💥Higher Interest Rates Eff Mortgage Originator (Long FED Fear of POTUS). New Chapter 11 Filing - Stearns Holdings LLC💥

Hallelujah! Something is going on out in the world aside from the #retailapocalypse and distressed oil and gas. Here, Blackstone Capital Partners-owned Stearns Holdings LLCand six affiliated debtors (the “debtors”) have filed for bankruptcy in the Southern District of New York because of…drumroll please…rising interest rates. That’s right: the FED has claimed a victim. Stephen Moore and Judy Shelton must be smirking their faces off.

The debtors are a private mortgage company in the business of originating residential mortgages; it is the 20th largest mortgage lender in the US, operating in 50 states. The debtors generate revenue by producing mortgages and then selling them to government-sponsored enterprises such as Ginnie Mae, Fannie Mae and Freddie Mac. To originate loans, the debtors require a lot of debt; they also require favorable interest rates. Favorable interest rates = lower cost of residential home purchases = increased market demand and sales activity for homes = higher rate or origination.

Except, there’s been an itsy bitsy teeny weeny problem. Interest rates have been going up. Per the debtors:

The mortgage origination business is significantly impacted by interest rate trends. In mid-2016, the 10-year Treasury was 1.60%. Following the U.S. presidential election, it rose to a range of 2.30% to 2.45% and maintained that range throughout 2017. The 10-year Treasury rate increased to over 3.0% for most of 2018. The rise in rates during this time period reduced the overall size of the mortgage market, increasing competition and significantly reducing market revenues.

Said another way: mortgage rates are pegged off the 10-year treasury rate and rising rates chilled the housing market. With buyers running for the hills, originators can’t pump supply. Hence, diminished revenues. And diminished revenues are particularly problematic when you have high-interest debt with an impending maturity.

This is where the business model really comes into play. Here’s a diagram illustrating how this all works:

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💥Sungard Napalms the United States Trustee💥

New Chapter 11 Filing - Sungard Availability Services Capital Inc Part I

Pennsylvania-based Sungard Availability Services Capital Inc. — a provider of “critical production and recovery services to global enterprise companies,” with $977mm of net revenue and $203mm of EBITDA in fiscal 2018 — filed a prepackaged chapter 11 plan in the Southern District of New York on Wednesday. And, if you blinked, you may have missed its residency in bankruptcy. Indeed, some lost their minds because Kirkland & Ellis LLP was able to shepherd the case in and out of bankruptcy in less than 24 hours — breaking the previous record only recently set in FullBeauty. Yes, people care about these things.*

The upshot of this expeditious bankruptcy case is that (a) the company shed nearly $900mm of debt from its balance sheet (reducing debt down to approximately $400-450mm) and (b) transferred 89% ownership to a variety of debt-for-equity swapping funds such as GSO Capital Partners, FS Investments, Angelo Gordon & Co., and Carlyle Group (who will also receive $300mm in senior secured term loan paper). Major equity holders — Bain Capital Integral Investors LLC, Blackstone Capital Partners IV LP, Blackstone GT Communications Partners LP, KKR Millennium Fund LP, Providence Equity Partners V LP, Silver Lake Partners II LP, TPG Partners IV LP — had their equity wiped out (we had previously highlighted KKR’s investment here in “A Hot-Potato Plan of Reorganization. Short BDC Retail Exposure,” discussing the broader context of BDC lending).

This is what the capital structure looked like and will look like:

That balance sheet is the driver behind the bankruptcy filing. Per the company:

This legacy capital structure was created based upon the Company’s historical operating model and performance and is unsustainable under current market conditions. When the capital structure was put in place, the Company benefited from a larger revenue base with substantially higher free cash flow. As business conditions evolved and the Company’s revenue declined, cash flow available to service debt and invest in products and services substantially declined. Consolidated net revenue declined by approximately 18% from approximately $1.2 billion in 2016 to approximately $977 million in 20188 while adjusted EBITDA margins remained within a range of approximately 20% to 22%. Negative net cash flow from 2016 to 2018 was approximately $80 million.

In other words, this is as clear-cut a balance sheet restructuring that you can get. Indeed, general unsecured claims are — as you might expect from a prepackaged plan of reorganization — riding through unimpaired. This consensual restructuring is clearly the right result. Getting it in and out of court so quickly is a bonus.

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