Friday, April 3, 2009

On ACAS' Debt

The comments on the last ACAS post have gotten long enough they deserve their own separate discussion. Imperator posted that (a) mark-to-market accounting changes should improve ACAS' NAV, but (b) creditors' power to accelerate payment under unsecured lines of credit could threaten ACSA, so (c) the ACAS bonds (which he noticed increasing in value) look attractive.

First, ACAS' bonds. If there seemed a liquid market for the things, I'd have bought. I have been informed the volume is so bad that when I ask, there are no offers. I easily believe other brokers make it easier to get quotes on "junk bonds" but mine apparently does not. But I'm not exactly overwhelmed with angst over missing them. Why? The bond holders aren't the ones with the right to accelerate, and though they are unsecured creditors like the banks offering ACAS lines of credit (in default not from nonpayment but by the technical terms of the line of credit, which require ACAS to maintain a minimum tangible net worth), bond holders would not be entitled to quicker repayment than provided in the terms of the indenture, which places their due date after the date of an acceleration demand. In short, it looks like these bond holders would be paid last among the unsecured creditors.

That doesn't exactly scare me, though; after all, I more-than-doubled my own ACAS holdings with a purchase at $1.80 after appreciating the current state of ACAS' recently-renegotiated unsecured line of credit. Why is that? First, the Trump principle: when you owe $1,000 and you can't pay it back, you have a problem ... but if you owe $1,000,000,000 and you can't pay it back, your bank has a problem. With the new mark-to-market rules in particular, a bank's power to make its balance sheet look good while ACAS is making regular, timely, quarterly payments in full of the amount due that quarter is much better than if the bank announces an impossible-to-meet acceleration and has to admit in its next quarterly filing that a previously performing asset was in fact now not being paid at all. Second: ACAS' management hasn't received any guarantees or waivers, but apparently has an understanding that the best thing for it and its creditors is to pay "default-rate" interest but remain free of acceleration demands. The banks get to declare timely payment and get a higher rate from a borrower with apparently solid interest coverage, which is much perfarable to the alternative.

Supposing an acceleration demand, though ... think about it. This isn't a margin call gone bad, in which ACAS' broker liquidates its account the next day. The only people who can sell ACAS' illiquid assets (which ACAS holds, not a broker) are ACAS' people. Liquidation won't happen any faster than ACAS can cause orderly sale, unless a bankruptcy trustee attempts a fire sale, which is definitely not in the interest of creditors, who want to be paid. Remember, ACAS' debt-to-equity doesn't leave the unsecured creditors with a lot of room if sales prices don't meet valuation levels. So the people in charge of the liquidation (if any) would almost surely be ACAS personnel, by agreement of the creditors and debtor in bankruptcy.

Once you see the eventual seller is ACAS itself and not a bankruptcy trustee, one must ask why the bank would bother to drag ACAS into bankruptcy in the first place. And there's your answer: as long as ACAS continues to offer attractive interest coverage, its lender banks probably prefer receiving default interest to the prospect of having to find another solvent borrower.

Thus, I agree with ACAS' management: acceleration demand isn't on the immediate horizon. Moreover, the right to demand acceleration isn't the power to make ACAS' illiquid assets suddenly liquid, so the effect of an aceleration demand isn't likely to aid the banks much, making it relatuvely unattractive. (If ACAS' assets were liquid and easily sold for full value by a bankruptcy trustee, this might be different, but they're not.)

Thus, I don't see a special reason the ACAS bonds are a better deal than the ACAS equity, unless one needs current income. The appreciation on the bonds on maturity will be nice -- but so will the appreciation of ACAS shares as share prices approaches NAV on the normalization of the markets in the same couple-of-years time frame in which the bonds would mature.

Yes, I wanted to buy the ACAS bonds for a triple on maturity plus interim interest, but I couldn't without work -- and I have enough work already, than you. Maybe in the future when I have time to rearrange my finances, I'll work out another solution for making my trades, and use a platform that will quote me all the weird CUSIPs on which I inquire. TD Ameritrade isn't it.

I think the bonds are a good deal. I think the equity will prove better, though of course the equity will lose in the event of insolvency. In the event of the catastrophic destruction of ACAS -- which I'm betting against, based on its ability to service debt; and I continue to be attracted by the likelihood of entering very nice deals in this distressed market -- people buying bonds at these levels probably will get their money back even if the company dissolves in bankruptcy, as ACAS' debt ratio has been managed to remain low. The debt is a conservative bet, if you can get a quote -- and I'd have done it if it weren't so much work.

So Imperator is right on the bonds, but I don't think I'm necessarily agreeing with him on the ACAS bonds for the reasons he suggests it ;-) On the other hand, I disagree for the time being on acceleration as a cause for near-term panic, and suggest that it doesn't help bond-holders though, in bankruptcy they would likely get paid (though it might be worth looking at the relative priority of the banks and the bond holders; I haven't checked that out).


Imperator said...

Well, to clarify, I think the bonds were a good deal, but not as great as the equity at 0.59, for regular investors anyways.

I was looking at it from ACAS management point of view. Buying back the bonds at the steep discount they were at would help take off a large portion of debt. They wouldn't have any real benefit from a stock buyback, since they are trying to reduce their debt capital in relation with the equity.

Here is some more info on the Bond for anyone playing along at home, from the 10-K pg 76:
"As of December 31, 2008, we were not in compliance with the asset coverage covenant for these notes.
Such noncompliance could lead to an event of default under the notes after the applicable cure period. Pursuant
to the terms of the notes, during an event of default, the trustee or at least 25% of the note holders may declare
the principal and accrued interest to be due and payable immediately. As of the date of this filing, an event of
default has not occurred and no acceleration actions have been taken by the note holders. However, we have not
obtained a waiver of the noncompliance issues from the note holders."

Anonymous said...

are u concerned w dilution from a stock divy... the need to pay nearly 300MM in divy from almost 120MM shares will hurt.

Jaded Consumer said...

re stock divvy dilution

There are two answers to this.

First, we don't know at what price the shares would be issued in lieu of dividend -- that is, at NAV, at market on some particular date, etc.

Second ... do we even need to know? A stock dividend is like a partial stock split: you end up with the same pie cut into different pieces. The only way this could result in shareholders having less fractional interest in the company after the stock dividend would be to have some shareholders get paid in stock, and others not. Yet, this isn't what's been described. What's been described is a scheme in which ACAS' mandatory dividend (in order to keep BDC status) is laughably being allowed to be paid mostly in shares. This is like throwing out the dividend requirement and saying a BDC can get tax-pass-through status provided it does frequent stock splits.

Pure silliness. The good news is that it allows ACAS to keep cash, which is good for both tangible net asset value and for reinvestment.

So: do I fear dilution from a stock dividend? Not while the new shares are being distributed in equal proportion to existing shareholders; in that case, it's in effect a split and does nothing at all to shareholder ownership (though it will naturally reduce assets per share, it will increase your shares, so your ownership is mathematically identical when the dust settles).

The interesting question might be the effect this has on options holders. Assuming the option doesn't treat the stock dividend like a split (though I'm not absolutely sure this is the case), options holders could be in for a surprise if they don't pay attention.

Nice day today, eh?

Anonymous said...

hmmm, interesting point regarding not knowing what share price will be used for the divy . . . i had just been assuming it would be market price on the ex-div date. issuing at NAV or some discount to NAV probably makes more sense.

and yeah, yesterday was nice. that last minute spike from $2.3 to $2.5 was unexpected icing on the cake. that WFC guidance put a hole in the head of my plan to double up on BAC though. ouch. that certainly wasn't the thursday trading i was expecting.


thanks for the ACAS updates on your blog, they've been extremely helpful.

any thoughts on the likelihood of agreements being reached regarding the debt covenants in Q2? the longer the better in some regards, but it would be nice to have some kind of ending on this issue, for better or worse, w/in the next few months.

Steven said...

I've heard people mention that someone is buying million dollar chunks of ACAS bonds. And that someone might be acas. I certainly hope so. I'd rather have them buy their own bonds back at 42 cents on the dollar than get a divvy in the meantime, should help get their leverage ratio back below 1:1 from the riducous 1.4:1 Good luck!

Jaded Consumer said...


Buying equity below NAV might be great for NAV, but it spends down equity and reduces net tangible value and thus impairs its leverage while exacerbating its credit situation.

Buying debt below value eliminates debt faster than it reduces cash (because ACAS must book debt at face value and not market), and thus (a) increases tangible net worth (spending $x to remove $2x debt is a $x advantage for the enterprise), (b) increases NAV (by increasing net worth while retaining same share count), and (c) reduces expenses (interest is an expense).

So while the NAV-boosting impact of below-NAV share buyback might be higher, the enterprise's safety as a going concern is improved by the debt buyback. ACAS is in too defensive a mode right now to be spending cash -- shrinking its business -- just to boost the NAV of remaining shareholders. Eventually, ACAS will want a broad shareholder base on which to raise money; reducing the float isn't really in ACAS' strategic interest, even if it's in the interest of shareholders.

On the other hand, I'd have bought ACAS bonds if I'd have been able to get a quote; I was informed they were too illiquid when I checked to even get an ask price. If someone has been snapping them up, it could be an ACAS bull looking for more security. At prices quoted earlier this year, the bonds promised a triple in about three years -- plus interest in the interim. Attractive.