Momentive Ruling Shakes Up Debt Markets

A judge’s ruling Tuesday in the bankruptcy of Momentive Performance Materials Inc. has shaken up the distressed investing world. The decision in favor of the company allows it to force holders of secured bonds to accept repayment in new debt at below-market interest rates, something the funds that own the debt had argued against.

The little known silicone maker’s bonds were the most actively traded corporate debt in U.S. markets Wednesday and Thursday. In all, Momentive bonds with a face value of more than $550 million changed hands, according to data from TRACE. Paper losses on the bonds have exceeded $60 million this week.

Momentive’s bankruptcy pits its owner, private-equity firm Apollo Global Management LLC, against funds that own $1.35 billion of the company’s so-called first-lien bonds. The two sides had been haggling for months and Judge Robert Drain’s decision was at least partially fueled by his frustration at the two sides’ inability to settle their dispute, people close to the litigation say.

Senior bondholders wanted Momentive to repay their bonds in full plus a premium — called make-whole — or issue them new bonds paying a market rate of interest. Apollo offered to pay the bondholders par value and accrued interest, but not the make-whole. The firm threatened to swap the first-lien bonds for new debt at a low interest rate if they didn’t agree.

In a marathon four-hour ruling from the bench Tuesday, Judge Drain sided with Apollo and said that senior bondholders must accept the debt offered by Momentive, albeit at a slightly higher interest rate than the company first proposed.

The decision was based on the principle that senior bondholders are not entitled to make a profit on the new debt they would receive. That, however, flies in the face of prior case law, says Kevin Starke, a distressed debt analyst at CRT Capital. The interest rate Judge Drain assigned to the new bond was arbitrary, he added.

“The ruling speaks for itself,” Judge Drain said in an e-mail. Spokesmen for Momentive and Apollo declined to comment.

The decision out of White Plains, where Judge Drain sits, has been felt far and wide in junk debt markets. Secured bonds in another large bankruptcy – Energy Future Holdings, or TXU –lost 5% of their value this week as doubts rose that holders would receive the make-whole payments they had been expecting.

Judge Drain’s ruling could be rendered irrelevant, however, if he grants a request from senior bondholders to change their previous votes rejecting Momentive’s bankruptcy plan and to accept its cash offer for their bonds. Failing that, the bond holders are expected to appeal his decision.