Distressed-debt titans take $1 billion beating from Texas rebuff

Friday , April 21, 2017 - 10:19 AM

Sridhar Natarajan and Steven Church

(c) 2017, Bloomberg.

The largest distressed-debt investors were hoping for closure and a big payday from the decade’s biggest U.S. bankruptcy. What they got instead was a $1 billion hole in their pocket.

That’s what happened to Energy Future Holdings Corp. creditors after Texas regulators blocked a sale of its key unit that was designed to pay them off. The ensuing meltdown in bond prices ensnared a Who’s Who of risk-takers, such as Jamie Dinan’s York Capital Management, Marc Lasry’s Avenue Capital Management and GSO Capital Partners, people with knowledge of the matter said.

Another firm that suffered losses, Paul Singer’s Elliott Management, is doubling down on its bet, snapping up debt discarded by rivals to gain control of negotiations, the people said.

The debacle marks another messy turn in Energy Future’s three-year trip through bankruptcy. It’s the second deal for the unit to unravel since the utility sought court protection in 2014 to restructure almost $50 billion of obligations, highlighting how high-stakes wagers in the distressed-debt world become even riskier when public regulators play a role. Some junior notes that traded at par as recently as November are now quoted at about only 30 cents on the dollar.

“With utility mergers, you really have to pay attention to regulators,” said Paul Patterson, a utility analyst at Glenrock Associates. “State regulatory approval isn’t something to be complacent about. There’s a litany of failed utility mergers.”

The carnage began in earnest on March 30, after members of the Public Utility Commission of Texas said Energy Future’s proposed sale of Oncor Electric Delivery Co., the largest owner of high-voltage power lines in Texas, to a Florida utility for more than $18 billion wasn’t in the public interest. In the tumultuous trading that followed, Energy Future’s 2018 pay-in-kind debt lost about half its remaining value in a single day. Holders also suffered a 17-cent drop on about $1.7 billion of second-lien notes from their February peak.

Selling Oncor was supposed to break the logjam that has kept Energy Future in bankruptcy. The utility was taken private a decade ago in a record leveraged buyout orchestrated by KKR & Co., TPG Capital and Goldman Sachs Capital Partners. The bet went bad when natural gas prices plunged.

The PUC rejection of Oncor’s sale, formalized on April 13, prompted York Capital and Avenue Capital to sell big chunks of their holdings, said the people, who asked not to be identified discussing confidential positions and trading.

But Elliott Management responded by buying even more of Energy Future’s obligations as Singer sought to build a dominant position among creditors, the people said. That leaves his firm poised to capture any upside from the next deal -- or stuck in a wrong-way bet that could go even further awry.

The fund is exploring a series of options, rather than just waiting for Oncor’s rejected suitor, NextEra Energy Inc., to come up with a better offer or an improved structure to help the deal go through, one of the people said.

Some PIK investors including GSO, the credit arm of Blackstone Group, have sought to hedge their losses by simultaneously betting against the second-lien notes, two of the people said. Representatives for York, Avenue, GSO and Elliott declined to comment.

NextEra has until May 8 to make a revised proposal, and the regulator will have another month to rule on it. The rejected bid potentially was good enough to cover claims owed on senior bonds and still compensate the unsecured PIK holders. One distressed-fund manager said he was being pitched the trade as a sure bet at well above par last year, with the bonds likened to Treasury bill or a zero-risk trade in which the only question was when holders would get bought out.

Now the concern is that conditions set by Texas regulators might lead to a new deal that slashes recoveries on the PIK bonds, which pay interest in the form of more notes instead of cash. On Monday, U.S. Bankruptcy Court Judge Christopher Sontchi said the state’s decision was “value destructive.” Terry Hadley, a public utility commission spokesman, said Texas regulators focused on whether Oncor’s sale was in the public interest, not on how it would affect the bankruptcy.

The commission’s ruling is hardly unique and not entirely a surprise. Just last year, the same regulator thwarted a bid by bondholders and an influential Texas family to buy a controlling stake in Oncor. Earlier this week, shares of Westar Energy slumped the most in almost seven years after Kansas blocked an $8.6 billion takeover by Great Plains Energy.

Dinan’s York Capital had amassed about $350 million in unsecured notes, the people said. Avenue, which had also established itself as one of the top holders of the PIKs, has discarded half its position since the commission’s ruling, one of the people said.

GSO’s stake in the entity’s debt at one point totaled about $300 million and was pared last year when the PIKs still traded around par, two of the people said. Its holding in that series is down to $50 million, one person said.

Energy Future’s power generation and retail electricity units emerged from bankruptcy last year under the ownership of creditors. What remains is the sale of Oncor, with the prospect that it can help pay down the remaining claims.

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Bloomberg’s Richard Bravo contributed.

texas-bankruptcy

Keywords: TXU-DISTRESSED-DEBT-DEBACLE

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