateral, or borrowing base, that’s pledged to support the
loan. Revolvers are usually secured by borrowers AR and inventory. Borrowing base may
be 50% of inventories, 75% of AR, etc.

If the borrowing base declines below a certain threshold (inventory goes down, for
example) you must repay the revolver or have it re-sized. Revolvers must always have
more collateralized against it then the actual notional value of the revolver.

What’s grid pricing?

Revolvers will something have grid pricing. For example, a revolver could have L+250-
350 where L+250 is the rate if only X% of the revolver is drawn, but if more than X% is
drawn then it goes up to L+350.

Why does this make sense? Well if a company draws, say, 75% of their revolver that
probably means they’re in need of quite a bit of cash for some reason. It could mean (but
doesn’t necessarily mean) they’re in at least a bit of a cash crunch. So, to account for the
lender’s risk in this case the coupon price on the revolver goes up.

What’s a springer or “spring forward”?

Check out the screen examples. In it we show what a springer looks like in practice. Let’s
say you have a Term Loan due in 2022, but have other Notes below them that are due in
2020. The Term Loan will often have a springing maturity such that if the Notes are not
re-financed significantly (leaving less than $10m left, for example) then the Term Loan
maturity springs before the Notes maturity.

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Why would the Term Loan put this in place? They are operating under the assumption
that if the Notes haven’t been re-financed by a certain date, then it’s because the company
is in a place of near-distress and can’t re-finance them. So, the Term Loan wants to make
sure they get re-financed or at least get first attention before the Notes become due.

Traditionally springers push the maturity 90 days before the other security comes due (in
this case the 2022 Term Loan would be pushed 90 days before the Notes if they aren’t
re-financed).

What things would you expect to change most for a distressed company on the
three financial statements?

▪ CapEx is often too high and should be lowered moving forward

▪ Working capital will decrease as you have write downs on inventory and accounts
receivable may decline
▪ One time legal, RX, etc. fees

In a “traditional” capital structure what are its elements?

▪ Secured Debt (including revolvers and term loans (TLA, TLB, etc.))
▪ Unsecured Debt (bonds)
▪ Subordinated Debt (bonds, below unsecured debt)
▪ Mezz Debt (anything like convertibles, preferred stock, PIK paying debt, etc.)
▪ Equity

Note: If the company is currently in Chapter 11 then it will have DIP financing at the very
top of the capital structure.

What’s the difference really between secured debt and unsecured?

Secured debt means that the debt is backed by collateral, unsecured means that it is a
generalized claim, not backed by specific collateral.

Do secured creditors always get treated as secured?

If their claim is larger than the value of their collateral the amount of the excess is deemed
an unsecured claim (technically called a “general unsecured claim”).

What makes mezzanine debt unique?

Much smaller in notional value and are almost always privately placed, highly illiquid, and
bought with the expectation of being held to maturity.

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Unsecured (mezzanine debt) always subordinated in rights of payment to bank loans and
other senior debt.

What other kinds of debt are there beyond what you would normally see in a capital
structure explicitly?

There will sometimes be an “Other” line item above equity. This will include things like
capital leases that can be considered as forms of debt (since they operate more like
financing than typical leasing, see “Accounting & Valuation Q&A” for more on capital
leases).

So if unsecured debt is, well, unsecured by collateral is there a recovery in the

event of default?

Yes, of course! If the company’s liquidation value is $400m, it has secured debt of $300m,
and unsecured debt of $200m then there will be a 50% recovery by unsecured debt.

Who owns the debt of a company?

The loans or bonds of any suitably large company are generally going to be owned by a
diverse, changing group of holders. Almost all loans are syndicated by the issuer and
bonds are, of course, dispersed as well by definition (although mezz debt can be privately
placed and held by just a few parties till maturity). Some loans (TLA only) may be held by
the issuer bank in size or in entirety.

The quickest way to find the holders is to go to Bloomberg (use code: HDS). If you need
pricing use Bloomberg and MarkIt (MarkIt in particular for loans).

Two main groups of syndicated loans?

Revolver and term loans, which are loans for a specified amount with fixed repayment
schedule. There can be more than one revolver (although it’s rare) that simply has a
different borrowing base (one for a/r, one for inventory, for example). Term loans are often
called TLA, TLB, TLC, etc. Usually anything beyond TLB has little or no amortization,
while TLAs have some (along with lower interest rate).

Note: “Syndicated loans” refer to loans that a bank will issue, but then sell off to other
counterparties retaining only a small amount of it on their own books. Syndicated loans
are, in short, securities that trade in a secondary market because they’re held by many
different counterparties. You can find out where they are trading via MarkIt and you’ll be
doing much of that in your day-to-day.

What do we mean by leveraged vs. unleveraged loans?

Leveraged are those with BBB- or Baa3 or lower. Leveraged just means that the credit
rating is below investment grade (IG). In other words, rated high yield.

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What’s the COD (cost of debt) for a company in distress? Where should new bonds
be priced?

Conventional wisdom is whatever the YTM (yield to maturity) is corresponds to what the
cost of debt should be. Intuitively this makes sense, however it’s not quite so simple for
distressed companies.

Perhaps the reason why bonds are trading down (to get to a high YTM) is because of the
need for those bonds to be refinanced. Maybe part of the reason they’re trading down is
doubt over whether they can refinance at all! Many times you’ll see a YTM much higher
than where new bonds will end up pricing.

So, the correct answer for the COD is somewhere around the YTM, but if the YTM is
being driven by lots of default bets then it’s likely lower (if indeed you can raise debt).

What’s a liquidity roll forward?

A projection of where liquidity will be in a year. We will assume that the revolver gets
drawn (or cash is diminished) by the amount of decrease in FCF next year. We make the
projection on how much FCF will decline by just making assumptions about revenue
declines, EBITDA margin contraction, and capex spend based off of what the company
has done in the past year (remember, this is restructuring, not M&A, so there is rarely an
in-depth model for a one-year projection).

A liquidity roll forward is basically just saying: how much is FCF declining next year and
how much of the cash and/or revolver needs to be used up to get FCF back to zero. Then
what is the liquidity left (cash + revolver) for the firm.

What is a restructuring ultimately trying to accomplish?

Whatever it’s formulation, a restructuring is ultimately about right-sizing a company and

ensuring that it has the capacity to not need to restructure for some years.

Would you expect Adjusted EBITDA of a company in need of restructuring to be

higher than it was, say, a year ago?

Yes. You’re adjusting for more one-time expenses. For example, you’d add back goodwill
impairment, litigation expense, any losses on asset disposal.

In cap tables do you use adjusted EBITDA or just EBITDA for leverage ratios, etc.?

Adjusted EBITDA, if possible.

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What are leverage and interest coverage ratios? Which are more important?

Both are covenants that will be found often in the term sheets of debt in the capital
structure of the company. Leverage is (Debt / EBITDA) and interest coverage is (EBITDA
/ Cash Interest Expense).

Generally speaking, leverage ratios are more utilized and looked at. They feature
prominently in all cap tables and are calculated at the secured level, unsecured level, and
for the totality of all debt.

Leverage ratios are often used at the secured level to determine either grid pricing (e.g.
if the revolver is going to go from L+225 to L+275, for example) or how much more debt
can be added to the secured area of the capital structure.

If looking at FCF, do we look at it on a levered or unlevered basis?

Unlevered. You want to look at cash flows unimpeded by debt, because you’re ultimately
coming up with restructuring alternatives that will change the debt structure of the
company.

What are fallen angels? Why do they matter?

Fallen angels are those bonds rated at the cusp of investment grade (BBB- or Baa3) that
then get downgraded one notch or more, making them high yield or distressed (depending
on your favored verbiage).

This matters because many mutual funds, pension funds, life insurers, etc. have
mandates to hold investment grade credit, but not high yield credit (due to the increased
risk, perceived or otherwise). So, in the hunt for the most promising yield, these funds
load up on the lowest grade investment grade debt they can find. This is all fine and good
until there are downgrades, in which case (regardless of what the funds believe the credit
quality really is) they must liquidate their positions.

This usually means that there’s a large price decline on a downgrade of bonds from IG to
HY, with a totally different subset of buyers (distressed funds) buying from the mutual /
pension funds.

Differences between LBOs and distressed debt investing?

▪ Usually get the largest capital infusion through a Chapter 11 in distressed, unlike
in an LBO where a capital infusion is inherent to the design
▪ More protection in distress investing as not taking equity stakes, taking debt
(sometimes very senior debt)
▪ Securities law less onerous for bond holders than is the case for common stocks

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 ▪ Not necessary to pay premium to gain control in distress (or to have as much
control as you can have blocking capacity of a POR with 33.4%)
o Remember: When you do M&A, you’re almost always paying some
premium to buy the company out. In distress, even if you want a large
position to have control in the Chapter 11 process, you can still just go out
into the secondary market and buy up bonds (although in illiquid markets it
can be hard to find all the owners, etc.)
▪ IRS code less favorable to distress than LBOs where get tax breaks on debt
o Remember: much of what makes an LBO “work” is the tax shield element

Why are YTM or YTC not really correct?

Because assumes you can reinvest at the same rate. Only really true for zero coupon
bond since no bi-annual interest payments.

This is why YTM is not used by all RX shops in cap tables. It’s just not that true that you
can re-invest at such high yields reliably.

What was Martin Fridson’s definition of distressed debt?

Yield to maturity greater than 1000 basis points more than the comparable underlying
treasury.

For example, if the 5yr treasury is trading at 0.37% than Fridson’s definition would be
10.37%.

Fridson is legendary in the distressed space. Read more about him here.

What blocks do bank debt and corporate bonds generally trade?

5 mil and 1mil, respectively.

When have there been a lot of defaults?

1931-33, 1970, 1990-1991, 2000-2002, 2007-2009

Tip: When speaking to more senior people in particular it’s fantastic to have a sense of
history about RX.

Chances C-rated bond defaults?

In one year 33%, in three years 65%.

Note: It’s important to understand this point, especially given the incredibly tight credit
spreads we’ve seen in the distressed space from 2010-2020. Part of the reason why you

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keep the screens and profiles updated is that the majority of companies with C-rated
bonds will eventually need to be restructured. It’s a matter of when, not if.

Why does Efficient Market Theory (EMT) not apply to distressed debt?

1. All counterparties do not have access to the same info (information asymmetry)
2. Many investors may have forced liquidations during highly volatile periods (e.g. the
fallen angel phenomenon), which is objectively irrational but done because of their
mandate
3. Have large transaction costs (bid/ask spreads wider than in IG or equity) with much
worse liquidity

What’s fulcrum security?

One that likely receives lots of equity in reorganization. The most senior class of debt that
is impaired and not paid in full.

Out-of-Court and In-Court Questions

What are the two possible avenues (or types) of bankruptcy?

Chapter 7 and Chapter 11.

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Chapter 7 is a full liquidation. In it, a U.S. Trustee is appointed by the court who has the
roll of liquidating the full assets of the company and then disbursing the cash by absolute
priority. This means there is a waterfall, if a TLA is the highest in the capital structure then
they are made whole before any money goes to the next highest in the capital structure,
etc. Chapter 7, as you would assume, leaves no element of the company behind. It’s a
pure liquidation.

In Chapter 11 a company’s reorganization is overseen by a court (usually in Delaware)

and involves the company coming up with a Plan of Reorganization (POR) and finding
out who the impaired classes are (those who will not be made whole but will get
something). Only those who are impaired classes get to vote on the POR. If the POR is
agreed to, then the company will re-emerge with their new capital structure that has been
agreed to by the relevant creditors (those who were impaired).

In Chapter 11 you will either have a pre-pack or a “traditional” Chapter 11. A pre-pack
involves a pre-planned POR that has already been agreed to by the relevant creditors
(baring some small issues to iron out) prior to filing. This allows for the company to quickly
emerge from Chapter 11 in only a few months. In a traditional Chapter 11 you’re starting
from scratch and the process can take years.

What is DIP Financing?

Debtor in Possession (DIP) is what the company that has filed a petition for bankruptcy
is called. DIP Financing is a special type of financing, only available to those who have
filed, that has super-priority over all existing elements of the capital structure. Roughly
70% of the time this DIP financing comes from those who have already given the company
loans. DIP financing is generally very safe as it has so much collateral backed up against
it and it comes with some very restrictive covenants.

Many companies, who have not been able to raise new debt prior to filing, will file Chapter
11 strategically in order to get access to DIP financing.

How do you calculate the amount of DIP you can give?

If have $50 claim on AR but worth $150 then $150-50=100 is the possible DIP. You
essentially look at traditional borrowing bases and say, “what is left that can be pledged
against a new DIP loan?”

Why is DIP lending so attractive to lender?

DIP lenders will be granted an affirmation or extension of their existing liens, new liens,
and super priority claim status in the event that the value of their collateral is not sufficient

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to pay those claims and even priming liens; this makes DIP lending a very safe and
profitable business.

To be clear, DIP loans are placed at the top of the capital structure, having absolute first
priority, and can be made by existing lenders or by an entirely different lender (most of
the time it comes from existing lenders).

What about M&A? What can you tell me about distressed M&A?

Distressed M&A can come in two forms. Either selling a distressed company prior to filing
or doing a Section 363 asset sale (which is essentially an expedited asset sale).

For most RX shops M&A bankers will be brought in on a “traditional” M&A deal. This will
normally be an asset sale (where a buyer doesn’t assume all liabilities and assets). There
is a fine line, in distress, between a divestiture and sale, because often what is left of a
company after an asset sale is not overly valuable.

Let’s say as part of the restructuring (out-of-court) you’re looking at creating new
1L Notes and have to go see if any distressed funds would be interesting in
participating. What are the steps involved in that?

As an analyst or associate you’ll have a list of distressed funds who could be interested
in these new Notes. You would then keep a spreadsheet tracking where these funds are
in the process. The exact steps these funds go through is:

▪ Step 1: Teaser Sent (describing the transaction structure broadly)

▪ Step 2: NDA Sent / Executed
▪ Step 3: Financials Sent (more detailed financials and terms of transaction sent to
the counterparty)
▪ Step 4: Term Sheet Received (which will have terms for funding amount, duration,
interest rate, and covenants)

What is a liquidation valuation?

In its most simple form, you are going through the assets of the company and assigning
a certain level of expected recovery from them if liquidated. While numbers may vary, the
following is a rough indication:

▪ Cash and cash equivalents

o 100% recovery
▪ A/R
o 80% recovery

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 ▪ Inventory
o Anywhere from 40-80% depending on how commoditized the inventory is;
the more commoditized the better!
▪ PP&E
o Land and building will be based on market values, equipment will likely be
close to book unless very bespoke
▪ Intangible assets
o Brand names, trademarks, etc. can still have market value; just because a
company has a bad capital structure doesn’t mean the brand is worthless!

What are four major steps in Chapter 11?

▪ Restructuring of the debtor’s operations by asset sales and contract assumptions

and rejections
▪ The development and dissemination of a proposed plan (POR)
▪ A vote on the plan by the claim and interest holders
▪ Confirmation of the plan by the bankruptcy court

What are important documents when Chapter 11 filed?

▪ Initial filing papers like affidavit signed by senior officer describing the reasons why
the debtor is seeking relief under Chapter 11
▪ Listing of the largest 20 unsecured creditors of record and the five largest secured
creditors
▪ Monthly cash reports
▪ Court docket (filing with the bankruptcy court)
▪ Listing of professional fee applications
▪ Petition to the court for automatic stay
▪ Listing of preferred creditors, critical vendors, and reclamation credits
▪ DIP proposals
▪ POR (plan of reorganization) potentially filed as well

What’s a full prepack?

When a Chapter 11 petition is filed it is accompanied by a complete disclosure statement

and a proposed plan of reorganization, together with an agreement to support the plan
that is binding on a sufficient number of the class to satisfy the applicable voting tests.
Increasingly more common. Can take just 45 days. 85-90% participation rate required.

Who wouldn’t like a pre-pack (pre-packaged bankruptcy)?

Management, out of the money creditors, and equity holders. Management may have
significant equity so want to wait see if get turnaround, or just keep their jobs longer, and
get higher EV.

Difference between section 301 or section 303 in Chapter 11?

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Voluntary by debtor of involuntarily by creditors or indenture trustee.

Meaning that the company voluntarily declares Chapter 11 or creditors do (on the basis
of technically defaulting for breaking covenants, missing payments, etc.)

Exclusive period to file plan of reorganization once Chapter 11 filed?

Have a 120-day exclusive period and 180-day period to solicit acceptances

So, a company files for Chapter 11 and then must come up with a POR. What’s that
include?

Section 1123 has five mandatory provisions.

1. Plan must designate classes of claims and classes of interest (e.g. must provide a
detailed cap structure).
2. Plan must specify any class of claims or interest that are not impaired under the
plan (e.g. classes that have full asset coverage thus will not be able to vote)
3. Plan must specify the treatment of any class of claims or interest that are impaired
under the plan (e.g. what are you offering them in the re-organized company upon
emergence from bankruptcy since they are impaired)
4. Plan must provide the same treatment for each claim or interest of a particular
class unless by requisite vote holders agree to a less favorable treatment
5. Plan must provide the adequate means for the implementation of the plan
(meaning, the plan must be feasible and achievable).

What classes do not get vote in POR?

Those who will be made whole and those who won’t be made whole at all. Only impaired
can vote. Section 1126 outlines this.

So, for example, if secured debt is completely covered then they won’t get to vote. Why?
Because they will not have to take a haircut on their securities.

Also, those who will not receive anything in the POR can’t vote. Why? Because they of
course would vote no, since they aren’t getting anything! Why would they vote yes to a
plan where they get nothing?

What is needed for a POR to be approved?

The plan is accepted if at least 2/3 of the notional amount (meaning dollar amount of
bonds or loans agree) and more than half number of the allowed claims of such a class
(meaning half the number of bond or loan holders, regardless of how much they hold).

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So hypothetically if you have someone who owns 75% of the bonds in a class, they can’t
vote alone to approve the POR for their class (even though they own over 2/3 of the
notional value). Instead 50%-1 of the other holders in the class agree as well, even though
they hold a much smaller dollar amount of bonds or loans.

What two valuations are done in confirmation process of a plan of reorganization

(POR)?

Liquidation analysis and going concern enterprise value (EV).

A liquidation test is done so that no party gets less than they would if the company just
liquidated instead of reorganizing. This should make intuitive sense, if you can make more
money just selling off all the assets of the company then you can reorganizing, then why
bother reorganizing?

An EV test is done to see what the company is really worth and thus what part of the
capital structure will be impaired. Since you aren’t liquidating the company, it’s impossible
to know with certainty who the impaired class is and just how impaired they are. That’s
why fights over valuation in RX are so pernicious; you’re applying an inexact science
(valuation) and that determines who will end up getting made whole, who gets impaired,
and who gets nothing.

What are the three legal tests for the confirmation of the POR?

Plan confirmation has three tests: feasibility, best interest, and cram down.

What is a cram down?

1129B(1) details this. Requires that in the event that not all impaired classes accept the
plan the court may still confirm if it does not discriminate unfairly and it is fair and equitable
with respect to those nonaccepting classes. Cram downs are quite rare as it obviously
involves the court taking a tough stand against someone who is impaired.

What is best interest test?

Plan confirmation has three tests: feasibility, best interest, and cram down.

Detailed in Section 1129(a)(7). Basically, what the best interest test is saying is that by
accepting the Chapter 11 POR you won’t be worse off than if the company just did a
Chapter 7 liquidation now (as it’s in your best interest to get the most value you can, so
the Chapter 11 value should exceed the Chapter 7 value).

What is feasibility test?

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Once restructured, the debtor will not likely liquidate or will not experience the need for
further financial reorganization in the future (Chapters 22s or Chapter 33s). Codified in
1129(11) of the BRC.

In other words, the POR must feasibly put the company on sound footing and not require
more restructuring later on.

When does absolute priority rule not apply?

When the plan is accepted by all voting classes by requite majorities. If a class of claims
so consents, a class below them can get something even though the consenting class
has not been paid in full (made whole). Nothing in the statue says the distributions in a
consensual plan need to comply with absolute priority rule.

How long do public companies stay in Chapter 11?

18 months to 3 years normally, unless there is a pre-pack in which case it can be just 30-
45 days.

Why do asset sales under section 363 instead of Chapter 7?

Management keeps control of process.

When does GAAP require restructuring costs to be filled?

Charged against income in the year in which the decision to restructure is made even
though the actual expenditures will take place over time. Liability reserve is created and
the actual expenses are charged against this reserve.

What do NOLs become after a Chapter 11?

Deferred tax assets for a reorganized company.

How to qualify for section 382 election for NOLs (allowing NOLs to be carried
forward into the newly reorganized company)?

▪ Shareholders and creditors of the company must end up owning at least 50% of
reorganized debtor’s stock.
▪ Shareholders and creditors must receive their 50 percent stock ownership in
discharge of their interest and in claims against debtor.
▪ Stock received by creditors can be counted toward the 50% test only if it is received
in satisfaction of debt that:
o Had been held by the creditor for at least 18 months on the date of
bankruptcy filing, or…
o Arose in the ordinary course of the debtor’s business and is held by the
person who at all times held the beneficial interest in that indebtedness.

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Note: NOLs are important to a restructured company. Basically, if current shareholders
or creditors don’t end up owning at least 50% of the re-organized company’s equity, then
the NOLs will be void.

Where do you get all the documents for bankruptcy court?

PACER for bankruptcy court; EDGAR for SEC

What is substantive consolidation risk?

Substantive consolidation is when liabilities of separate legal entities are treated as being
merged into one entity. Changes value of creditor claims through invalidation of any
priority a claim may have had due to corporate structure and thus affect the potential
recoveries of certain creditors. Kmart had this happen to them.

What’s critical vendor payments risk?

Critical vendors are those vendors who are paid post petition and distressed debt investor
has to decide who they think will be in those groups.

Critical vendors, as the name implies, are those who are essential to the company being
an on-going concern. In other words, without them the company wouldn’t survive so you
need to have cash available to pay them. All non-critical vendors have the automatic stay
leveled against them, precluding them from the ability to collect on their debts in the short-
term.

How can you block a POR?

Hold 33.4% of bonds in an impaired class. Can still have cram down if at least one
impaired class voted yes and if judge deems deal to be equitable.

Why does Third Avenue (and many other distressed funds) try to get 50% of any
issue?

Revolves around fact that in the indentures for almost all publicly traded bonds, any
nonmoney provision in the indenture can be modified or abrogated by the consent of 50%
of the outstanding issue.

So, for example, if you want to block the capacity to be primed (have new money put in
front of you in the capital structure) you can if you own 50% of a certain class of bond.

What does a typical prepackaged (pre-pack) POR do?

▪ Obtain new exit financing from banks (primarily DIP loans)

▪ Reinstate or repay old bank loans

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 ▪ Reinstate trade creditors
▪ Reinstate leases and other executory contacts
▪ Issue 90 and 95% of common stock to former bond holders (they may get pieces
of new debt issuance as well)
▪ Issue 5-10% of common stock to former junior creditors, former preferred
stockholders, and/or former common stockholders
▪ If there is litigation pending, set up and finance a litigation trust and give the
common stock a small participation in lawsuit recoveries, if any
▪ Issue options on 6 to 12% of the common stock outstanding to management to
incentive them to stay around (despite probably having lost a great deal on their
prior stock holdings in the company)

What causes the “three strikes you’re out” in bankruptcy?

This refers to so called Chapter 33s. After their third trip to doing a Chapter 11, it appears
they are destined to be liquidated so will be forced to file Chapter 7.

Let’s take a step back, what really happens in out-of-court restructuring?

Creditors typically either negotiate a change in terms of existing obligations or complete

a voluntary exchange of financial interests.

Example: You have senior secured bonds that are trading at distressed levels and
maturity is coming up. You raise a new 2L (second lien security), give 80% of the value
of the bonds to bondholders in the form of the new 2L, and ask them to absorb the 20%
in their lost value. So, if they held $100m in bonds, you’re giving them a new “financial
interest”, senior to where they were before, worth $80m. This may not seem enticing, but
maybe bondholders believe their recovery value in a Chapter 11 would only be 40%
(equivalent to $40m). If creditors believe this can help right-size the company and not
make them take an even bigger hit down the road, they may be enticed.

What acceptance rate do exchange offers need (for an out-of-court restructuring)?

Typically exchange offer needs 90% acceptance.

Example: you want to exchange senior bond holders into a new 2L (second lien), but you
want them to take a 30% haircut. So, if $100m bonds outstanding you give them $70m
worth (distributed evenly, of course) of the 2L. If 90% accept then you can push this deal
through.

What are bondholder committees and their rights?

Basically, in an out-of-court scenario you’ll have bond-holders band together in what’s

called a bondholder committee in order to negotiate with the company as to what they will
accept in an out-of-court restructuring scenario. This committee will often hire a bank to
help them do analysis, coordinate, etc. and this is how RX shops get creditor mandates!

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Typically, then a large bondholder will take the initiative to contact other significant
bondholders and solicit their participation in an informal bond holder committee to
negotiate on behalf of the overall bondholder group. This group will then hire a bank.

Can’t force anyone to do anything out-of-court, but can get nonpublic info to make better
informed decisions. Company pays for legal and associated expenses of the committee.

This all sounds great, but there’s a downside. This downside is the reason some
distressed funds won’t join a committee (because they will have to disclose when they
buy or sell securities).

Downside of being on bondholder committee?

Sign confidential agreement and will then have to disclose when selling or buying
securities of the firm. Also, can’t tell others about nonpublic info (of course!). The
bondholder can’t be unrestricted until filing of nonpublic info to public via 8-K, 10-Q, or
10-K.

This is a great article about CIT Group Inc. and their bondholders committee negotiations
from way back in 2009 when lots of interesting restructurings happened. Houlihan Lokey
advised the bondholders (not surprising as HL does many creditor-side mandates).

What is big boy letter?

1. Acknowledgment by the non-restricted part that he or she is aware that the is in

possession of nonpublic info
2. Waiver of claims that non-restricted party might otherwise have under securities
laws because of the restricted party’s possession of nonpublic info

What’s priming?

For example, Debtor in Possession (DIP) financing gets superior claim to all others out of
a Chapter 11. This primes everyone else in the capital structure, but you have to prove it
doesn’t impair secured holders.

So priming is just when a new piece of the capital structure is added to above existing
pieces.

If debtor wants to provide some little value to equity holders what does it need to
get from all impaired classes?

Obtain the consent of, or provide full recoveries for, all impaired creditors or the plan will
fail as violation of absolute priority rule.

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In most Chapter 11’s – theoretically – equity gets nothing. This makes sense as they are
obviously at the very bottom of the capital structure. However sometimes current equity
holders will be thrown a bone (this is often called a “tip” or “tipping”).

What are borrowing bases?

An asset backed lending (ABL) facility can be obtained with the amount you can draw
from this facility being a set percent of the underlying asset the ABL is collateralized
against.

Note: ABL is just a revolver.

The borrowing base is how much can be borrowed against this asset (the asset is really
just a line item on the balance sheet). For example, a typical ABL will be defined as having
a borrowing base comprised of 50% inventory or 75% eligible receivables. The point is
that collateral should cover loans no matter what so you can’t just use the line item on the
balance sheet.

What’s asset coverage?

Just assets/debt. You will often see asset coverage shown through the capital structure,
so how do the assets cover the 1L term loan, what about the 1L term loan and the rest of
the secured creditors, etc.

What’s one way to add debt when there is insufficient asset coverage?

Preferred equity. Can be converted, at the issuer’s option, into true debt. Mandatory
redemption features (have to be repaid) and blur the line with debt. Failure to make a
dividend or redemption payment has limited repercussions so some argue not true debt
(for example, can’t have a technical default with preferred debt). Usually issued when
leverage very high. Also, could do convertible bonds.

What are convertible bonds? How can they be issued in an out-of-court

restructuring to get around asset coverage issues?

Like preferred stock, convertible bonds are issued by distressed companies to get around
asset coverage issues.

Feature allowing the holder to convert the face amount of the bond into specified number
of shares. Share price to convert is significantly above the share price at the time the
bond is issued. Expected for stock to increase above the issue price and then convert
and can cash out gain. Of course, if stock declines in value then the convertibility option
become worthless, but the debt is still valid, and coupons can be clipped and hopefully
principle will be repaid (called busted converts when this occurs).

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Note: Convertible bonds normally reside quite far down in the capital structure (unless
you have very limited debt in the capital structure). So, if a company near distress issues
it you are betting on a turnaround, because if the company files you will likely be severely
impaired (get back a low % of total invested into the converts).

When you can’t make interest coverage what can you do from an out-of-court
perspective?

Issue discount notes or PIK notes. Under GAAP interest expense is still recorded on the
income statement, but each structure is essentially allowing the cash payment on the
interest to be deferred until maturity.

What happens when bank debt trades below 70?

Banks and CDOs are much more likely to become sellers, often for non-value related
reasons (e.g. CDOs have mandates for types of debt they hold, banks have risk weighted
asset (RWA) considerations that make holding distressed debt very expensive). In these
situations, there exists opportunities to accumulate bank debt at cheap prices not
because the value isn’t there, but because folks have just needed to get out of it.

What’s of interest in bankruptcy filing in PACER after a Chapter 11?

▪ Initial petition and related schedules and all subsequently filed monthly operating
reports.
▪ Debtor’s schedule of 20 largest unsecured creditors; this gives insight into
unsecured creditor committee.

What does BRC 363 allow?

Asset sale where the buyer purchases asset free of all liens and claims with little or no
risk of the transaction being subsequently unwound. Only debtor can propose to sell
assets pursuant to BRC 363. 363 is open outcry bid in person at some location (normally
court). Have stalking horse bid to make sure you set minimum amount. Have breakup fee
and incremental bids.

When is complete liquidation (Chapter 7) preferable?

When little stable cash flow or are likely to require additional capital infusions in the future
no matter what the restructuring is.

Remember: if the company has negative FCF into perpetuity, no “right-sized” capital
structure will make a difference!

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 Credit Questions

Why are credit ratings not that great of an indicator for distress?

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They are lagging indicators.

What’s a covenant? Three broad types?

A rule laid out in the indenture and loan documents by which a company agrees to operate
as part of the terms of the loan or the bond.

▪ Affirmative covenants refer to something the company must do

▪ Financial/maintenance covenants are typical of bank debt and include financial
tests
▪ Negative covenants typically prevent or restrict what a company can do

Default? Technical default?

When the company that issues a bond or loan fails to make required payment. Technical
default occurs when maintenance/affirmative covenants are violated (for example, breaks
the required leverage or interest rate coverage ratios).

LIBOR?

An interest rate that is often used as the base rate for floating rate notes.

Note: LIBOR is being phased out, but is still the convention that’s utilized.

What’s pari passu?

Latin term meaning without partiality. Generally, refers to two debt instruments being
ranked equally in the capital structure.

What’s pro forma?

As a matter of form. Refers to financial statements that have been adjusted for certain
assumptions such as a merger or new debt offering.

Note: For RX “pro forma cap tables” refer to the cap tables that you’ll create illustrating
what the cap table will look like after a restructuring.

What’s YTM?

Yield to maturity. Takes into consideration price paid for bond or loan as well as interest
payments and principal payments to be made over the life of the bond and the amount of
time to maturity. The YTM is an annualized return on investment. Assumes cash
payments are reinvested at the same rate as the bond/loan is paying, which is often an

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erroneous assumption when dealing with distressed (as you can’t get the same high
returns reliably on cash coming in from interest payments!).

Difference between TLA and TLB?

No hard rules. TLA tend to be held by commercial banks and TLB by institutional investors
like mutual funds of CLOs. TLA better terms, lower maturity, more amortization. TLB
rarely have meaningful amortization. Can sometimes (but rarely) be tranches beyond B.

Can you change loan covenants if the company gets into trouble?

Yes, for a fee (called a consent fee, often part of a restructuring involving needing the
consent of a revolver). It’s usually easier to get changes with loans than with bond holders.

Most common ratio used for liquidity?

EBITDA/interest ratio if 1x can just cover interest expense. Normally adjusted EBITDA
also minuses capital ex

What does EBITDA/debt tell you about the coverage ratio?

For example, if it’s 250/1500 = 0.17 so if company had a 17% interest rate its interest
coverage ratio would be 1x.

What is debt incurrence covenant?

Under what terms a company is allowed to add to its debt. Based on leverage ratio
debt/EBITDA. Sometimes (although rarely) EBITDA/interest expense used.

What are restricted payment covenants?

Holder of a bond or loan would want the company to meet certain goals before it can use
money to either pay dividends on the equity, do stock buybacks, or be able to retire
securities that are more junior.

For example, the restricted payment covenants can say you can only use the company’s
funds for stock buybacks or to retire junior securities if EBITDA is over 1.4x interest
expense (in other words, coverage ratio over 1.4x).

What’s a tender?

Company offers to purchase securities. If the company wanted, for example, to change a
covenant it could buy 51% of the bonds outstanding (if it is a non-money clause, like
subordination).

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Could do exchange offer instead if the company had limited cash (offer to exchange the
bonds for a new set of bonds with perhaps a higher interest rate).

What is an amend and extend?

Company negotiates with the banks to agree to keep in place the basic terms of the bank
agreement, but with a longer maturity. This will require bumping their interest payments
or paying a consent fee or doing a term loan pay down.

What’s original issue discount?

Bonds issued below par (100) at origination. Essentially a form of yield enhancement.
The cash interest is still the same for the company, as there is a set coupon rate, but the
yield for the buyer of bonds is higher as they’re only putting in (for example) $90 at
issuance, but getting $100 back at maturity.

What’s fulcrum security?

One that likely receives lots of equity in reorganization. The most senior class of debt that
is impaired and not paid in full.

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