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Linn Energy: A Look At Recovery Levels

Summary

Linn paid its March bond interest payments, while taking the 30-day grace period on its April interest payments.

This should only be seen as buying Linn time for further negotiations. A near-term restructuring is still extremely likely and in the best interests of credit facility lenders.

When a particular debt class is significantly impaired, the next lower level in the capital structure receives a fraction of that recovery.

Exceptions may occur when the recovery for the lower-ranking debt or equity has a minimal effect on the recovery for the higher-ranking debt.

This means that the unsecured debt will need to recover double its current market value before the common equity can possibly recover $0.15 per unit. Likely common recovery is zero.

Linn Energy (NASDAQ:LINE) paid its March bond interest and elected to take the 30-day grace period on its April bond interest payments. It also negotiated an amendment to its credit facility that prevents a default until May 11. I don't think this changes Linn's situation as the best explanation for Linn's moves is just that it needed more time for restructuring negotiations and wanted to avoid an early default in the meantime.

There has also been discussion about my previous article where I wrote about how I believed that Linn's common equity will be worthless based on the apparent significant impairment of the unsecured bonds. However, there were some examples of companies that had unsecured debt receive limited recoveries in restructuring, and still offered more than zero return for the common equity.

After doing some additional research, I still believe that the common equity is very likely to receive zero recovery. However, it does appear possible that the common equity could get thrown a few crumbs. Those crumbs will be much less than the current market value of the units, though, unless the unsecureds do much better than expected. It would probably take a near full recovery of the unsecureds for the common equity to see a recovery greater than its current price. The unsecureds are trading for around 12 cents on the dollar currently, indicating a lack of confidence in more than a modest recovery.

Recovery Levels During Restructuring

Taking a look at actual recovery results shows that if one level of the capital structure is impaired, then the next level down in the capital structure gets a significantly lower recovery. For example, if the first lien debt is impaired, the second lien debt typically gets a limited recovery. Moody's mentions that the typical recovery should fall to the right and below of the curve in the graph below. So if the first lien recovery is 60%, the second lien recovery should be less...


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