Fitch: Dynegy illustrates ring-fencing and importance of covenants

The Dynegy Holdings LLC (DH) corporate reorganization moves and bankruptcy case events demonstrate the value of protective covenants for bondholders, according to a report from Fitch Ratings.

The lack of covenants in DH’s unsecured notes enabled the 2011 corporate restructuring transactions, including the coal asset transfers from DH to parent company, Dynegy, Inc. that were later deemed fraudulent by a bankruptcy court examiner based on the presumption that the company was insolvent at the time.

Fitch notes also that DH’s bankruptcy provides an example of effective ring-fencing in practice, which enabled the parent company and the coal and gas units to remain outside of the DH bankruptcy. Payments on the senior secured loans at the coal and gas subsidiaries were unaffected by the DH bankruptcy.

Fitch’s prior published analysis assigned a Recovery Rating of ‘RR3’ for DH’s senior unsecured notes, reflecting a likely recovery of between 51%-70%. Fitch based its estimate on the value of the coal and gas assets and excluded any potential unsecured claim distributions from the sale of two plants, (Roseton and Danskammer), which is a component of the settlement reached May 2, 2012.

The settlement would also undo the coal asset transfers and a conforming amended plan of reorganization could clear the way for an exit from bankruptcy if the settlement is approved by the bankruptcy court and the requisite majority of unsecured creditors.