CTA Credit Analysis & Debt Markets for Distressed Companies 2 — Questions and Answers
Question 1: A 'lien' in the context of corporate restructuring gives a creditor:
- The right to vote in a bankruptcy election
- A legal claim against specific collateral that can be enforced if the debtor defaults (Correct answer)
- The ability to appoint the CRO
- Priority over all other claims regardless of documentation
Correct answer: A legal claim against specific collateral that can be enforced if the debtor defaults
A lien gives the secured creditor the right to seize and sell the specific collateral pledged as security for the debt, providing recovery protection that unsecured creditors lack.
Question 2: In analyzing a distressed company's debt structure, 'first lien' vs. 'second lien' refers to:
- The order in which loans were originated
- The priority of claims against collateral in the event of liquidation, with first lien having superior collateral rights (Correct answer)
- The maturity date of the obligations
- The interest rate differential between the two tranches
Correct answer: The priority of claims against collateral in the event of liquidation, with first lien having superior collateral rights
First lien lenders have first priority claim on collateral proceeds, recovering before second lien holders, which creates fundamentally different risk profiles and recovery expectations.
Question 3: A 'revolver' in corporate debt structures is best described as:
- A long-term fixed-rate bond
- A revolving credit facility that allows the company to borrow, repay, and re-borrow up to a stated limit, typically providing liquidity management flexibility (Correct answer)
- A convertible bond that automatically converts to equity
- A one-time term loan with a bullet maturity
Correct answer: A revolving credit facility that allows the company to borrow, repay, and re-borrow up to a stated limit, typically providing liquidity management flexibility
Revolving credit facilities provide flexible liquidity, and their availability — or restriction — during distress is often a key indicator of a company's ability to manage through a crisis.
Question 4: What is 'negative pledge' covenant in a loan agreement?
- The borrower's pledge to maintain negative equity
- A restriction preventing the borrower from granting additional liens on assets to other creditors without the lender's consent (Correct answer)
- A lender's agreement not to sue the borrower for 90 days
- A requirement that the company maintain negative working capital
Correct answer: A restriction preventing the borrower from granting additional liens on assets to other creditors without the lender's consent
A negative pledge covenant protects existing lenders from having their collateral priority diluted by new secured creditors claiming the same assets.
Question 5: In the context of distressed debt, 'recovery rate' refers to:
- The speed at which the company returns to growth
- The percentage of face value that creditors actually receive through the restructuring or liquidation process (Correct answer)
- The interest rate on DIP financing
- The rate at which the company's cash balance recovers post-restructuring
Correct answer: The percentage of face value that creditors actually receive through the restructuring or liquidation process
Recovery rates vary significantly by seniority and collateral quality, with senior secured creditors typically recovering 60-90%+ while unsecured creditors may receive pennies on the dollar.
Question 6: A 'make-whole' provision in a bond indenture is relevant in distressed situations because:
- It ensures bondholders receive full principal regardless of the company's financial condition
- It requires the issuer to pay a premium upon early redemption equal to the present value of remaining interest payments, creating a significant redemption barrier (Correct answer)
- It guarantees the bond price will not fall below par value
- It allows bondholders to convert to equity at any time at full par value
Correct answer: It requires the issuer to pay a premium upon early redemption equal to the present value of remaining interest payments, creating a significant redemption barrier
Make-whole provisions make it very expensive for a distressed company to voluntarily redeem bonds early, as the required premium can be enormous, complicating voluntary restructuring efforts.
CTA Credit Analysis & Debt Markets for Distressed Companies 2
A 'lien' in the context of corporate restructuring gives a creditor: