Thursday, March 22, 2012

Arcapita bankruptcy - The benefits of the bankruptcy process

Arcapita is working through the bankruptcy filing and with their public statements to portray the hedge funds who bought the debt in the secondary markets as the bad guys who forced the company into a hastily prepared bankruptcy to 'protect' the company's other creditors.  Arcapita's preferred method was to 'extend-and-pretend' the $1.1 billion syndicated murabaha facility for three years.

However, as Bloomberg notes, the hedge funds had their own concerns that Arcapita was paying unidentified consultants ($96.3 million so far this year) and had sold an asset to Qatar Islamic Bank,  two weeks before the bankruptcy, which Bloomberg reported "has a relationship with Arcapita".  For any creditor, the prospect that Arcapita could move funds around freely if it remained outside of bankruptcy (perhaps distributing it to other investors or moving it to countries where it would be harder to recover) is a legitimate concern. 

I have seen arguments made that paint the hedge funds as the 'vultures' who bought the murabaha at a discount, pushing an otherwise healthy company into bankruptcy.  However, it is impossible to know whether Arcapita is a healthy company because of the lack of transparency into their financials (the most recent statements available are for the quarter ending September 30, 2011), and they provide little transparency on the operating companies' financial situation.

As I mentioned in a post earlier this week, Arcapita reports on their own website that they have only one portfolio company that they bought after the financial crisis.  That is J. Jill which they bought less than a year ago in a leveraged buyout.  As I reported in the past year for The Islamic Globe, J. Jill's debt has been downgraded twice to Caa by Moody's (and CCC by Standard & Poor's) on concerns about high debt levels and that prospects for J. Jill to breach debt covenants.  While J. Jill is one of the only company where there is some vision about the leverage levels of portfolio companies, it led investors to be concerned that Arcapita's investments (as reported on their balance sheet) might not be accurately valued. 

If the assets were more significantly impaired than Arcapita has assumed in its financial statement, the equity Arcapita holds in the portfolio companies might be written down (e.g. if a company like J. Jill were taken over by its creditors, which could wipe out equityholders).  Holders of the murabaha including the hedge funds might want to force greater disclosure of the true financial position of the portfolio companies, as well as Arcapita itself, and a more transparent outcome.  This is where bankruptcy can work well, because it tries to find the most equitable solution for creditors, as well as providing a way for the business (if possible) to continue as a going concern.

At this point, it would be easy to jump to the conclusion about the financial state of Arcapita or the motives of the hedge funds who bought the debt at a discount.  However, it makes more sense to wait until a fuller picture of the case emerges as Arcapita works through the bankruptcy process.

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