Class As could be Punch restructuring stumbling block

* Cash goes straight to junior notes

* Threat of default could win over seniors

* Equity holders already on board

By Owen Sanderson

LONDON, Feb 7 (IFR) - Punch Taverns announced itslong-awaited restructuring proposals on Thursday, spending itsavailable cash on cramming down junior bondholders, rather thanpaying down senior debt.

Punch's strategy includes extending the maturity on itssecuritisation debt, restructuring financial convenants andpaying off junior debt which is trading below par.

Senior bondholders, who are usually first in the queue forprepayment, are likely to be the main stumbling block for theproposals because spare cash is being diverted to the juniors.

Certain Punch stakeholders, including funds that hold morethan 50% of the equity in the group company, have already agreedthe proposal.

Senior creditors are facing extended maturities and fewsweeteners to get them to agree the proposal, just the ultimatethreat of default and the chaos it would cause.

Punch holds most of its tenanted pubs - and all of its debt- in two whole business securitisations, Punch A and B, with fewassets at group level. The managed pub estate securitisation,Spirit, was spun off in 2011, now operates as a separatecompany.

The two securitisations require very different strategies atgroup level. A default in Punch B would crystallise pension andother liabilities, which would suck cash out of the group.

According to the company's investor note, these liabilities"could exceed the cash resources available to the Group todischarge those liabilities".

Default of Punch A would not crystallise liabilities atgroup level, so the group's management was incentivised to spendspare cash on dealing with Punch B first. Punch A bondholderswill get a maturity extension and benefit from a cash sweep, butreceive no upfront payment.

The big surprise from the prosposals has been the decisionto apply available cash to the class B and C notes in Punch B,rather than to senior notes in either securitisation.

But this makes sense from the borrower's perspective - classB and C coupons are more costly, and more than 50% of the juniornotes were in the hands of the equity holder group - but seniorbondholders normally can expect that they should get cash first.

James Martin of Barclays writes "Punch B class A bonds, wethink, have been bid up recently on the expectation that theywould have received the prepayment rather than the juniors,while...The proposal produces similar leverage for the class Asthen, but extends the expected and new legal weighted averagelife."

The management are pitching their case to senior bondholderson contractual links between the securitisations and Punch, andthe cost savings from integrated management at group level.

"Default of one or both securitisations would give rise tooperational uncertainty and loss of scale synergies estimated atGBP15m-GBP35m per annum," according to the investor presentationreleased on Thursday.

If Punch A noteholders allow Punch B to default, forexample, by blocking the proposals, the financial supportapplied from the Group to Punch A could dry up, as Punch Bpension liabilities drain cash from the group.

A default on Punch A could also crystallise large swapmark-to-market costs, which would be attached to thesecuritisation, not to the group. At the moment, this is GBP277m(and GBP55m in Punch B).

Investor appetite for aggressive negotiation could belimited. The class As in Punch A are already trading at par,meaning few bondholders will have much appetite for a protractedenforcement and forced sale. But equally, have little incentiveto sit back and allow their bonds to be extended.

JUNIORS LOOK BETTER

According to Martin, junior bondholders in Punch A are thebiggest beneficiaries of the proposal. They get extended, butget continued high running yield for around 10 years, withcertainty that was not present before the restructuring.

"For the class B, C and D bondholders, we think therestructuring proposals are positive since they reduce the riskof a short-term forced sale, increase the length of time to clipthe coupons and improve the chances of recovery."

In Punch B, class B and C bondholders get a write-down upfront - class B1 gets 65%, B2 gets 63%, and class C gets 26%.But this gets paid partly in cash upfront, from the surplus atgroup level. Punch B class Bs get 75% of their payment in cash,with the remainder in newly issued B3 notes. Class C gets 50% incash, and 50% in new notes.

Martin estimates that these new notes, in turn, would alsofind a level at around 75-80% of par given their coupon of7.205% and compared to other subordinated pub bonds.

A majority of the Punch B junior noteholders have said theysupport the proposals - this consists of Glenview Capital,Octavian, Luxor Capital, Alchemy and Avenue Capital. These fundsalso hold over 50% of the Group's issued share capital andaround 25% total of Punch B.

Ambac and MBIA, who guarantee GBP990m of Punch notes, alsoapprove of the scheme, as do the trustees of the Punch B pensionscheme. (Reporting by Owen Sanderson; editing by Alex Chambers)