Debt For Equity Swap Of The Week

From The Telegraph:

The owner of the 1,600-strong Coral betting shop chain and the Gala Bingo business said four of its mezzanine debt owners had taken control after converting their £558m holding into equity and injecting another £200m cash to pay down senior debt.

Candover, Cinven and Permira – the buyout houses which owned what was once Britain's biggest private company – have exited the group. Permira is thought to have lost most of the £500m-plus it invested... Apollo, the biggest mezzanine holder, will emerge as Gala's largest shareholder with a 25pc stake. Cerberus will own 18pc, with Park Square taking 8pc and York Capital, 4pc.

1. Just to strip away a bit of jargon, 'senior debt' means most likely to be repaid and 'junior debt' or 'mezzanine debt' means least likely to be repaid, i.e. just above share capital.

2. So we can imagine Candover et al to be like over enthusiastic buy-to-let landlords, who borrowed money from Apollo et al but couldn't repay it out of rental income (in this case, the profits generated by Gala Coral. Apollo et al repossess the rented properties (the underlying business), and because the rented properties have some value and generate income, they don't demolish the rented properties (liquidate the business) they just take it over and keep going. Candover et al appear to have been wiped out, because they were in 'negative equity'.

So far so good.

3. The gimmick is that banks are actually in the same position as Candover et al*. The banks they have assets of a certain positive value (mainly money they have lent to people and which is being repaid with interest) and a to a large extent they are financed by borrowing money from other people (call it 50/50 between ordinary depositors and bond holders).

4. In the absence of government bail outs and guarantees, the shareholders would have been wiped out long ago, bond holders would have waived the right to be repaid the full face value of their loans to the banks (i.e. 'bonds') and would have become shareholders instead. Ordinary depositors can be considered to be 'senior debt' in this example, and would not be converted to equity.

5. What's interesting in this case is that the negotiations had been dragging on for nearly a year.

* You sometimes find almost endless chains - perhaps Apollo are in hock to a bank, so that bank takes over part of Apollo (debt-for-equity swap); but then that bank finds the value of its Apollo stake is not enough to repay its own bond holders, so the bank does a debt-for-equity swap with its own bond holders (who are in many cases other banks) and so on and so forth until the whole credit bubble is collapsed back to the underlying assets on one side (houses or businesses) and people who own them on the other side, without dozens of middlemen in between.