Breaking the Cheyne
7 July 2008
An agreement has been reached in respect of the restructuring of Cheyne Finance, a structured investment vehicle (SIV) that has succumbed to the ongoing liquidity and credit crunch. This agreement may herald a change in fortune for the beleaguered SIV – the question being, is there now a viable restructuring option available to other SIVs facing cashflow problems?
Only a year ago SIVs occupied a market segment of approximately $400bn (£200.97bn). For more than a decade, through SIV technology, arrangers accessed cheaper asset-backed commercial paper (ABCP) and medium-term note markets to finance higher yielding and longer-term debt securities, such as collateralised debt obligations (CDOs) and collateralised bond obligations (CBOs).
During 2007, investor appetite for structured credit products fell dramatically. Concerns spread quickly from the US subprime residential market to many structured products, including residential and commercial mortgage-backed securities, CDOs, CBOs, and even ABCP (traditionally considered one of the safest investments possible).
The SIV was now operating in a market with scarce liquidity. While a traditional ABCP conduit might rely on liquidity support from a bank arranger, the SIV, having more limited liquidity support, faced severe cashflow problems because it could not get funding from investors avoiding SIV paper.
The situation was complicated by the sharp decline in market value of the SIV’s assets. Valuation experts had difficulty determining the fair market value of the SIVs assets, requiring some valuation teams to use a blend of ‘mark-to-model’ and ‘markto- market’ methodologies to calculate discounts on assets.
Cheyne Finance entered into a highly publicised receivership and market participants have been waiting with bated breath to see how it plays out.
One of the initial challenges in the Cheyne Finance restructuring was how to form aninformal committee comprising a representative sample of senior creditors. The purpose of the senior creditors’ committee is to provide a forum in which the receiver can liaise with creditors in relation to all aspects of the receivership. Of course, the interests of the senior creditors were at odds with those of the capital noteholders. Differences arose, however, between the senior creditors over ‘time subordination’. Creditors holding senior short-term debt positions wanted the receiver to repay debts as they matured on a ‘pay-as-you-go’ basis, while creditors holding senior long-term debt positions wanted the receiver to declare an insolvency event and make all outstanding debts immediately due and payable on a pari passu basis.
The receiver decided to seek directions to clarify the time subordination issue and the meaning of “insolvency event” in the programme documentation. Two leading judgments on these points were handed down in September and October 2007, and the receiver was finally in a position to consider restructuring and other options available to Cheyne Finance’s creditors.
The receiver courted a number of proposals from leading investment banks and eventually settled on that submitted by Goldman Sachs in November 2007. This offered a solution acceptable to the majority of senior creditors at the initial stages of the receivership. In effect, a new vehicle would be created into which a majority of the SIV’s assets would eventually be sold following an auction effectively underwritten by Goldman Sachs.
The proposed plan accounts for the ‘optionality’ that senior creditors were insistent on maintaining from the commencement of the receivership. The creditors wanted different options to be available in a restructuring plan. Some wanted to ‘cash out’; some wanted ‘passthrough’ notes issued by a new vehicle; some wanted zero-coupon notes providing certainty on principal repayment; and some wanted a vertical slice of the underlying assets. The plan allows each senior creditor to choose a restructuring outcome that most suits its commercial needs.
Indeed, there are wrinkles to be ironed out in respect of the plan. The market will need to see how the auction process works in practice – establishing the value of the SIV’s assets has been notoriously hard since the start of the credit crunch, and even the proposed terms of the auction allow the receiver to delay the auction in certain situations (for example, a continued deterioration in market conditions). There will doubtless be other questions raised when the restructuring is actually implemented and creditors exercise their optionality.
Market participants will have to wait to see if the restructuring can be successfully implemented. But if a successful resolution of the receivership is effected, creditors of other distressed SIVs could have a workable model for moving forward through receivership and leaving the worst behind them.
Mark Fennessy and Sharad Samy are partners and Mark Griffiths an associate at Orrick Herrington & Sutcliffe